Dynamics of Agri-food Supply Chains in Transition Countries

Johan F.M. Swinnen

The World Bank

Sarajevo ConferenceSarajevo ConferenceMay 24-26May 24-26, 2004, 2004

Background

Breakdown of the relationships of Breakdown of the relationships of farms with input suppliers and farms with input suppliers and output markets. output markets.

Contracting and vertical coordination Contracting and vertical coordination in supply chain emerging to in supply chain emerging to overcome these obstacles overcome these obstacles

Processes have been an engine of Processes have been an engine of growth in most advanced ECA growth in most advanced ECA countries. countries.

Key Issues / Questions How How importantimportant / / generalgeneral is this is this

process ?process ? Which Which models ?models ? WhichWhich conditions conditions are required ? are required ? EffectsEffects ? ? Who gets the Who gets the benefitsbenefits ? (What about ? (What about

small farmers ?)small farmers ?) Which role does Which role does FDIFDI play ? play ? Implications for Implications for government policygovernment policy

and and international organizationsinternational organizations ? ?

Methodology

Series of case studies, interviews Series of case studies, interviews and surveysand surveys

Different sectors (dairy, cotton, Different sectors (dairy, cotton, fruits & vegetables, …)fruits & vegetables, …)

Different countries across ECADifferent countries across ECA

1. Important ?

Yes.

Farms selling on contract in Central Europe (% of all)

   Farm Comp.

Family Farms

Hungary 1997 94 17

Czech 1999 98 46

Slovak 1999 96 35

Dairy in North Poland ALL dairy companies assist suppliers ALL dairy companies assist suppliers

(farms) through : (farms) through : Input supply programsInput supply programs Credit programsCredit programs Extension servicesExtension services

PART : Bank loan guarantee programs PART : Bank loan guarantee programs

Programs for SMALL and LARGE Programs for SMALL and LARGE supplierssuppliers

Dairy in Bulgaria, Slovakia, Poland Credit Inputs Extension Vet. Bank Total PL 50 67 50 0 50 43 1994 SK 0 0 83 17 17 23 BG 9 18 9 0 0 7 PL 83 100 83 17 83 73 1998 SK 17 17 83 17 33 33 BG 45 64 18 18 18 33 PL 83 100 83 17 83 73 2002 SK 100 33 83 17 50 57 BG 82 91 73 18 36 60

CIS

5 country study : 40% of agri-food 5 country study : 40% of agri-food processors offers credit to suppliersprocessors offers credit to suppliers

Kazakhstan cotton : 71% of cotton Kazakhstan cotton : 71% of cotton farmers contracts with ginner, with farmers contracts with ginner, with assistance packagesassistance packages

How Important ? SugarSugar sector : 80 – 90 % of CEEC sugar sector is sector : 80 – 90 % of CEEC sugar sector is

FDI, using contracts & farm assistance programsFDI, using contracts & farm assistance programs

DairyDairy & oilseeds& oilseeds sector : significant FDI, and sector : significant FDI, and most companies implement programs, with most companies implement programs, with strong spillover effects on domestic companiesstrong spillover effects on domestic companies

SupermarketsSupermarkets : Some, but not generally : Some, but not generally

After 1998 : VC in After 1998 : VC in RussianRussian food chain by food chain by domestic investments from outside agriculturedomestic investments from outside agriculture

KazakhstanKazakhstan : grain trading companies investing : grain trading companies investing upstream; cotton ginning : contracting mostly upstream; cotton ginning : contracting mostly with small farms, ...with small farms, ...

2. Multiple Models & Motivations

Commodity specificCommodity specific Transition-stage specificTransition-stage specific

Securing basic suppliesSecuring basic supplies Quality !Quality !

