Testing a profit margin hedging model as a price riskmanagement solution for crop farmers in South Africa

Abstract

Risks inherent in the agricultural environment are often complex and include a combination of risks such as production risk (weather), market risk (uncertain prices), technological risks (new production techniques), price risk (changes in input and output prices) and institutional risk (changes in policies). Also, farmers experience personal and financial risks, which relate to cash flow and the ability of the business to generate sufficient profit. Literature shows that crop farmers manage price risk to fulfil the end-values of security, feeling good and operating a viable and competitive business. A profit margin hedging approach could effectively be used as a price risk management strategy. Although certain other agricultural industries are using profit margin hedging as a risk management strategy, not much is known of the usage and success of this strategy in crop farming. A gap in research exists where an effective plan combines the various components into an effective crop risk management strategy. It is also evident that a gap in practice exists where all the components identified in the literature are not combined into a working model to do better price risk management on a daily basis. Consequently, this study aimed to test the performance of such a new profit margin hedging (PMH) model, with and without using put options as a pre-harvest strategy, against the performance of a control group. The study was conducted in the Free State Province in South Africa. Data for eight (8) seasons of a group of ten farmers were obtained from a bureau service. The data was analysed using the software suite Jamovi 1.0.7.0. Independent t-tests were used to compare the profitability of the new PMH model to the control group. Statistically, significant differences were reported between the groups. The study found both a significant improvement in profitability and a stabilising effect on profitability when using a profit margin hedging approach. This study proposes that crop farmers can operate more viable and secure businesses by utilising a profit margin hedging model.