The Development Impact of Small and Medium Enterprises:Lessons Learned from SEAF Investments

V O L U M E I I : C A S E S T U D I E S

Acknowledgements

SEAF gratefully acknowledges the Department for International Development of the United Kingdom, the Ford Foundation of the United States, and the State Secretariat for Economic Affairs of Switzerland, which provided grants to make the study possible. Special thanks are due to all SEAF investors who have provided resources to SEAF’s funds to invest in some 210 companies worldwide. Their continuous support has enabled SEAF to carry out its commercial and developmental mission. This report has prepared by a team of staff from SEAF headquarters in Washington DC and SEAF country offices for the relevant case studies. The team consists of MinhChau Nguyen (leader), Genta Arovas, Davis Broach, Hector Cateriano, Lyubomira Buresch, Peter Righi, and Nam Pham (consultant). Professor Stephen Smith from George Washington University in Washington DC provided SEAF with the conceptual framework on facilitating and assessing the poverty alleviation impacts of SME assistance, and worked with SEAF staff on one of the field trips to Peru. The authors gratefully acknowledge the support from Bert van der Vaart and Mildred Callear who have guided the team in preparing the report. Special thanks are due also to our research team: Rachel Rochat, Sondra Albert, and Sam Sezak, and our editor: Rachel Weaving.

Table of Contents Artima (Supermarket Chain, Romania)

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Fideos Coronilla (Organic and Gluten-Free Pasta and Snack Producer, Bolivia)

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Ken-4 (Meat Processor, Bulgaria)

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Molino (Grain Mill, Peru)

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PPZP (Pig Farm, Poland)

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Printop (Industrial Ink Producer, Peru)

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Symbio (Organic Produce Distributor, Poland)

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Tambo Inca (Flour Mill, Peru)

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Telezimex (Electronic Components Distributor, Romania)

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Victoria Classics (High-End Clothing Manufacturer, Peru)

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The financial rates of return and economic rates of return for the companies profiled are based on the actual financial statements of the companies, the companies’ projected figures for the future years, interviews with company employees and other stakeholders, and publicly available economic and financial data. Company financial statements are the responsibility of company management. SEAF works with company management to improve the integrity of financial reporting. Select companies have annual IAS or local audits. Where audits are performed, data is adjusted as necessary to conform to audited results. In cases where the companies did not have projections, SEAF staff did their best to project the data needed for the model based on their knowledge and data availability from the past performance. SEAF and its representatives expressly disclaim any representations or warranties, expressed or implied, as to the accuracy of the future results. Past performance may not be indicative of future performance. See Volume I, Main Report, for more information on the methodology used for the case studies, as well as an analysis of the aggregate results.

Prepared August 2004 by the Small Enterprise Assistance Funds, Washington, D.C.

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Romania—Artima

Introduction Artima Retail Investment Company (Artima) owns and operates supermarkets in the Banat and Transylvania regions of northwestern Romania. These regions contain approximately 50 percent of Romania’s total population of 22 million. Although Artima’s headquarter offices are located in Timisoara, one of the primary cities in the region, its current nine supermarkets are located in secondary cities with population sizes between 50 and 200,000. These towns and cities are without many of the conveniences of the more modern cities in Romania, while Bucharest and other major cities in Romania are rapidly joining Europe’s level of development. The total market for fast moving consumer goods (FMCG) in Romania is approximately €5.5 billion, with modern retailers making up only 11 percent of this market. Artima began its operations in 2001 with approximately US$ 2 million in invested capital. During the first year Mr. Banu (the main owner) and his partners opened three supermarkets, achieving €1.88 million in revenue. In 2002, the Romanian fund managed by SEAF, the Trans-Balkan Romania Fund (TBRF), invested US$ 650,000 in Artima. Artima opened three more stores. In 2003, Artima opened an additional three stores financed by the investment from the Growth Fund (also managed by SEAF), and a follow-on investment by the TBRF. To date, Artima has built nine supermarkets in the following cities:

Lugoj Supermarket All locations are considered to be at the most convenient locations in their respective towns, given their central location and the amount of foot traffic. For example, in Resita the supermarket is built in the most densely populated part of the city and in Lugoj it is built in the center of the town, and in Deva the location has been leased on the ground floor of Ulpia Commercial Center (in the very the center of the city) for 25 years. Artima has been able to obtain these premium locations with relatively attractive conditions largely due to the lack of any other significant economic activity in these cities and Artima’s willingness to finance infrastructure improvements as part of its investment. Artima’s investment objective is to become the first (and most strategically located) supermarket in secondary cities in the Transylvanian and Banat regions. The level of economic activity and development in these cities is generally large enough to support a supermarket with 800 square meters of selling space and approximately 5,000 stocking units (SKUs) but too small to support another supermarket. Provided

