Risk Management for Greenhouse and Nursery Growers in the United States

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1 Risk Management for Greenhouse and Nursery Growers in the United States Dr. Robin G. Brumfield, Specialist in Farm Management Dr. Edouard K. Mafoua, Research Associate in Agricultural Economics Rutgers, The State University of New Jersey The Green Industry and the U.S. Agriculture Floriculture and environmental horticulture are the fastest growing segments of the agricultural industry in the U.S., averaging 7% annual growth since Nursery and greenhouse crops, including bedding plants, potted flowering plants, foliage plants, cut flowers and cultivated greens, landscape nursery plants, unfinished plant material, sod, flower and vegetable seeds, are the sixth largest agricultural commodity group in the U.S. with a farm gate value of $10.9 billion in 1997, representing 11% of total farm cash receipts. Grower cash receipts for the U.S. green industry reached $12.1 billion in This growth is due to increasing urbanization and rapid growth of new residential and commercial developments, and to the continued strength of the U.S. economy, resulting in greater disposable income and increased consumption of horticulture products. U.S. retail expenditures for green industry crops have grown an average of 5 percent annually since 1989, reaching $54.8 billion in 1998, or $203 per capita (USDA, 1999). Sources of Risk Compared to many agricultural crops, greenhouse or nursery crops offer the opportunity to produce a fair amount of income on small acreage. With this income potential, however, come sizable risks. Risk results from the inability to predict the future accurately. Sources of

2 risks that may affect the grower s income are production, marketing, financial, legal, environmental, and human resource risks. Production risk concerns variation in output arising from many uncontrollable events such as weather (wind, rain, hail, etc.) insects and pests, technical challenges, diseases, input quality and availability. Fire, theft, and other casualties are also sources of production risk. Marketing risk concerns price risk and the availability of markets. Price risk is related to the variability of the price of commodities or the price of inputs, and to unanticipated forces that lead to dramatic changes in retail and wholesale prices. Financial risk has three basic components: interest rate risk, liquidity, and solvency. Interest rate risk concerns the cost of short-term, intermediate, and long-term debts. Liquidity concerns the ability of a business to pay its cash obligations in a timely fashion. Solvency concerns protecting the equity in a greenhouse business at adequate levels. Financial risks interact with other risks. Legal and environmental risk results from changes in policies and regulations that affect greenhouse and nursery business. For example, changes in government rules regarding the use of pesticides, tax, trade, environmental, or credit policy may alter the cost of production. Human resources risks may result from events associated with greenhouse operators and their families, professional consultants, and employees (e.g., theft, accidents, death, divorce, injury, seasonal labor needs, or poor health of key personnel). 2

3 Risk Analysis How do you analyze risk? Chances are you have already analyzed some risks associated with your greenhouse or nursery operation. To be systematic about risk analysis you should:?? Identify the nature and importance of various sources of risk (e.g., production, marketing, financial, legal and environmental, and human resource risk) that may be present in your business. In other words, identify what causes you to earn lower profits or incur a loss instead of a profit.?? Evaluate your risk-management strategies and practices (e.g., work force training programs, implementation of safety programs and devices, insuring crop yields and crop revenues, enterprise diversification, organizational changes, riskreducing input use, alternative marketing channels, vertical integration, production and marketing contracts, maintaining financial reserves and liquidity, leasing inputs, and hiring custom work, etc.).?? Identify the cost effectiveness of various risk-management alternatives on overall and targeted risk reduction. This can be done using a cost and benefit analysis of alternative responses to various risks, partial budgeting, payback, net present value analysis, or other economic tools.?? Evaluate the impacts of different types of risk on decision-making and performance, and on efficiency and profitability of the greenhouse or nursery business. 3

4 Risk Management Strategies Risk management strategies consist of a variety of responses that may reduce the probability of an unfavorable event occurring and may reduce the adverse consequences if the event occurs. Some of the risk management options available in conventional farming are not available to nursery and greenhouse producers because of the nature of product mix in these industries. For instance, growers producing ornamental horticultural and floricultural products do not have the ability to shift risks via futures and options markets, which are available to grain producers. Green industry crops do not have price supports, and federal crop insurance is not available for many of them. Management Responses to Production Risks Examples of management responses to production risk include crop insurance, enterprise diversification, input use, contract production, and evaluation of new technologies. Crop Insurance There are many types of federal crop insurance programs that offer a variety of insurance products to protect against yield and revenue risks: Multiple peril crop insurance (MPCI), crop revenue coverage (CRC), income protection (IP), revenue assurance (RA), group risk plan (GRP), group risk income protection (GRIP), crop-hail insurance, and adjusted gross revenue insurance (AGR). Several questions to be considered when you want to consider a crop insurance plan:?? Should I buy crop insurance??? Which crop insurance product will best compliment my marketing plan? 4

