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The apple, the orange and the risk that lies between

Mark Ludtke Published on 09 February 2012

2011 did a lot to rebuild the spirits and the balance sheets of dairy producers. It also featured a spirited debate about dairy price reform, margin protection and safety nets.

As of this writing, the Dairy Security Act seems destined for inclusion in the 2012 Farm Bill in some form.

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No matter what happens with the public policy debate, the risk management approaches that are being talked about really are apple-and-orange comparisons. No comparative calculators will magically tell you which approach is best for you.

You’ll have to look at each individually as it becomes available. Part of the equation is philosophical, and part is math. No approach is easy. In the end, it boils down to whether you want to use marketing tools to manage risk, capture opportunity or both.

In the interim, many producers remain without any safety net for a milk price drop or margin squeeze that unfortunately could come again.

Your operation may be in a position to wait and see what comes of dairy price policy; however, I can tell you that exactly one year ago I was having “wait-and-see” conversations with producers about what the new safety nets would look like. And here we are in 2012, still waiting and seeing.

Fortunately, prices have held and have granted the wait-and-see crowd time to learn about risk management. We do not know when the bull market will end. (Yes, they always end.) And we do not know when or if a safety net will be available, or what it will look like.

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Although LGM-Dairy and a margin protection program could indeed be part of a sound risk management strategy, these programs simply won’t be available or able to do the job for most producers any time soon.

If you want the job done …
Ask yourself some important questions: Can I afford to wait for a policy-related safety net to be put in place? What risk do various price drops pose to my operation?

Your lender certainly has input here, and as you work through these questions, you will determine your risk tolerance. Even though milk prices have been strong, the fact remains that if you want to protect yourself from price risk, you’ll have to do it yourself.

Marketing “on your own” differs from the insurance or margin protection program approaches in that it not only seeks to manage risk – it seeks to take advantage of price opportunity, too. When you use cash, futures and options tools, you can proactively design strategies that allow you to build the best possible price for your milk, taking your risk parameters into consideration.

On the flip side, you can use these tools with the goal of incrementally lowering your cost for feed inputs, while securing the inventory you need.

So what can you be doing now to protect what you have built or rebuilt?

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Take cover
Consider all the tools available to you right now to protect against risk. There are multiple ways to learn – from independent reading and tutorials to workshops to sitting down with an adviser one-on-one. While there is a time and effort commitment to mastering the toolbox, this is knowledge you can utilize for the rest of your career.

Once you learn how the tools work, you can start developing strategies that achieve your risk management goals. To manage risk well, you actually should have multiple strategies planned at any given moment.

For example, if you think the milk price is going to hold strong, have a strategy in place to incrementally capture today’s strong prices. And also have a strategy in place if the price drops. Thinking about a strategy in advance of the price move is what enables you to move quickly.

Finally, think about whether you have the time to learn, develop multiple strategies on a regular basis and then actively manage your positions. If you can’t devote the time and discipline to this process, you may need the help of an adviser.

Capture opportunity
In the popular business book Good to Great (Collins, 2001), the author tells the stories of companies that did not settle for average profits. These companies have the people and systems in place that take them from good to great.

Dairy producers have spent the last two years cutting costs and becoming as efficient as possible. Our nation’s dairy producers are great innovators and great at production. Marketing may be that final frontier of opportunity to explore – the one that takes the entire operation from good to great.

Maximizing market opportunities differs from protecting a profit margin. Protecting a margin is good. Maximizing it is great. To maximize, you need to consistently use a marketing approach that gives you flexibility and helps you build a good overall average price over time.

That’s more than a safety net. That’s management innovation.

Steve Jobs is quoted as saying, “The cure for Apple is not cost-cutting. The cure for Apple is to innovate its way out of its current predicament.” Soon thereafter came the iPhone revolution.

Cost-cutting, safety nets and risk management are only part of the equation for dairy profitability. The innovative dairy producer is also thinking about using marketing strategies to capture opportunity. P D

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Cover yourself in the interim
• Do I have goals for what I want to achieve with my marketing strategies? (These goals should be related to my risk tolerance and what I am willing to spend to capture a certain price level.)

• How much am I willing to spend to create a floor for my milk price or a ceiling for my feed prices?

• How long do I want that floor, or ceiling, in place?

• For what portion of my milk do I want the floor established?

• Have I considered the safety net tools available to me now?

• Do I have a relationship with a trusted adviser who can explain how the various available tools will perform in various price scenarios?

• Do I have contingency price targets built in to trigger my safety net if prices start to fall?

• Am I watching the markets regularly so that I know when those triggers are hit?

• Do I have the discipline to implement my strategies if those triggers are hit?

• Can I afford to wait for a policy-related safety net to be put in place? What risk do various price drops pose to my operation?

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Mark Ludtke
Stewart-Peterson Group Inc.

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