Location Pop. Date Opened Resita 93,000 Oct. 2001 Lugoj 49,000 Nov. 2001 Deva 76,000 Nov. 2001 Sannicolaul* 38,000 Jun. 2002 Caransebes* 41,000 Aug. 2002 Oradea 220,000 Nov. 2002 Bistrita 100,000 Jun. 2003 Baie Mare 200,000 Nov. 2003 Petrosani 60,000 Dec. 2003 Total: 517,000 - * Includes population in nearby areas.

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that the store locations are run efficiently, the investment thesis is that a larger international or domestic chain will ultimately purchase these locations at a good return for the Fund’s investors. Development Impacts The quantified results of SEAF’s development impact analysis are presented below.

The sections below describe the impacts on each stakeholder, which were quantified to reach the above. Private Returns The Artima investment plan calls for significant investment over four years in fixed assets as the supermarket chain establishes its potential market share growth, several years of organic growth where Artima increases its market share and operational efficiency to steadily increase cash flows, and finally a terminal value for the shareholders when the business is sold to a strategic buyer. Artima has rapidly grown from US$ 2 million in revenue in 2001 to approximately US$ 18 million in 2003. As the company grew and obtained larger buying power, gross margins have gradually increased from approximately 16 to 19 percent. Although unprofitable in the first two years of operation, Artima’s increasing capital base has resulted in net cash profitability in 2003. Artima’s success factors among its clientele are the location of the supermarkets, the range of products it made available, the quality of the goods on offer, and the modern retail experience that was previously non-existent. While SEAF’s investments in Artima are still less than two years old, SEAF believes that the financial rate of return to its investors will be substantial. There have already been three strategic parties who have approached Artima with an interest in purchasing the company.

2003 Statistical Revenues in 2003 (US$) 18,358,746 Gross margin (%) 19 Net margin (%) - 1 No. of employees 271 % of low - skilled workers 39 Avg. wage for low - skilled (US$) 77/m SEAF investment to date (US$) 3,096,525 Realized proceed s to SEAF (US$) 106,188 Realized and unrealized (US$) 3,973,353 Multiple of capital invested 1.28

Financial & Economic Financial rate of return (%) 12 a Economic rate of return (%) 122 b Benefit/cost rat io (0% discount) 6.81 c Benefit/cost ratio (10% discount) 3.94 c

a return to the company b return to society c additional dollars generated for society from every dollar invested in the company in constant terms

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Impacts on Labor Artima’s impact on labor is quite significant due to both the number of employees hired and the level of training they receive. As an example, each supermarket requires approximately 50 employees, 15 of which are unskilled. The remaining 35 employees are considered skilled or semi-skilled, not necessarily based on their previous job history, but due to the training and skills that are required on the job. This training is critical to Artima as the skills required for the jobs do not exist on the market. As an example, of the approximately 50 employees hired per store, about 35 are sent for one to three weeks of training at another Artima store to learn retail skills such as cashier management, product outlay and display, and inventory control. Skills necessary in the butchery and bakery departments, for example, may exist on the market, but have to be upgraded in order to comply with Artima’s standards and industry best practices. Artima is therefore responsible for a significant amount of training, in addition to the simple hiring of employees. Employment Since its start up in 2001, employment in 2002 reached 568 people. Direct personnel costs were eight percent of revenue, about twice the industry average in a market where salaries are generally low. Due to the complexity of Artima’s business and the need for a sizeable headquarters presence to prepare for the scaling up of the business, the first few years of operations have required a 60/40 split of skilled to unskilled employees. Due to economies of scale at headquarters, once the network is fully built out, growth of unskilled labor versus growth in skilled labor should grow at a ratio of two to one. Wages Artima’s wages for its skilled labor, on average €2,100 per annum, are roughly at or near the average skilled wage in the economy, while its unskilled labor wages began above the minimum wage and are trending downwards toward equilibrium. Therefore, beyond 2002-2003, SEAF is not counting any direct salary contributions to the measured total development, economic or financial impact. However, because Artima, unlike many of its competitors, operates in the official economy, it pays the necessary taxes associated with employment in Romania. Black market operators—which in Romania represent the bulk of the food-retailing sector—avoid the taxes. A table of these taxes follows below.

