Using a Marketing Plan to Manage Market Risk originally titled: Risk Issues in Alternative Markets

1. Using a Marketing Plan to Manage Market Risk (originally titled: Risk Issues in Alternative Markets) Denise Mainville Agricultural & Applied Economics Virginia Tech May 28, 2006 Danville

2. 2 Introduction Types of risk Different risks for different markets Role of a marketing plan in mitigating risk

3. 3 Types of Risk Operational (short-term) risk Price Yield Quality Significant amount of producer control, can be planned for in the short term, however also contains a “random” element—i.e. you can do everything right to have a good yield, but weather will come into play too.Significant amount of producer control, can be planned for in the short term, however also contains a “random” element—i.e. you can do everything right to have a good yield, but weather will come into play too.

4. 4 Types of Risk Strategic Risk Concerns producers’ positioning in the market relative to longer-term forces Examples Buyer power Entry of new competitors Evolution of consumer demand Policy—trade liberalization, regulations These longer-term factors have direct influence on operational risk Producers have less ability to influence these factors, but can also do more to anticipate and plan for them Beyond day-to-day fluctuations in weather, etc., today’s market is the result of changes in underlying forces that can be anticipated and planned for Beyond day-to-day fluctuations in weather, etc., today’s market is the result of changes in underlying forces that can be anticipated and planned for

5. 5 Different Risks for Different Markets Consider a spectrum of “market types” Open markets: e.g. commodity markets for corn and soybeans Contracting: Broilers, High-protein corn Alliances: Situation where you have tight relationships with buyers, with some degree of shared risk (e.g. Cooperatives) Vertical integration: You provide your own marketing services, e.g. direct marketingOpen markets: e.g. commodity markets for corn and soybeans Contracting: Broilers, High-protein corn Alliances: Situation where you have tight relationships with buyers, with some degree of shared risk (e.g. Cooperatives) Vertical integration: You provide your own marketing services, e.g. direct marketing

6. 6 Different Risks for Different Markets As you move from L to R along the spectrum, the nature of the market and risk changes Commodity Markets (e.g. soybeans, cattle) Many buyers & sellers Readily available info Operational risks predominate (Price, yield, quality) Risk mgt. options may include Hedging w/futures & options Crop insurance Revenue Insurance

7. 7 Different Risks for Different Markets As you move rightward across the spectrum Fewer buyers & sellers Info less available about quality, price, volumes sold Investments become more specific to relationship As you move R, operational risk mitigated some through relationships (e.g. contracting) Strategic risk becomes predominant

8. 8 Contracting Price, yield risk reduced, however other risks can increase E.g. Make an investment to qualify for a contract, but what will it be worth if buyer decides not to renew contract? Gives buyer strategic advantage in negotiation

9. 9 Different Risks for Different Markets Alliances Issues of opportunism may be less pronounced However you become more subject to ups and downs in market as you share risk

10. 10 Different Risks for Different Markets Vertical Integration You decide to undertake your own marketing activities—you therefore accept all risk, must undertake strategic action to protect market Risk management strategies include product & market diversification, even more key is undertaking strategic analysis prior to investment

11. 11 Using a Marketing Plan to Mitigate Risk

12. 12 The Marketing Plan Good marketing plans don’t start w/marketing “Marketing” as commonly used refers to how to get people to buy what you have produced. A sound marketing plan must start w/the decision of what to produce Must start with assessing both operational and strategic risk

13. 13 The Marketing Plan Consider several alternative enterprises that interest you (not just 1) Only 1 gives you no alternative After analysis, the seemingly less attractive market might win you over

14. 14 Consider 3 questions for each alternative Q1. What are prices relative to production costs that you anticipate and investment requirements to enter market? “Snapshot” of market Indicates short-term attractiveness and feasibility of entering market

15. 15 Q2. What are trends in the market in terms of levels and variability of product & input prices, and how will that affect profitability in the near-medium term? This question still relates to operational risk, however hints at longer term issues It is a retrospective question, however, looks at how things have been as if they will continue in the same manner

16. 16 Q3. Where is this market going over the medium-long term? Does the product meet consumers’ evolving demand (quality, novelty, convenience, low-carb, etc.) (if not demand may decline over the long term) Is competition increasing due to changes in technology or trade regulations? What is happening among buyers? Consolidation? How might this affect you?

