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

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

Types of Risk
Operational (short-term) risk
Price Yield Quality

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 Policytrade 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
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Different Risks for Different Markets

Consider a spectrum of market types

Open Markets

Contracting

Alliances

Vertical Integration

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

Open (Commodity) Markets

Contracting

Alliances

Vertical Integration
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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

Open Markets

Contracting

Alliances

Vertical Integration
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 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

Open Markets

Contracting

Alliances

Vertical Integration
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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

Open Markets

Contracting

Alliances

Vertical Integration
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Different Risks for Different Markets

Vertical Integration
You decide to undertake your own marketing activitiesyou 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
Open Markets Contracting Alliances Vertical Integration
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Using a Marketing Plan to Mitigate Risk

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The Marketing Plan

Good marketing plans dont 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
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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

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 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

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 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
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 Q3. Where is this market going over the medium-long term?

Does the product meet consumers evolving demand (quality, novelty, convenience, lowcarb, 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?
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 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 Doesnt 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.
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 Each question is relevant to each market, however immediacy of strategic questions increases as you move rightward
Q3 Evolution Q2-Trends

Q 1 -Today

Open Markets

Contracting

Alliances

Vertical Integration
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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
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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

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Marketing Plan
A Marketing Plan that reduces risk must consider
Short-term profit potential
What are todays 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)
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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)

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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?
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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?
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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
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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)
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Steps in a Risk Management Plan

4. Think Strategically
What strategies can I use to protect myself from risk?

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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
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Resources
Risk Management Association www.rma.usda.gov

National Ag Risk Education Library www.agrisk.umn.edu

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Risk Issues in Alternative Markets

Denise Mainville Agricultural & Applied Economics Virginia Tech