Personnel Taxes: Levies on the employer: 24.5% Social Insurance 3.5% Unemployment Funds 0.75% Working Book 7.0% Health Insurance 0.5% Risk Funds 36.25% Total Levies on the employee: 9.5% Social Insurance 6.5% Health Insurance 1.0% Unemployment Funds 17.0% Total

Quantifiable Non-Salary Benefits Although wages for all employees are held at or near the market standard at Artima, there are a multitude of non-salary benefits paid to employees on a regular basis. These non-salary benefits are generally employed throughout Eastern Europe in order to increase the employees’ monthly current income without incurring even higher pension and health contribution liabilities to the government by the employee or

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company. At Artima these benefits include €30 meal tickets per employee per month and at-work meals for all employees, travel allowances, apartment rent, and cash bonuses based on performance at the management level, which can equal up to three times the monthly wage. On average these benefits total an additional €1,200 per employee premium and constitute the total quantifiable non-salary input to the economic impact for purposes of the developmental impact study.1 Artima has pioneered a performance incentive scheme, previously untried and unfamiliar in the context of the local labor market, where wages previously were never tied to performance. The structure encourages managers to focus on money-saving and money-earning aspects of store performance by sharing a portion of the savings with the manager. The scheme has the potential to be applied at the operational store level for specific tasks, although it is at present too unfamiliar to be introduced to the total labor force at Artima. The basic parameters of the scheme are as follows:

Monthly Performance Measurement – Store Level Value (€) Base Salary 200 Revenue meets turnover target 50 OPEX held within 4% of turnover 200 Theft and shrinkage rates below 1% of turnover 100 Inventory revolves less than 21 days 50 Out of stock % held at target minimums 200 Total Potential Wages 800

Training Prior to their employment by Artima, skilled managers were generally either self-employed entrepreneurs or worked at the management level in a large company that was closed under privatization, while unskilled labor and skilled labor below the managerial level were previously employed in small shops or on the black market at below the minimum wage. Regardless of their background or level, each and every employee has undergone intensive training, as modern retail is virtually unknown in the cities where Artima builds its supermarkets. According to one store manager (verified by others), training is generally split into three categories: work culture, professional environment, and retail skills. Hiring decisions are based on the employee’s willingness to be a productive employee and determination. Because of the work culture created under a state-controlled economy and the contraction in the Romanian economy since then, everyone goes through training on work culture and expectations, as well as how to manage working in a professional environment where productive teamwork is crucial. Training for skilled employees generally takes one to three weeks on-site at another store location, while store managers require up to three months of intensive training. Besides the elements of work culture and professional environment and other retail skills that are taught less formally on the job, skilled employees work with their counterparts at other store locations to develop the necessary skills in cash management, inventory control, the information technology system (which tracks the flow of goods from warehouse receipt to point-of-sale), and theft control. Store managers are trained in the above areas in greater depth, as well as skills in personnel management, performance measurement and tracking, and budgeting, among others. Training continues on a monthly basis to go over new procedures and/or retail trends. In addition, store managers conduct their own training programs at the store level through weekly meetings with the chiefs of each department. These costs are accounted for through the opportunity costs of the employees’ wages and are included in the quantified developmental impact analysis. 1 Quantifiable non-salary benefits are annualized for total employment during store expansion years and do not necessarily match fiscal year financial statements.

