‘Risk intelligent’ managers: Find the weakest link and fix it

Dairy businesses – like cows or plants – frequently have at least one ‘constraint’ that limits performance. For many dairies, it’s managing price risk and opportunity.

By Scott Stewart

Dairy producers often look beyond their own industry in search of techniques that work for other businesses. Human resource management and accounting practices come to mind as key areas where dairy farms share some of the same challenges and opportunities as other businesses.

And, if you’ve been reading the wider business media in 2010, you’ve seen a greater emphasis on risk management. Maybe that’s because so many companies – previously thought of as impervious to failure – have indeed failed because they did not properly manage risk. In fact, BusinessWeek recently published a special report on the subject, describing a new world with “permanent volatility” and offering the characteristics of a “risk intelligent” company.

Is your dairy “risk intelligent?” Perhaps so, in many key management areas. Dairy producers have become experts in balancing risk and opportunity in every aspect of production: animal health, rations, crop production, milk quality, facilities and more. For these fine-tuned businesses, the last frontier left to conquer is managing price risk and opportunity.

Find the weakest link

I belong to a peer group of executives that meets regularly to discuss business and management issues. (I too seek input from outside my own industry.) One of our guest speakers talked about the “Theory of Constraints,” popularized in a business management book called The Goal, by Eliyahu Goldratt. According to the Theory of Constraints, every organization has, at any given point in time, at least one constraint which limits its performance relative to its goal. A constraint can be internal or external, a machine, a person, or managerial, like a policy or procedure.

My ears perked up when our speaker described the origins of this theory. Agricultural scientist Carl Sprengel found plant growth is controlled not by the total amount of resources available, but by the scarcest resource – the limiting factor. Beginning in the 1920s, Justus von Liebig went on to popularize this science and called it “Liebig’s Law” or the Law of the Minimum. Plant growth could be improved, Liebig taught, when the most limiting nutrient was increased. Farmers learned to save a lot of resources by zeroing in on the most limiting factor.

In other words, to improve performance, find the one thing that’s holding you back, and fix it.

The Theory of Constraints can apply to today’s milking parlors, feed rations or crop production. Perhaps you have one person or one production aspect holding back the whole farm from being the best it can be. No one can improve until the weakest link is found and strengthened.

Is it marketing?

Increasingly, lenders and business consultants are using words like “essential” and “crucial” to describe the importance of price risk management on dairies. They see how skilled producers have become in production management, and they also know how “permanent volatility” can wreak havoc on the balance sheet. They are zeroing in on the one management area that is not yet so finely tuned: the management of farm marketing.

If we apply the Theory of Constraints to today’s dairy operations, one could argue marketing is indeed the most limiting factor. The absence of a consistent, disciplined approach to marketing means your business is open to risk in the forms of extreme revenue fluctuation and the squeeze of low milk prices with high feed costs. Removing these constraints on the financial side of the business enables the production side of the business to thrive and grow.

How? Consistent price risk management could put you in the financial position to expand or update facilities at the right time – when milk prices are at a low point.

Think about it: Everyone wants to expand when milk prices are high, driving up the costs of those investments and, consequently, increasing risk. What if you could expand or modernize when the cost of that investment was at its lowest point, rather than at its highest? That’s a successful business strategy.

So if a consistent, well-managed marketing approach is a constraint for you, how do you remove the constraint? The simple answer is you make a commitment to learn and manage marketing, both feed buying and milk pricing. That’s easy to say, but difficult to do. Some dairy producers have tried to get started by dipping their toe in the water, marketing sporadically, only to be dissatisfied with the results. Other producers study marketing, endeavoring to learn all they can about it, and find themselves overwhelmed and frustrated.

There are likely limiting factors at work here. To be a better marketer, consider again the Theory of Constraints. Figure out what’s holding you back, and remove that barrier.

Key factors affecting

marketing performance

Having spent nearly 30 years in the commodity business, I have found five key factors impacting marketing performance:

1) Knowledge

2) Time

3) Risk tolerance

4) Discipline

5) Experience

Successful marketing requires proficiency in each of these areas. Any one area could be a constraint, holding back overall performance. For example, perhaps you are very knowledgeable about the fundamentals of milk pricing. Maybe you are excellent at making decisions and laying out a proper milk marketing strategy. That’s great. But if you lack the discipline or the time to pull the trigger and execute the strategy, your milk marketing knowledge is all for naught, and your balance sheet is going to feel the effects.

Evaluate your marketing process the same way you evaluate other aspects of your business. Methodically look at it, figure out what you are good at doing, and focus on trying to improve your most limiting constraint. For example:

• Do you know and understand all the tools and strategies available to you as a marketer, and how and when to apply each tool or strategy?

• Do you have the time to work through all the potential price scenarios, develop risk and opportunity management strategies for each possible scenario, and consistently watch the markets for signs that triggers are about to be hit?

• Do you know the impact of each potential marketing strategy on your farm’s overall financial position? Have you set goals for your marketing that will help guide your decision-making? Are all the members of your management team in sync with those goals, so your decisions are not second-guessed?

• Once all this goal-setting, analysis and planning has been done, do you have the discipline to act when triggers are hit? (Note: This is a key constraint for dairy producers as markets trend upward. Producers, understandably excited about higher prices, tend to forget that when markets move up fast, they can also move down fast. Those who abandon a disciplined approach in favor of “letting it ride” can miss out on the long-term benefits that a consistent, disciplined marketing approach provides.)

• What past experiences are skewing your judgment? Do you have enough experience to keep all market news and events in perspective?

Because these success factors are consistently present among the best and most satisfied marketers, we’ve developed an objective assessment tool that helps producers identify and zero in on marketing constraints. Producers tell us such an assessment is a good place to start. Marketing is a big frontier. If marketing is the one thing holding back your business in the “permanently volatile” and uncertain economy ahead, you need to commit to it, find a method to dissect the challenge, and get it done.

Leaders laser in

One more word of advice as you begin: We can learn from our grain producer friends who have been dealing with commodity markets regularly for more years than we have in dairy. The lesson is this: Don’t let all the hype and news about markets overwhelm you and keep you from setting up a consistent, disciplined approach tailored to your operation’s needs. There will always be advisors with divergent opinions and news articles with market predictions. To be successful, don’t fall into the trap of trying to predict what the market will do. Instead, use your time to prepare for uncertainty. Filter out the noise and learn the strategies that will deliver the best possible overall price for the long-term, considering your own risk tolerance and financial situation.

Marcus Buckingham, in his management book, The One Thing You Need to Know, observes the best business leaders consistently laser in to the core of any concept.

“Today, you must excel at filtering the world,” he writes. “You must be able to cut through the clutter and… distinguish between what is merely important and what is imperative.”

What is the “one thing” holding your business back from achieving its goals? To save yourself a lot of frustration and wasted energy, find your most limiting constraint and focus on that limiting factor first, until that is no longer your primary constraint. Then repeat, repeat, repeat. Now you’ve created what business management experts call a “cycle of continuous improvement.” That’s intelligent.

Disclaimer: There are no guarantees that using strategies will translate into successful marketing.

FYI

Scott Stewart is president and CEO of Stewart-Peterson Inc., a commodity consulting and marketing services firm based in West Bend, Wis. He can be reached via phone: 800-334-9779 or e-mail: scotts@stewart-peterson.com. Details about Stewart-Peterson’s Marketing Assessment ProfileSM (MAP) can be found at www.stewart-peterson.com.

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