Forget finance: Agribusiness risks could reap greater rewards

Forget finance: Agribusiness risks could reap greater rewards

The agribusiness sector offers investors greater risks and rewards than the financial sector: take a look for yourself.

Imagine a decentralized global industry, historically important to the political and economic stability of nation-states, undergoing unprecedented change. Agribusiness is such an industry. For many reasons, it is developing deeper complexity, especially along the length of its supply chain. Too few businesses in the sector are thinking strategically about what this means for their operations, the risks and implications inherent in these changes and in complex systems, or the supply disruptions and resulting pricing challenges that inevitably result.

What is needed is an end-to-end understanding of the system.  What exists in most instances is a too-narrow focus on what goes on in the immediate vicinity of any given operator or corporation.

It is not possible to discuss the agribusiness supply chain intelligently without bringing into focus the system’s intrinsic risks, and the costs these risks entail. The difficulty is this: to understand the risks it is necessary to examine all the links in the chain, everything from farm to consumer. This is a tremendous task, especially for producers, processors, distributors, and retailers who might be used only to dealing with those links immediately next to them, upstream or downstream.

As the food supply chain grows longer, and as each business, each link, in the chain engages in increasingly complex transactions or relations with other links, the need for a systemic understanding of the chain’s risks and rewards becomes pressing.

This isn’t your daddy’s agribusiness

A generation of pent-up change has begun in agribusiness and what we see emerging is a more complex sector – from farm operators to their service suppliers, from the processors and distributors of farm goods to the retailer and the end customers – than what we knew 30 years ago. Though the economics of the agricultural supply chain are driving it to stretch longer and longer physically (shoppers buy Chinese garlic near Gilroy, California, “The Garlic Capital of the World,” cheaper than the locally grown variety), it is not simply a matter of additional links being forged. The design, structure, and operation of the chain are now more complex than they were 30 years ago.

A serious shortcoming of these changes is that they are occurring without the benefit of much strategic thinking or planning. The various links in the chain are generally not too concerned about the system itself. If anyone is thinking about the operation of the entire system, the risks that emerge from it, and developing strategic approaches, they are the larger players, such as Wal-Mart, ConAgra, and Dannon.

But agriculture is far from a centralized industry. For example, US Department of Agriculture (USDA) data show that 55% of all farms account for less than 1% of production in the US. North Carolina State University reports that almost 90% of American farms are owned by individuals or family corporations. You do the math. US net farm income is estimated by the Congressional Research Service to be about $121 billion in 2013. US consumers spend about $547 billion on domestic food, according to North Carolina State University. Any way you look at it, significant value is being created all along the supply chain.

How Complex Systems Fail, by Richard I. Cook, MD, of the Cognitive Technologies Laboratory at the University of Chicago, is a “short treatise on the nature of failure.”  First published in 1998, the pamphlet summarizes 18 key points about failure in complex systems. Preferring the industrial euphemism “accident,” the study uses the words “risk” and “uncertainty” only once. Though written about complex systems in general, all 18 points find expression in the agriculture industry. Five of them are particularly applicable:

  1. Complex systems are intrinsically hazardous systems.
  2. Catastrophe requires multiple failures – single point failures are not enough.
  3. Complex systems run in degraded mode.
  4. Catastrophe is always just around the corner.
  5. Change introduces new forms of failure.

Farming is a “fantastic place to be”

I alluded to the changes taking place in agribusiness and the food supply chain in a previous article. Hedge funder Jim Rogers of Rogers Holdings sees in these changes a significant shift in resources from the financial sector to agriculture. He said in a recent interview with CNBC, “all those kids who got MBAs made a terrible mistake.  They should have gotten agricultural degrees….  Farming has been a disaster for 30 years.  It is now going to be a fantastic place to be.”

Jim Rogers is right. As the financial sector’s risk and reward paradigm evolves towards diminishing rewards for any given amount of risk, the agribusiness and food sector’s risk and reward characteristics are becoming more attractive. The global dimension that supports agricultural production, processing, and distribution is part of this attraction. There are plenty of opportunities to create value for agriculture products, opportunities that did not exist 30 years ago. But much restructuring lies ahead.

Agribusiness has always been risky. What is different now is the alluring promise of greater reward for that risk. But additional risk is being created by the very industrial structure promising augmented reward. This should not be surprising. What is surprising is the lack of development of suitable strategies for managing and alleviating the risks that characterize the changing dynamics of the agriculture supply chain. If change creates value, by definition it creates new, and unforeseen, risks. What follows are Dr. Cook’s points #1, #3, and #5, above.

Businesses that develop strategies for managing agribusiness risks effectively will create value, leading to a more efficient relationship between risk and reward for themselves and throughout the industry. Strategically implemented risk management will be an essential component of an agribusiness operation’s competitive advantage. Strategic risk management will help define, occupy, and maintain a company’s competitive position in the agribusiness industry.

About Author

Steven Slezak

Steven is on the faculty at Cal Poly in San Luis Obispo, California, where he teaches finance and strategy. He taught financial management and financial mathematics at the Johns Hopkins University MBA program. He holds a degree in Foreign Service from Georgetown University and an MBA in Finance from JHU.