5 ?? What are the major sources of production risk and what type of coverage is needed??? What amount of coverage is needed in terms of cash flow needs??? What are the implications of a crop loss on my ability to meet my debt obligations??? What are the costs of the various types of coverage and which offers the best protection for the level of coverage needed? Business Diversification Diversification concerns producing combinations of crops whose production is not directly related under variations in weather. Growers may also diversify production practices or may disperse production geographically. Another form of crop diversification is planting different varieties that mature at different rates and perform differently under alternative weather conditions. Several questions should be considered when you want to diversify your activity:?? What knowledge and management capabilities are needed for enterprise diversification??? Which additional capital investments would I need to diversify??? What is the added labor needs of a diversified enterprise??? Where are potential new markets??? What are the income relationships between the diversified enterprise and the existing enterprise??? Will diversification spread management and labor too thin and impact the existing business negatively? Input Use Input use is a major production risk management practice. Insect and disease prevention and control are important inputs for all ornamental producers. Pest management strategies are 5

6 necessary to minimize the risk of insects and disease. Irrigation system and type of equipment are also important inputs for nursery and greenhouse crop production. Having excess machinery will allow growers to extend the size and scope of their operations and gain economies of scale, but may increase overhead costs. Several questions should be considered that are related to input use and availability:?? Should I increase the size and the scope of my greenhouse operation??? Should I change my current land lease arrangement??? Should I lease or buy equipment??? Should I produce my own plugs??? Should I buy plugs??? Should I buy pre-finished plants? Contract Production In some contracts (similar to ones used in the poultry industry) an outside company coordinates all aspects of the business from production to consumer (vertical integration). Production contracts usually detail inputs to be supplied by the contractor, the quality and quantity of commodity to be delivered, and the compensation to be paid to the grower. Consider the following questions when you want to be engaged in this type of contract production:?? Which benefits will the production contract provide??? What flexibility will I be giving up??? Do I understand the conditions of the contract??? Do I need legal advice? Evaluating New Technologies 6

7 A new technology may lower input costs and improve environmental quality, or may lead to higher crop yields. You may choose low risk technologies; you may reduce the effects of yield risk through irrigation, pest management practices, and site and plant cultivars selection. Several questions to be considered when evaluating new technologies that you would like to adopt:?? What is the economic benefit of adopting a new technology??? Does the adoption of new technology reduce my risk??? Would it be more profitable to manage risk by adopting new technology or by diversifying over several crops??? Is it a better risk strategy to use a production risk management strategy, such as buying AGR insurance, compared to adopting new technology? Management Responses to Marketing Risks The increased variability of commodity prices has increased growers awareness of price risks and placed a premium on good marketing skills. Developing a marketing strategy or plan requires careful evaluation of the supply and demand for ornamental products and investigation of market alternatives. There are many marketing options which are available to the ornamental producer: wholesale market, marketing cooperatives, local retail, roadside stands, farmers markets, Internet and/or mail order, pick-your-own operations, and direct delivery. Vertical coordination and marketing contracts are becoming increasingly important in marketing. So is the strategy of spreading sales to reduce dependence on buyers or market segments. Consider these questions when you want to develop a marketing plan:?? What are the potential costs and returns associated with alternative marketing strategies??? Does my marketing plan cover the entire calendar or crop year? 7