Many constructions (simple & Many constructions (simple & complex)complex)

Key is “Non-traditional” design Key is “Non-traditional” design (also e.g. Warehouse Receipt (also e.g. Warehouse Receipt Systems)Systems)

Reasons for Contracting – CEE  Czech Slovak Hung

Contract price higher 12 10 10

Avoid price uncertainty 6 21 33

Guaranteed sales 60 50 43

Immediate payment 7 11 3

Easier to get credit 0 0 9

Contract - inputs or TA 10 6 2

Other 4 2 0

Reasons for Contracting Kazak Cotton Farmers

Agri-business Motivations for Vertical Integration

Early stage : Early stage : SecuringSecuring basic basic suppliessupplies (ex: pre-finance, inputs, (ex: pre-finance, inputs, …)…)

Advanced : Upgrading Advanced : Upgrading qualityquality of of supplies (ex: technical and supplies (ex: technical and management assistance, management assistance, investment loans, loan guarantees, investment loans, loan guarantees, …)…)

Supermarket Assistance to farms

Available evidence indicates that Available evidence indicates that modern retailers introduce similar modern retailers introduce similar packages “if they have to” to packages “if they have to” to secure quality supplies. E.g.secure quality supplies. E.g. Central America (Berdegue et al)Central America (Berdegue et al) Croatia (Reardon et al)Croatia (Reardon et al)

Transition Region is Special Collapse of farm output and livestock Collapse of farm output and livestock

numbers creates discrepancy between numbers creates discrepancy between processing capacity and supplyprocessing capacity and supply

History of poor qualityHistory of poor quality

This makes it a “SUPPLIER’s MARKET” This makes it a “SUPPLIER’s MARKET” (compared to other regions)(compared to other regions)

Some Examples of More Complex Models

Integrating Multiple Stages : INTERBREW (Brewing

Multinational) Core business = brewingCore business = brewing Forced to vertically Forced to vertically

integrate to ensure quality integrate to ensure quality malt/barley/seedmalt/barley/seed

General strategy applied General strategy applied differently in different differently in different countries b/c of local countries b/c of local conditionsconditions

Bring in co-foreign Bring in co-foreign investors to assist with non-investors to assist with non-core activities and set up core activities and set up farm assistance programsfarm assistance programs

Programs interlink marketsPrograms interlink markets

Brewing Co.

Malting Co.

Barley farm

Seed supply

Proces./Retail – guaranteed supplier loans: JUHOSUKOR in Slovakia

& KONZUM in Croatia

Retailer/processor Retailer/processor provides loan provides loan guarantees for guarantees for bank loans to bank loans to supplierssuppliers

Retail/Processing Co.

Bank

Farm

Dairy Processor Becomes Financial Institution: DANONE in Romania

Processor takes Processor takes on banking on banking function:function: provides loans provides loans

to farms to farms based on based on

business plans business plans takes collateraltakes collateral

Provides payment Provides payment guarantee for guarantee for input suppliersinput suppliers

Processing

Bank Input Supplier

Farm

Lending with distributed risk: RABOBANK - SPVs

Financial institution Financial institution is foreign investoris foreign investor

Special purpose Special purpose vehicle (SPV) to vehicle (SPV) to distribute risk equally distribute risk equally among partnersamong partners

Ex. where group of Ex. where group of small farmers formed small farmers formed cooperative to cooperative to participate in SPVparticipate in SPV

Processing co.

Bank Input Supplier

SPV Farm

3. Contract Enforcementis essential for ANY model

Crucial to make VC sustainable Crucial to make VC sustainable

Not obvious: Many cases and Not obvious: Many cases and stories where contract enforcement stories where contract enforcement problems undermines VCproblems undermines VC

Private enforcement mechanisms Private enforcement mechanisms can be more important than public can be more important than public institutionsinstitutions

4. Effects Important Important DirectDirect Effects : Effects :

Enhanced QUALITY (& higher prices)Enhanced QUALITY (& higher prices) Increased PRODUCTIVITYIncreased PRODUCTIVITY

(eg CIS study)(eg CIS study)