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In 2003, Artima began a formal training program for its top managers which requires six managers to take a different MBA course at the local university at a cost of €600-€800 per course. About twice a week, attendees take the material that they have learned in the courses for the week and meet together with the other managers in the course and teach each other what they have learned. Mr. Banu states that teaching while learning at the same time is the best way to ensure that the managers absorb the material and is the most effective way to spread the cost of the training among as many managers as possible. Artima does not fund any manager seeking a full MBA degree, opting instead to offer individual courses to as many managers as possible. In 2003, the total cost of this hybrid formal/informal training for one academic semester was €4320, and it is expected to total €10,000 in projected years. In addition, the development impact analysis factors in a 20 percent premium on skilled employees’ wages as the retail skills that the employees learn are not present in the local labor market and are therefore highly prized and marketable. To date, however, Artima has lost only three upper managers, one voluntarily due to relocation to Bucharest, and two dismissed due to corruption. Consumer Surplus Artima provides a wider range of choice of products previously unavailable in the local market, and often at a higher (and more consistent) quality. Artima prices its goods at the same level as the current market, maintaining an average gross margin of 15-16 percent,2 compared to average margins of more than 25 percent in developed markets. Even when Artima’s margins are lowered, such as in Oradea, store prices often remain above local market prices. This is primarily due to the prevailing level of black market competitiveness, as unregistered markets avoid the 19 percent VAT and other taxes, and, due to the cash economy, permitting smaller shops to report lower sales to authorities. It is difficult to measure the effect of quality or wider assortment of goods in an accurate and quantifiable way. It is also not clear how highly consumers currently value quality versus cost due to current household economic conditions. However, it is clear that Artima is providing local consumers with choices as to reliability of product presence and quality, range of selection, and convenience. It is also raising the standards of quality associated with food products, even if doing so may in the short run result in incremental costs to the business. For example, Artima’s butchery follows all health and sanitary conditions for meat produce, including daily veterinary inspections—which accordingly adds to the total cost of providing meat products. Therefore, Artima is not price competitive on meat products, as the black market does not bear these costs. Artima’s meat sales are below expectations and are often a loss-producer when spoilage and price reductions are factored in. Despite what would appear to be definite contributions to consumer welfare, SEAF has not made any quantitative estimate for such factors. It is reasonable to suppose that the surplus values provided by Artima are substantial, given the significant growth in turnover per store over time. Therefore, the total quantified developmental impact for Artima is likely understated. Producers of Complimentary Goods Artima stores have impacts through at least two complementary economic agents, although more that were not captured in the study may exist. These are the security service providers, responsible for in-store security at each location, and local construction companies, responsible for the construction of new stores. 2 Total gross margin averages 17 percent due to other income, such as listing and slotting fees.

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Zen Security According to a regional manager, Zen Security is a security services provider with approximately 1000 employees, with a 9-10 percent market share in Northwest Romania. Its employees are generally former sportsmen who have a strong work ethic and now face limited employment opportunities. Each Artima store requires four security agents for each of the two shifts, as well as one supervisor who is usually responsible for two to three stores. Artima signed a services contract with Zen to provide overall security at each store location that is based on a fixed monthly rate, minus the cost of goods for all inventory theft above the targeted 0.74 percent.3 Inventory theft is monitored through the difference between all goods sold according to the point-of-sale information system, minus adjustments due to spoilage, and the hand-count inventory performed daily on a revolving basis throughout the month. The contribution to development impact is based on Artima’s security costs, with an assumption that Zen has a 12 percent gross profit margin. An employment effect is added with the (conservative) assumption that 10 percent of Zen’s operational costs are due to personnel. Local Construction Providers Artima’s construction costs average about €1 million for each new store location. Of this, 50 percent are direct on-site construction costs, and another 30 percent are indirect costs that are required to renovate the location or make other infrastructure improvements that are not necessary for store operations but are required due to obligations in the concession contract with the city. The remaining 20 percent are materials and equipment that are imported. The development impact of these complementary providers is estimated at a 12 percent gross profit margin on the approximately €800,000 in total local construction costs. The employment effect is based on the assumption that 20 percent of these costs are due to labor. While not absolutely necessary, the 30 percent of construction costs that are required as part of the city concessions for the locations are often in interest of both the city and Artima. These costs may be due to road improvements, park development, and renovation of at least part of the commercial center,4 and are further explained under the section Neighbors/Community Development. Other minimal complementary economic agents that were deemed too minimal to include in the analysis are the costs of employment advertisements in local newspapers and pick-up fees charged by local banks on cash stored on location from operations. More generally, one can see how supermarkets like Artima have important multiplier effects on the local economy. Profits of Local Suppliers Based on Artima’s total inventory records, it was only possible to confirm that 1.41 percent of total store revenue is derived by local producers. This figure may be under-reported due to distributors that purchase local goods, but operate on a national scale. Total national suppliers of Romanian goods amount to about 25 percent but are not included in the development impact for conservative reasons. Local producers are generally able to maintain a 25 percent gross profit margin, though informal produce suppliers rarely include the costs of their own labor into the cost of goods. Although the quantifiable impact is minimal, Artima’s introduction of bar coding into the local supply chain has had significant, if not quantifiable, effects on local producers. Previously, with informal markets and the non-existence of retail shops managing their operations though an IT system, bar coding was unknown and unnecessary to sell goods in the local market. However, Artima’s IT system requires bar coding on all products. To affect this system, Artima has helped local suppliers create their own bar codes

3 Total inventory shrinkage is target at 1-1.1 percent. The difference is due to spoilage and returns. 4 This is a multi-storied building in the centre of town that formally sold most of the commercial goods under the planned economy.

