The Role Of Risk In Decision Making And Problem Saving: Agribusiness Industry
Abstract
As defined in ISO 3100 published in 2009, risk is the uncertain goal achievement which could be either positive or negative. Risk is also covers other goals of a business besides life and health of individuals. In business, risk is defined as the probability of a business to lose value on its capital, for example, equipment and liquid securities (Francis, 2014). Risk management helps with optimization and achievement of various goal. Decision analysis constitutes methods, theory, practices necessary in systematic addressing of important yet risky decisions. It includes methods for identification, representation and assessment of important aspects of risky decisions, resulting in recommendation of a certain approach that consistently puts into consideration the possible effects, the associated probabilities of the effects and the relative predisposition of the possible outcomes (Parikh, 2017).
Introduction.
Agribusiness managers use different decision making styles to acquire, process and utilize information in decision making and problem solving. Risk implies a level of vagueness and an inability to have full control over the outcomes of a given action. Managers make problem-solving decisions under three different circumstances: certainty, uncertainty and risk (Aken & Berends, 2018). In a risk environment, decision making becomes quite difficult since managers have no access to complete information. Precisely, a manager might understand the problem and the alternative solutions, but is not sure of how effective each solution is going to be. The agribusiness industry like any other industry, faces various risks and calls for critical understanding and decision making to ensure that such problems are dealt with accordingly.
Risks encountered in agribusiness industry.
There are five general types of risks associated with agribusiness:
Production risk. This refers to any production activity or event that has a range of possible outcomes. The major sources of production risk in agriculture are climate changes, weather, genetics, technology, pests and diseases, quality of inputs and efficiency of machinery in use. This type of risk stems from uncertainty of natural processes of growth in crops and livestock.
Market (Price) risk. This refers to uncertainty about the prices that producers ought to receive for commodities or those they should give in payment of inputs. It largely focuses on lack of surety about access to the market, prices to charge and costs incurred (Szylar, 2014). Such risks arise from protectionism and international trade as they have an effect on market access.
Financial risk. This is the risk that pertains to financing of the agribusiness entity (Apostolik & Donohue, 2015). Some sources of such risk include changes in the rates of interest or the credit availability, or changes in regulations put in place for credit allocation.
Institutional risk. This relates to unpredictable changes in the regulations and policies put in place by formal or informal institutions that affect agriculture. The government, which is a formal institution, may come up with unpredictable alterations in policies and regulations creating risks, something that farmers have limited control over.
Human or personal risk. These are those related to individuals and relate to issues pertaining human health or relationships that affect the agribusiness entity or members of the household in question. Such risk emanates from death or illness of family members, transmission of diseases from livestock to humans, injuries from farm machinery among others.
Risk in decision making and problem solving in Agribusiness
Risk and uncertainty are essential components of business decisions. Reasonable amount of research has been done to give explanations for questions about the uncertainty and risk in agriculture. It is evidently hard to even think of any other industry where risk and uncertainty are more useful than in agriculture. Any individual farmer seeks to establish a preferred combination of activities with unexpected different and levels of expected independent returns. As discussed above, the sources from which uncertainty and risk emanate in agriculture are diverse and numerous ranging from climate- related events to animal diseases, from financial uncertainty to policy risks (Sarhadi & Burn, 2016). A holistic approach is hence necessary since agricultural risks are not in isolation, but are rather connected to each other, having strategies and policies designed to manage risks as part of the system.
According to differences in risk preference, farmers can be divided into three types: those who love taking risks (the risk- loving), those who do not like taking risks at all (risk-averse) and those that have neutral liking to risk taking (risk-neutral). Historically, the behavior of various individual agricultural producers pertaining to risk and uncertainty has been studied quite profoundly. A big fraction of farmers adopts strategies that are risk-reducing and involve elements like diversification, liquidity, flexibility and take a lot of caution when trying new tools and use of certain levels of input whose returns are far below than highest level of expected returns (Hardaker, 2015). Risks involves imperfect knowledge with complete knowledge of the probabilities of the possible outcomes. The analysis of decision making in agriculture under risky and uncertain conditions, requires that farmers know all the possible payoffs and are aware of the probability of each possible outcome occurring (Albright & Winston, 2015).
Various criteria have been put in place to help with decision making in agribusiness to ensure that there is optimization during uncertainty and risk.
Maximin criterion. Here, the decision maker selects a strategy whose worst (highest) loss is deemed to be preferable than the least (lowest) loss of all other approaches possible in given circumstances.