Important Important IndirectIndirect Effects: Effects: SpilloversSpillovers Contract replication by other Contract replication by other

companiescompanies Farm assistance replicationFarm assistance replication Household level spilloversHousehold level spillovers

Change in yields in Central Europe 1989-2000

Change in QualityDairy in North Poland 1996-

2001

Household Spillover Effects

Reduced risk (guaranteed price Reduced risk (guaranteed price for contracted crop) in absence of for contracted crop) in absence of insurance marketsinsurance markets

Improved access to credit (cash Improved access to credit (cash for contracted crop) with for contracted crop) with imperfect capital marketsimperfect capital markets

Increased productivity of non-Increased productivity of non-contracted activities, through contracted activities, through improved management and better improved management and better input useinput use

5. Foreign investment (FDI)

Conceptually, no need for FDI Conceptually, no need for FDI Empirically: Empirically:

FDI is driving forceFDI is driving force for contract for contract innovationsinnovations

DomesticDomestic spilloversspillovers are important are important Several exceptions: FIG investments Several exceptions: FIG investments

(Russia, Kaz), Cotton Kazakhstan(Russia, Kaz), Cotton Kazakhstan Crucial factor appears Crucial factor appears access to outside access to outside

financefinance (and management strategy) (and management strategy)

6. Will small farms survive ?

Key concernKey concern

Lots of stories and intuitionLots of stories and intuition

Usually based on little evidenceUsually based on little evidence

The Key Concern

Modern supply chains (or Modern supply chains (or “The “The supermarket revolutionsupermarket revolution”) will ”) will push a large share of farmers, in push a large share of farmers, in particular small farmers, out of particular small farmers, out of the market as they fail to meet the market as they fail to meet the requirements to sell to these the requirements to sell to these chains (“The supermarkets”)chains (“The supermarkets”)

The Key Concern

Small farmers may ‘fail to make the Small farmers may ‘fail to make the grade’ because :grade’ because :

1.1. Fixed component in transaction Fixed component in transaction costs makes it more costly to costs makes it more costly to deal with many small farmers deal with many small farmers than with a few large farmsthan with a few large farms

2.2. Small farms are constrained Small farms are constrained financially (internally and/or financially (internally and/or externally) for making necessary externally) for making necessary investments investments

Evidence ?

Many stories but little ‘hard evidence’Many stories but little ‘hard evidence’

What exists suggest thatWhat exists suggest that We should take this concern We should take this concern

seriouslyseriously But the But the realityreality is much more is much more

complex and nuancedcomplex and nuanced than than assumptionsassumptions

Evidence – part 1 Interviews with agri-food companies Interviews with agri-food companies

confirms preference for larger suppliersconfirms preference for larger suppliers Specialized wholesalers and supermarkets Specialized wholesalers and supermarkets

prefer to work with (relatively) large FFV prefer to work with (relatively) large FFV producers in Croatia (Reardon et al 2003) producers in Croatia (Reardon et al 2003)

Danone and Megle in Bulgaria and Danone and Megle in Bulgaria and Romania have strategy focused on >20 Romania have strategy focused on >20 cow farms cow farms

CIS study finds 60% of processors have CIS study finds 60% of processors have minimum size for some of its farm minimum size for some of its farm assistance programsassistance programs

Evidence – part 2 Examples of company programs to Examples of company programs to smallsmall

farmers being quite farmers being quite successfulsuccessful. Eg. . Eg.