17. 17 This third question relates to the factors underlying supply & demand, the forces which determine price and other trends considered in Q 2. However it looks to the future, and allows you to anticipate major changes that may be on the horizon Doesn’t mean you will necessarily decide not to enter, but a key means of risk management is anticipating issues and planning for them ahead of time.

18. 18 Each question is relevant to each market, however immediacy of strategic questions increases as you move rightward…

19. 19 Marketing Plan In developing a marketing plan, need to Identify strategic and operational risks in market, and tools available to deal with them Match them with own Goals & values Financial situation Risk tolerance level Cash flow needs Anticipated production costs

20. 20 Using a Marketing Plan to Mitigate Risk A Marketing Plan allows a producer link Goals, values, objectives with Reality Goals, values and objectives are what the producer wants to respond to Reality includes not only what the market is today, but also what it is likely to become tomorrow

21. 21 Marketing Plan A Marketing Plan that reduces risk must consider Short-term profit potential What are today’s prices, what are your likely costs of production, and what investments are required? Strategic issues An attractive market (one with high potential profitability) is likely to attract more than just you— Is there anything to keep others from entering and driving prices down? Geographic advantages (e.g. farmers’ markets) Production advantages (quality or price)

22. 22 Steps in a Risk Management Plan 1. Identify Specific Goals “To make as much profit as possible” vs. “To make $10,000 in profit each year for next 5 years” Specificity allows you to work back to performance needed to achieve goals (ex. X acres w/Y cost of production sold at Z price)

23. 23 Steps in a Risk Management Plan 2. Identify & Evaluate Alternative Enterprises of interest Can I get into the market (what investments are needed?) Can alternatives meet goals (profit potential)? How variable are the parameters (price, yield, quality) that must be adhered to in order to meet goals? Am I willing to bear the risk involved?

24. 24 Steps in a Risk Management Plan 3. Project to the Future Is this a market that is attractive to everyone or is there some aspect of it that gives me an advantage? High profit potential can attract many producers, pushing down prices Is the market limited by geography, production requirements, or other issues that can limit entry? Do you have an advantage (geographic, knowledge, production, or relationship) that gives you an advantage?

25. 25 Steps in a Risk Management Plan Factors affecting entry Size of market (a small market might be too much trouble for the biggest players) Geographic location of market (do you have there location advantages)? Nature of production High perishability & close to market Cultural factors Relationship with buyer Familiarity with market niche

26. 26 Steps in a Risk Management Plan 4. Consider Long-term Issues The decision to enter a market need not last a life time, but as necessary investments increase, you need to look further to the future… How is demand for this product likely to change? Does it meet consumers’ demand for products that are convenient, tasty, nutritious, novel, low-carb, etc…? How is supply likely to change? Are technologies coming on board that will reduce costs for someone or make entry easier? (e.g. mechanized harvest, new seed varieties) Are new entrants likely to come on board due to changes in policy and/or technology? (E.g. China & apple concentrate, Mexico & tomatoes)

27. 27 Steps in a Risk Management Plan 4. Think Strategically What strategies can I use to protect myself from risk?

28. 28 Conclusion Different markets carry different risks In choosing an alternative market, must take a broad and informed view of risk to be faced Addressing strategic risk early allows you to anticipate and deal with operational risk By evaluating multiple options, may end up in a different market than you thought

29. 29 Resources Risk Management Association www.rma.usda.gov National Ag Risk Education Library www.agrisk.umn.edu

30. Risk Issues in Alternative Markets Denise Mainville Agricultural & Applied Economics Virginia Tech