Maximax criterion. This is an optimistic approach. It provides that the decision maker explore the maximum payoffs of various options and choose the one with the best outcome. The maximax approach fascinates decision makers who like to take chances and are in a position to survive any losses without experiencing major inconveniences, and also those attracted to high payoffs.
Minimax regret criterion. This criterion analyses the loss that results from occurrence of a given situation having the incentive of the selected option being smaller than that which could have been obtained from that particular situation. It emphasizes on avoidance of the worst possible effects that could arise when making decisions. Here, the decision maker examines maximum loss of each approach and chooses the one with the least value.
Laplace’s criterion. This criterion suggests that if there is no available information about the likelihood of various outcomes, it is only rational to assume them to be likely equal. After calculation of the expected payoffs for each option, the one with the largest value is selected.
Hurwicz’s criterion. This criterion was postulated by Leonid Hurwicz in 1951and it involves selection of the minimum and the maximum payoff to each course of action. This criterion aims at finding a common ground between the two extremes presented by the optimist and the pessimist criteria.
Even with the above discussed criteria on decision making under uncertainty and risky situations, we cannot assume the many ways stakeholders in the agribusiness industry adopt to try and minimize the risks they engage in. Like most business minded people, farmers have been known to be risk averse as they do all they can not to take risks that would otherwise cripple their businesses. Farmers have several ways of managing the risks they encounter and most of them combine various strategies and tools. Agricultural risk management is an approach that helps vulnerable farmers and provides leverage for investment and finance to such households (Juvvadi, Gangaiah & Chandra, 2015). Through this approach, farmers are able to prepare for risks and assess them, and also learn how to adapt risks to ensure survival of their businesses. The following ways are used to mitigate risks that arise in agribusiness:
Hedging. This is a strategy that facilitates reduction of potential risk of changes in prices that could happen in the period between planting and harvesting of crops for sell. It involves taking opposite positions in the cash and future markets (Cramer, Paudel & Schmitz, 2019). It encompasses the strategic use of financial instruments to cancel out the risk of any untimely movements in price. For instance, before committing to a certain crop, farmers can get in future contracts where they set predetermined prices for their crops, ensuring that the determined price can cover for the costs of production incurred and still make profit.
Insurance. Farmers undertake crop insurance to cushion themselves against losses from yields as a result of natural calamities such as fire, drought or floods and other adversities that limit the growth of crops or impede crop emergence (Ghalavand, 2017). Agricultural insurance protects crops, livestock, farming and harvesting practices from setbacks. It is very important as it helps fight poverty also since natural disasters are unpredictable can have major economic effects on people doing agribusiness.
Professional management. To ensure that they alleviate the unpredictable occurrences associated with production agriculture, farmers delegate management of their farms to a professional farmer whose decisions are based on maximization of profits (Phillips, 2015). A person who knows what they are doing is able to take charge of variables such as water, diseases and the weather.
References
Aken, J.E., & Berends, H. (2018). Problem solving in organizations: a methodological handbook for business and management students. Cambridge: Cambridge University Press.
Albright, S. C.,& Winston, W. L. (2015). Business analytics: data analysis and decision making. Stamford, CT, USA: Cengage Learning.
Apostolik, R., & Donohue, C. (2015). Foundations of financial risk: an overview of financial risk and risk-based financial regulation. Hoboken, NJ: John Wiley & Sons.
Cramer, G. L., Paudel, K. P., & Schmitz, A. (2019). The Routledge handbook of agricultural economics. Abingdon, Oxon: Routledge.
Francis, D. (2014). Risk. London: Penguin Books.
Ghalavand, K. (2017). Agriculture and crop insurance: theory and case study. New Delhi: Regal Publications.
Hardaker, J. B. (2015). Coping with risk in agriculture: applied decision analysis. Boston, MA: CABI.
Juvvadi, D. P., Gangaiah, B., & Chandra, K. S. (2015). Agricultural risk management. Hyderabad: Centre for Good Governance.
Parikh, A. (2017). Risks in Agriculture Farmers Perspective. Singapore: Springer Singapore.
Phillips, P. W. B. (2015). Biotechnology, agriculture and development. Cheltenham, UK: Edward Elgar Publishing.
Sarhadi, A., & Burn, D. H. (2016). Climate change projection and time-varying multi-dimensional risk analysis. Waterloo, Ontario, Canada: University of Waterloo.
Szylar, C. (2014). Handbook of market risk. Hoboken, NJ: Wiley.