Croatian F&V suppliers to Croatian F&V suppliers to supermarketssupermarkets

Kazak cottonKazak cotton Polish and Romanian dairy Polish and Romanian dairy

e.g. Friesland Romania works with e.g. Friesland Romania works with 40,000 small farms through 1,000 40,000 small farms through 1,000 collection centers; contracts include collection centers; contracts include farm assistance packagesfarm assistance packages

Impact on Loans and Investment Small farms in Polish Dairy sector

Size (# of cows)

Invests (% of total)

Uses loan to invest (% of A)

Uses dairy loan

(% of B)

Uses bank loan

(% of B) A B C D

1-5 52 54 41 50 6-10 78 51 43 70 >10 92 74 43 75 ALL 76 58 43 69

Impact on small farms – Poland dairy

Evidence – part 2

CIS study finds that processors do not CIS study finds that processors do not discriminate on size for providing discriminate on size for providing basic programs (agronomic support, basic programs (agronomic support, physical inputs, prompt payments, …)physical inputs, prompt payments, …)

Both Polish dairy study and CIS study Both Polish dairy study and CIS study find that FDI companies are not more find that FDI companies are not more likely to cut small farms as suppliers likely to cut small farms as suppliers (the opposite)(the opposite)

More importantly Modern dairy companies focusing on Modern dairy companies focusing on

high-quality market (incl retail sector) high-quality market (incl retail sector) tend to assist small farms; compared to tend to assist small farms; compared to market channels targeted to informal market channels targeted to informal and low quality sales which do notand low quality sales which do not

In Lithuania, all credit which small dairy In Lithuania, all credit which small dairy farms get is through the dairy farms get is through the dairy companies (cannot get access to bank companies (cannot get access to bank loans or public assistance, incl SAPARD)loans or public assistance, incl SAPARD)

Why work with small suppliers ?

In some cases processors have In some cases processors have no choiceno choice : : small farms represent most supply (eg small farms represent most supply (eg Poland, many Balkan countries, Poland, many Balkan countries, Transcaucausus, Kyrgyz, …)Transcaucausus, Kyrgyz, …)

Eg. Romania: 95% of dairy farms have 1-2 Eg. Romania: 95% of dairy farms have 1-2 cows.cows.

=> Small Farm Paradox ?=> Small Farm Paradox ? ““processing companies stressed that processing companies stressed that

willingness to learn, take on board advise, willingness to learn, take on board advise, and a professional attitude were more and a professional attitude were more important than size in establishing fruitful important than size in establishing fruitful farm-processor relationship” (CIS study)farm-processor relationship” (CIS study)

Supply Chain Revolution or Evolution ?

Several factors suggest that the Several factors suggest that the impact of the supermarket impact of the supermarket revolution on farmers, including revolution on farmers, including small farmers, may be less small farmers, may be less dramatic in some contexts, and dramatic in some contexts, and may have positive effects in may have positive effects in transition countriestransition countries

A. Supermarket is part of chain

For vast majority of farm output there is For vast majority of farm output there is no direct link with supermarkets: FFV is no direct link with supermarkets: FFV is 15-20% of ag output. Most farm produce 15-20% of ag output. Most farm produce (milk, grains, sugar, cotton, etc.) is (milk, grains, sugar, cotton, etc.) is processed before it reaches retail sector. processed before it reaches retail sector. The impact on these farms will be indirect The impact on these farms will be indirect through the food processing sector.through the food processing sector.

The effects may be more similar to that of The effects may be more similar to that of FDI in food processing. These effects have FDI in food processing. These effects have been positive in several cases for small been positive in several cases for small farmsfarms

B. Farm structure is mixedShare of large farm companies (% land use)Share of large farm companies (% land use)

SlovakiaSlovakia 9090

Czech RepCzech Rep 7474

HungaryHungary 4545

RomaniaRomania 1818

CroatiaCroatia 55

PolandPoland 1515

RussiaRussia 8585

C. Next step in major changes

Agricultural restructuring in Agricultural restructuring in transition countries (Output, trade, transition countries (Output, trade, employment, FDI, food industry employment, FDI, food industry restructuring, ….) has been restructuring, ….) has been dramatic over past 15 yearsdramatic over past 15 years

Revolution or evolution ?

