By: Larry D. White and Wayne T. Hamilton
There is a certain amount of risk and uncertainty associated with almost every decision you make. You must be optimistic about your decisions, or else you would not implement them. However, realistic optimism is based on a careful study of all the evidence. Successful managers look for evidence that a plan might not work, as well as evidence that it will. They do not rely on general rules of thumb, and they do not make the same decisions year after year for fear of trying new approaches. Your chance of success depends on selecting the right things to do and then doing them right. To select the right things to do you must thoroughly evaluate the possible outcomes of each decision.
What Are Your Odds?
Are you a gambler who relies on luck, or do you plan and calculate the odds associated with all decisions and alternatives? Are you reckless or cautious? Why do some people seem to beat the odds by sustaining their rangeland resources and succeeding financially even under adverse conditions, while others are always out of forage, out of feed, out of water and out of money?
Top operators recognize that successful business management is, to a large extent, successful risk management. Even if you can’t control a particular business risk, you can manage your business to compensate for it. In some cases you can even capitalize on the risks you face.
Understanding Risk, Probabilities and Uncertainty
To understand the concepts of risk, probability and uncertainty, let’s consider drought. Drought is common on Texas rangelands. Its frequency and duration increase as you move from the eastern to the western part of the state. The odds are that there will be drought 1 to 3 years out of 10 (east to west, respectively). But what do these odds mean? Will there be a 1-year drought, a 3-year drought, or two 3-year droughts within the next 10 years? And when will they occur?
Odds are probabilities based on the study of many individual occurrences. You can use probabilities to summarize known outcomes of an action implemented many times, but that won’t tell you what will happen if you implement that action. An 80 percent chance of success is the same as a 20 percent chance of failure. The manager’s responsibility is to decide whether or not that 80 percent chance of success is good enough.
Consider a decision about brush control. If you are told that a certain practice will help you achieve 80 percent control of brush, that may sound very good. But you must look beneath the claim and calculate the odds. Some questions you’ll want to ask include: Have 100 percent of the operations that used this practice achieved 80 percent or better control of brush? Is 80 percent the average of results achieved by all operations? The risk involved depends on the answers to such questions. If the answer to the first question is yes, then there is little risk in using this practice.
However, if the 80 percent is an average result, you need to see the risk assessment index (frequency) of different results to be able to determine your risk. Using a risk assessment index is one way to beat the odds in making management decisions.
Using a Risk Assessment Index
Table 1 shows the risk assessment index for our brush control example. It is important to understand what the numbers mean. An average is different from a median, which is different from mode, which is different from frequency. The range of values observed in the various brush control efforts determines the amount of difference that could occur. The average control was 89 percent, but for some operations the result was as high as 100 percent and for some it was as low as 61 percent. The median was 93 percent control (half had less and half had more). The mode, or most frequent result, was 95 percent. The relative frequency of results (percent chance of greater control) is a better tool for evaluating your risk than the other calculations.
With the risk assessment index you can determine the potential effect of not achieving the brush control you need. For example, if you have to achieve about 90 percent control or greater to maintain your planned stocking rate, then you have only a 60 percent chance of being successful. On the other hand, if 60 percent brush control is adequate for your situation, this practice will be successful and carries “no risk,” unless your situation differs from those studied.
Understanding Cumulative Risk
Management involves taking a series of actions designed to achieve the results you want. Each individual action carries its own risk. Cumulative risk is the combination of probabilities for a number of decisions / actions. Let’s use a simplified livestock grazing example to illustrate.
A) Five hundred animal units are needed to pay business overhead and family expenses.
B) Median rainfall is necessary to produce adequate forage for the enterprise without over grazing.
C) Minimum weaning weights must be 500 pounds (the minimum for the ranch over the last 10 years).
D) At least 85 percent calf crop must be weaned (the minimum for the ranch over the last 10 years).
E) A market price of $0.85 per pound is needed (the median for the last 10 years).
F) Annual direct costs per animal unit can not exceed $25 (the maximum for the ranch over the last 10 years).
To calculate the cumulative risk for this example, multiply the probabilities for each item: B (0.50) x C (1.00) x D (1.00) x E (0.50) x F (1.00) = 0.25
Thus, there would be only a 25 percent chance of success (or a 75 percent chance of failure) with this scenario. It is very easy to overestimate your chance of success unless you look carefully at cumulative risk and probability.
Rather than starting with the number of animals you want to have, start with the amount of forage you can realistically expect to produce (allowing for possible drought). Usually the size of the herd should be no more than 50 to 70 percent of “normal” carrying capacity (requiring adjustment one out of ten years). This allows you to accumulate a forage reserve to help when a drought occurs. With part of your forage “set aside,” the forage supply risk changes and the cumulative risk for this scenario becomes: B (0.90) x C (1.00) x D (1.00) x E (0.50) x F (1.00) = 0.45, or a 45 percent chance of success.
Your financial survival depends on your stocking rate (which reflects your resource stewardship) and, of course, animal performance and your financial responsibility. Many ranchers increase stocking rate to achieve higher income, but as stocking rate increases so does risk. Increasing the stocking rate creates wider fluctuations in weight gain and reproductive performance. It also degrades the rangeland, lowers future carrying capacity, causes more weed and brush problems, decreases the amount of rainfall entering the soil, and increases erosion. Thus, risk of failure increases significantly. Calculate the cumulative risks for yourself and determine how much risk you can afford.
