A great awakening is happening across the dairy industry as many dairy operations are beginning to engage in price risk management. It’s a whole new management frontier to explore. And it’s another responsibility on the farm for someone to do or oversee. When a new endeavor is first adopted on a dairy operation, it often takes a while before that task becomes fully integrated. At first it is part of someone’s job description by default.

For example, as technology has advanced, the person who was the most computer savvy became the de facto IT guy on the dairy. It was that person’s job until it became apparent that you needed more expertise to integrate technology on the dairy.

When it comes to risk management, you have several choices for creating a disciplined approach that is integrated into the financial management of your dairy. Let’s take a look at the choices and the best practices for oversight of the price risk management function.

Should I do it myself?
Some producers handle marketing very well. They have the interest, knowledge, time and discipline to do it. For many dairy owners or managers, it is not practical to add marketing to your list of duties. Not because you’re not smart enough to do it; rather, because good marketing is completely counter-intuitive to every other business skill you use to manage your dairy.

What do I mean by “counter-intuitive?” A good business person gathers all the pertinent facts needed to make a decision, and when you have evaluated all the information, you make a decision.

Marketing decisions, however, are very different. Gathering the information only tells you what has happened in the past. That information is already factored into the market prices and has little predictive value of future prices.

Click here to see PD Editor Walt Cooley's related video interview with Scott Stewart of Stewart-Peterson.

So you are required to make decisions facing great uncertainty. If you wait until you have enough information, you’ve almost always missed the major market move.

If you are going to be responsible for your farm’s marketing, you have to overcome that thirst for information and instead apply structure and discipline to your marketing. Here’s where an adviser can play a key role.

Much like a personal trainer adds discipline to a plain old gym membership, the adviser adds discipline to the marketing function.

There are many different types of advisers out there, and it is important to understand the services offered, and, importantly, how the advisers are paid for their services.

Should I use a broker?
Soon after the dairy markets were created in the mid-1990s, dairy producers who were early adopters began using traditional brokers to establish market positions, much like the grain industry has done for years.

A traditional broker is someone who places orders on your behalf and is typically paid by a commission on each transaction that is executed.

In order to do a good job for clients, brokers will offer strategic advice and suggest positions that make sense. Levels of service and philosophies vary widely among brokers, so if you go this route, you need to be completely comfortable with your broker and the level of service he or she provides.

For example, some will call you when certain triggers are hit. Others (usually the “discount” brokers) will wait for you to call them when you decide it is time to place an order. It’s important to know how communication will be handled so you do not miss opportunities.

Fee-based service approach
Some dairy producers prefer a consulting service that is fee-based, meaning you pay a fee for the adviser’s time, or for the number of pounds of milk marketed or the amount of feed managed for the next year.

Once you are enrolled, the adviser provides you with strategy recommendations, and you can choose to follow those recommendations, or not to follow them.

Among fee-based services, there are different fee structures. For example, if you are paying a fee for consulting, the transactions may be discounted lower than a traditional broker’s transaction fee. That’s one of the arguments for a fee-based model. In order for the adviser to earn your business year after year, the service needs to bring you value. There is built-in accountability.

Best practices for oversight
Once a broker or advisory service is selected, there is still a management and oversight function. Someone on the dairy should “own” that job, so that the broker or adviser has one clear point of communication.

Here are some other “best practices” for oversight of the price risk management function:

• Assign it to someone who has the time and discipline. The price risk management function cannot be a leftover task that falls by default to someone on the team. It must be part of the job description, and that person should seek input from the management team as well as report back how the approach is working using various metrics.

• Seek input. Many people could potentially have input into the dairy’s price risk management approach: The business consultant can crunch numbers and provide a perspective of how various price points for feed and milk impact the overall financial position of the farm.

The lender can give input on risk tolerance and available dollars for margining positions. The feed manager can provide input on flexible feed choices that are acceptable to achieve goals for the ration.

The milk plant representative can describe contracting services available from the milk plant. The person responsible for risk management takes all of this input into consideration, shares it with their marketing adviser, and then together they can choose the best course of action.

• Trust and verify. The person in charge of marketing needs to have the freedom to make decisions. Fear of being second-guessed on a buying or selling decision is the greatest cause of paralysis (and therefore missed opportunities) in marketing. If you have measurements in place, the marketing approach can be evaluated on the basis of those metrics, not on the results of any one decision.

• Use the right metrics for oversight. You cannot use your milk check as a way to evaluate your marketing, because it is only one piece of the equation at any given point in time.

Neither can you use your commodity hedging statements, because the balance in your hedge account at any given point in time is not a true measurement of your overall price received.

The true measurement is your weighted-average price, which blends all your marketing activities together into one net price.

Weighted-average price is the net average price received over time for all of your milk production (or paid out for feedstuffs). Your price at any given point in time might be higher or lower than the current market price; however, long term it should be your goal to make strategic and incremental sales or purchases that build the best possible weighted-average price for all your production (or feed purchases).

It is “weighted” because some decisions have more impact on your average price than others, thus, it keeps you focused on the impact of each decision.

Weighted-average price is a great metric because it is objective, not subjective. If at any point in time you feel (emotionally) like your marketing is not performing, calculating your weighted-average price will tell you how your decisions have performed against the market price for the past quarter, past year or past three years.

The person in charge of your marketing should be able to tell you what your weighted-average price is at any given time, and what impact the proposed recommendations will have on the weighted-average price.

• Gauge your lender’s confidence. This is a bit more subjective than the weighted-average price metric; nevertheless, it is still an important measurement of how well your price risk management is performing. If your lender is happy, your business will have the agility it needs to survive through volatile price cycles.

As a whole, our industry is gaining some confidence when dealing with the markets, and we’re taking steps toward better management of the volatility that is sure to impact us in the years ahead. Small steps toward building an effective risk management team can be one giant leap forward for your dairy. PD

Disclaimer: Futures trading involves risk of loss and should be carefully considered before investing. Past performance may not be indicative of future results.

PHOTOS
United Pride Dairy of Phillips, Wisconsin, recently discussed at World Dairy Expo how it has built a framework for financial management teamwork. Pictured from left to right are Paul Salm, BMO Harris Bank; Ed Jasurda, co-owner, United Pride Dairy; Tim Swenson, Lookout Ridge Consulting; Matt Mattke, Stewart-Peterson, and Jon Pesko, co-owner, United Pride Dairy. Photo courtesy of Stewart-Peterson.

Mark Ludtke
Business Development
Stewart-Peterson Inc.