8 ?? Have I checked my marketing plan against my financial plan to make sure that income from marketing covers cash flow needs??? Have I calculated production costs and estimated my yield to determine my break-even point? Management Responses to Financial Risks The preventive approach to managing financial risk is accurate, up-to-date financial records and financial analysis of key ratios and cash flow projections and statements. By using a financial analysis system, growers can be aware of the magnitude of emerging financial management problems so that they can react to them. Maintaining emergency lines of credit with lenders, delaying or reducing business and personal expenditures are responses to managing cash flow. Insurance is a financial response to risk, which provides a specialized source of liquidity. Pacing investments and limiting credit and leverage and accepting another job in addition to managing the greenhouse are financial responses to risk. The capital structure of your business or your debt management are likely to affect the risk exposure of your business and may force you to operate at sub-optimal levels leading to inefficiency. You also need to investigate how to spread depreciation, interest, taxes, insurance, rental or advertising costs that are fixed in the short run over several commodities. Several questions should be considered when you want to implement these responses:?? What are my short-term and long-term goals? How do they affect my financial planning??? Should I consult with a bank or other lending institutions??? Should I consider hiring a financial planner or accountant??? Which records will I need to monitor the financial status of my greenhouse business? 8

9 ?? Which financial packages and computer software might help me??? What have been the trends in my business s key performance indicators??? How do the ratios for my operation compare to those of similar operations??? What are the alternative sources of financing and their terms and conditions? Management Responses to Legal and Environmental Risk Two salient risks are tort liability and environmental regulations. Tort liability arises from civil law suits filed because of negligent or unintentional injury to property or people by the grower, employees, or family members in the course of the firm s business activities. The general response to this risk is to carry general business liability insurance. Avoiding environmental risks in part is consistent with some of the production risk management practices. Accurate records should be kept on the applications of herbicides, pesticides, fertilizers, and water usage. Consider these questions when you want to implement responses legal and environmental risks:?? How much liability insurance do I need??? Are certain contracts beneficial to me? If so, which contracts??? Do I understand all the implications of a contract before I sign??? When do I need to consult an attorney in regard to contracts??? What regulatory agencies are involved? What permits do I need??? Do I need to perform an environmental audit??? Have I reviewed my property and liability insurance policies? Management Responses to Human Resource Risks 9

10 Responses to risks such as illness, injuries, death, and divorce are health, disability, and life insurance. Have plans in place for how you will manage the loss of an employee. Maintain an appropriate insurance program, and plan for estate transfer. Good labor management is a key to your business profitability. Understanding the labor market and planning for adequate and experienced labor is critical to having a high quality product ready for the market. You also must provide training to employees. You must understand a number of federal and state regulations that apply to farm labor and are administered by a number of agencies and create a set of compliance documents that can eliminate and/or prevent in penalties and loss of labor. Consider these questions when you want to deal with human resources issues:?? Does everyone understand your business plans and decision-making structure??? Do I understand the goals of other family members??? Do I have an employee handbook??? Do I have incentives in place for employees? Summary Sources of risks that may affect the grower s income are production, marketing, financial, legal, environmental, and human resource risks. You need to be systematic about risk analysis. First, identify the nature and importance of various sources of risk that may be present in your business. In other words, identify what causes you to earn lower profits or incur a loss instead of a profit. Secondly, evaluate your risk-management strategies and practices. Then, identify the cost effectiveness of various risk-management alternatives on overall and targeted risk reduction. Finally, evaluate the impacts of different types of risk on decision-making and performance, and on efficiency and profitability of the greenhouse or nursery business. 10

11 Sources Mid-Atlantic Risk Management Education Conference. August 6 and 7, 1998, Williamsburg, Virginia. USDA Census of Agriculture. United States Department of Agriculture, Washington, DC. USDA Floriculture and Environmental Horticulture Situation and Outlook Yearbook. Economic Research Service, United States Department of Agriculture, Washington D.C. October Related Websites Brumfield, R.G. and E.K. Mafoua An Adjusted Gross Revenue (AGR) Insurance Analysis for the Giacomo Vegetable Farm, Anytown, Cumberland County, New Jersey. Brumfield, R.G. and E.K. Mafoua An Adjusted Gross Revenue (AGR) Insurance Analysis for the Borst Greenhouse, Anytown, Middlesex County, New Jersey. Brumfield, R.G. and E.K. Mafoua An Adjusted Gross Revenue (AGR) Insurance Analysis for John Doe Nursery, Anytown, Cumberland County, New Jersey. Brumfield, R.G. and E.K. Mafoua An Adjusted Gross Revenue (AGR) Insurance Analysis for the Smith Greenhouse, Anytown, Middlesex County, New Jersey. Acknowledgement The risk management education initiative is a joint project sponsored by Rutgers Cooperative Extension and the Risk Management Agency (RMA) of the United States Department of Agriculture (USDA). 11