Beating the Odds
To beat the odds, calculate cumulative risk using the worst outcome seen for each part of the scenario over the last 10 years. This will constitute your survival level. Then adjust your goals and management to achieve at least this level of performance every year. This should allow you to keep the ranch and reduce debt. Profits in better years should be used to service debt and make effective investments without increasing overhead (pay cash when possible). Off-ranch investments may be more profitable and less risky than ranch investments.
It is also necessary to monitor your resources constantly and look for warning signs that your projected outcomes are not occurring. Then you can look for alternatives and adjust your management strategy before small problems become big ones. Compare all the alternatives before making important decisions. Everyone’s ranch, goals, management skills, financial resources and risk-taking comfort zone are different. To beat the odds, make sure you can survive and have the income you need even if you can not achieve the income you want. Remember that you will not achieve the income you want every year. Sometimes the key is to reduce losses.
Selecting the Right Things to Do
It is more important to set appropriate goals and achieve them than to select particular technology or tools. Rather than focusing on what to do, the good manager first identifies the responses he needs (forage production, weaning weight, etc.) to achieve his goals, and then selects the most appropriate way to achieve those responses. If the responses you need to reach your goals are not achievable or have too much risk, then your goals are unrealistic.
Identify each step in the process of reaching your goals, then identify the cumulative risk. In the Total Ranch Management approach, you identify the annual overhead expense necessary to keep the ranch or property and the minimum family lifestyle expense. The total of these two is the minimum gross margin (GM) you need from all sources of income– ranch enterprises, off-ranch investments, and off-ranch employment or other income.
For example, if the overhead expense is $40,000 (taxes, land payments and other long-term debts) and the minimum needed for a modest family lifestyle is $35,000, then the minimum GM from all income sources is $75,000. If the ranch is to supply all the GM income and it comprises 10,000 acres, then you need a minimum income of $7.50 per acre. A survival GM budget should identify the lowest animal production and highest direct costs over the last 10 years to determine the survival stocking rate for the ranch. In this case a cattle operation would have to produce a minimum GM of $262.50 per animal unit, if stocked at 35 acres per a.u. Is this realistic? Will your range resource be sustained? What about drought years and poor markets?
The Total Ranch Management livestock management decision aid (available from the Texas Agricultural Extension Service) allows you to quickly determine the number of animal units, production per unit, value per unit, and direct cost per unit needed to achieve your goal with a balanced herd composition and your culling practices. See Extension publication B-5036, “Stocking Rate Decisions,” for a discussion of the procedure for balancing stocking rate with financial needs. From the needed stocking rate you can calculate the needed forage supply, then determine if it is realistic for your ranch and expected rainfall. With this information you can determine likely budgets for each enterprise and find the combination that best achieves your goals.
Brush control practices, fences, water facilities, etc. are potential investments that require a large capital outlay and have risk. There are always alternative investments with different risks and potential returns. Because the costs and returns associated with range improvement practices occur at different times in the planning period, you must analyze their “present value” (and / or “internal rate of return”) in order to compare them with alternative investments and other opportunities. The Texas Agricultural Experiment Station has developed software called ECON that helps managers assess the present values of different investment opportunities. The software allows you to use “what if” scenarios to determine relative risk. ECON simply accounts for the added costs and revenues associated with range improvement practices occurring in each year of the planning period, discounts them with the appropriate discount factor, sums the discounted costs and returns, and subtracts the summed discounted costs from the discounted revenues. The difference is the “net present value” (NPV) of the range improvement investment. If the NPV is zero or positive, the investment should be economically feasible. For more information contact the Center for Grazinglands and Ranch Management at Texas A&M University.
Dealing with risk and uncertainty requires perception, assessment, and careful management (planning, implementation, control, and adjustment). If you do not perceive risk, assess it, and manage for it, your enterprises and resources may not survive.
Other publications in this series:
L-5368, Making Better Decisions
L-5371, Common Grazing Management Mistakes
L-5375, Common Brush and Weed Management Mistakes L-5377, Forage Quality and Quantity
L-5374, Rangeland Health and Sustainability L-5370, Drought
L-5369, Toxic Plants
L-5376, Seeding Rangeland L-5372, Types of Risk
For further information:
Halpern, D. F. 1989. Thought and Knowledge. Hillsdale, New Jersey; Lawrence Erlbraum Associates Publishers.
B-1630, Causes of Farm and Ranch Failures. Texas Agricultural Extension Service.
McCollum, T. 1993. Managing stocking rates to achieve livestock production goals in North Texas and Oklahoma. In Proceedings of Managing Livestock Stocking Rates on Rangeland Symposium, Texas Agricultural Extension Service.
Troxel, T. R. and L. D. White. 1989. Texas TRM – Total Ranch Management: An Integrated Educational Program for Texas Ranchers. In Proceedings of the National Integrated Resource Management Leadership Conference. November 1988, Denver, Colorado. USDA-ES and National Cattlemen’s Association.
White. L. D. 1994. Total Ranch Management – Strategic Management of Range Ecosystems. In Proceedings of the 8th Australian Rangeland Conference. June 1994, Katherine NT, Australia.
B-5036, Stocking Rate Decisions, Texas Agricultural Extension Service.
L-5141, Do You Have Enough Forage? Texas Agricultural Extension Service.
For additional range management information see: http://texnat.tamu.edu
Support for this publication series was provided by the Texas Agricultural Extension Service risk management initiative.
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