Change in ag employment 1998-2001Change in ag employment 1998-2001

Revolution or evolution ?EU – CEEC trade in ag and food productsEU – CEEC trade in ag and food products

1988-20011988-2001

D. Retailers and vertical coordination may play positive role for key weaknesses

Key weaknesses of ECA farms :Key weaknesses of ECA farms : Shortage of finance for Shortage of finance for

investmentsinvestments Quality Quality Access to high value marketsAccess to high value markets

Retail investments and coordination Retail investments and coordination with supply chains may assist farms with supply chains may assist farms in these areasin these areas

7. Implications for policy

Create right conditions for Create right conditions for business investment business investment

Competition policy !Competition policy !

Competition is VERY Important

Induces horizontal spillovers and the Induces horizontal spillovers and the spread of farm assistance packages spread of farm assistance packages

Constrains (potential) rent extraction in Constrains (potential) rent extraction in chain chain

E.g. Kazak cotton story: competition E.g. Kazak cotton story: competition among processors for suppliers induces among processors for suppliers induces assistance programs, collection center assistance programs, collection center investments, etc.investments, etc.

Bad Policies are Worse than Bad Weather

VC may survive defaults due to VC may survive defaults due to unforeseen and one-time events (eg unforeseen and one-time events (eg bad weather in Kazakhstan)bad weather in Kazakhstan)

However, inappropriate government However, inappropriate government intervention may destroy VC intervention may destroy VC Eg Ukraine in 1990sEg Ukraine in 1990s

Implications for investments and projects TraditionalTraditional Public goods : eg Public goods : eg

rural electricity (Azerbaijan), rural electricity (Azerbaijan), rural roads (Romania), …rural roads (Romania), …

NewNew instruments: Focus on instruments: Focus on Chain Finance, Chain Finance, Quality & Bringing small farmers Quality & Bringing small farmers

‘on board’ ‘on board’ Example Example

Finance The Chain

Warehouse receipt programsWarehouse receipt programs

LeasingLeasing

Reverse FactoringReverse Factoring

……..

How to benefit small farmers ? Bring / Keep them in Bring / Keep them in

=> LOWER TRANSACTION COSTS=> LOWER TRANSACTION COSTS

Ensure fair distribution of rentsEnsure fair distribution of rents

=> EMPOWER THEM=> EMPOWER THEM

Reduce Transaction Costs Lower Lower transporttransport costs (eg improvement of costs (eg improvement of

rural infrastructure)rural infrastructure)

Reduce Reduce number of transactionsnumber of transactions by by intermediary institution between farm and intermediary institution between farm and processor/input supplierprocessor/input supplier collection points collection points

Milk (ex Poland, Romania, …)Milk (ex Poland, Romania, …)F&V (supermarkets in Latin America, … F&V (supermarkets in Latin America, …

farm associations, but need farm associations, but need instrument/incentive system to ensure instrument/incentive system to ensure homogenous (and high) quality homogenous (and high) quality

……..

Empower the (Small) Farmers

Stimulate ASSOCIATIONS of farms Stimulate ASSOCIATIONS of farms Bargaining with companiesBargaining with companies Lobbying the governmentLobbying the government

Stimulate COMPETITION in the chain (input suppliers, Stimulate COMPETITION in the chain (input suppliers, processors, traders, …)processors, traders, …)

Organize INDEPENDENT institutions for product quality Organize INDEPENDENT institutions for product quality assessmentassessment

Quality Control and Rents in Kazak Cotton Chain

Extra payments for clean cotton ? NO Extra payments for clean cotton ? NO (99%)(99%)

Fines for ‘dirty’ cotton ? YES (100%)Fines for ‘dirty’ cotton ? YES (100%) Is your cotton mixed with that of other Is your cotton mixed with that of other

farmers ? YES (100%)farmers ? YES (100%) Can you inspect quality of processed Can you inspect quality of processed

cotton from your seed cotton ? NO (97%)cotton from your seed cotton ? NO (97%) Who assesses the quality of your Who assesses the quality of your

cotton ? GINNER’s LAB (100%)cotton ? GINNER’s LAB (100%)

Quality Control and Rents in Kazak Cotton

The end