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for their products. Although strictly in Artima’s commercial interests, the add-on effect has been to open up the nationwide market to local suppliers who are now able to participate in large distribution networks. In addition, the IT system that Artima employs was developed in conjunction with a Romanian software company who has since employed the ERP system in other retail companies as the market grows and as retailers become more sophisticated in Romania. These undoubted benefits are not quantified in the analysis. Competition and New Entrants Despite the many positive influences Artima has on the local economy, it is also clear that Artima has a negative impact on those enterprises or individuals that were previously selling FMCG’s in these cities and regions. Artima’s success will therefore directly affect existing employment, especially so in the informal markets, although less so in small shops. Artima estimates that a new store takes about 15-30 percent of the previous market size5 upon entry to the city, factoring out organic market growth and the market of goods that were previously unavailable. Although no official statistics exist, the estimate is that approximately 100 employees/entrepreneurs in the black market and small shops go out of business when a new Artima store opens.6 According to interviews with Artima employees who were formerly part of the black market employment pool, the average monthly wage was about €25, and often required 6-7 days of labor per week. Combining these factors, there is an annual negative €30,000 adverse impact per new store on employment in the local economy. As our study of the effect on employment concentrates on the “economically inactive” versus the unemployed, official statistics are unlikely to support these assumptions. Our analysis is based on assumptions that were derived from interviews with Artima management and staff. The effect on local unofficial employment must also be counterbalanced with the official employment created by the new store. A new store is the largest commercial business in some of the smaller towns, with roughly 50 employees per store and revenues between €1-3 million per store. Based on Artima estimates derived from employment interviews, almost all of their employees at the store level either previously worked unofficially in the same sector, or were economically inactive. With official employment, not only is the minimum salary almost three times their wages earned in the unofficial economy, but employees also join the national health and pension system and receive the other non-salary benefits. Furthermore, Artima only requires that the employees work five days a week. This factor offsets the original negative impact on employment. As previously mentioned, Artima also pays 19 percent VAT and other corporate taxes and fees on the market share they replace. Neighbors/Community Development Artima makes many infrastructure improvements to the cities as part of its concession agreements. In almost every city where Artima has developed a new location, some type of civic concession has been part of the agreement. A table follows below:

Store Location (City) Civic Improvement per Concession Agreement Resita Refurbishment of central park: e.g., paths and lighting. Lugoj Expansion of parking facilities in downtown area. Deva Rent. Some renovation to Commercial Center. Sannicolau Minor improvements to main road and main intersection. Carensebes Rent. Major renovation of bottom floor in Commercial Center. Oradea Shared 1/3 of the costs of new park in formally abandoned land space,

construction of playground.

5 This figure is a range of the total market share estimated with the black market and official figures. 6 Though registered, small shops are included in this analysis as most employment in the shop is unofficial.

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Bistrita Minor infrastructure repairs. Baia Mare Development of abandoned land space, new parking near bus station. Petrosani Development of abandoned land space for commercial activities, and

enhanced traffic patterns. In many cases, whether Artima takes over abandoned land or underdeveloped commercial space, improvements in the land area around the store location improve traffic flow (car and foot) and increase the visibility of the location. For example, the park developed in Oradea around the store was formerly an abandoned pit between high-rise housing developments. This area, which was bypassed by traffic between the surrounding high-rise housing, has been transformed into a large green space and playground that not only enhances the quality of life of nearby residents, but is a gathering and crossing point for residential traffic, which improves store revenue. Improvements to commercial centers revitalize a formerly popular commercial area in the center of the city, which in turn re-energizes the city center. Although not completely commercially necessary for the development of new stores, Artima is willing to absorb these extra costs as part of the agreement for a multi-year concession since these costs improve traffic flow and visibility of the location. These non-quantifiable benefits that the Artima investment brings to the community, including the improved quality of life factor due to infrastructure improvements in the center of the city, increased assortment, and higher quality goods, are not included in the development impact tallies. Other Social Benefits The main other social benefit from Artima’s business is the financial contribution to the government and local financial institutions. As detailed in the model, Artima’s contribution to the government comes less from profit taxes (for the first few years, Artima has a tax credit due to its losses), but through other contributions such as unreclaimed Value Added Taxes, import taxes, other corporate taxes, contributions to the National Pension Fund, and other social taxes, including excise taxes. While these contributions may be taken for granted in developed economies, Romania only recently was granted the status of a market economy by the US government, and still has not passed the hurdles for the same designation from the European Union. In addition, the government must undertake significant fiscal reform in order to qualify for eventual EU membership. Artima, by replacing the market share of non-tax paying businesses, thus makes substantial contributions to the normalization of Romania’s fiscal budget one city at a time. There are also benefits such as financial institutions’ profits made from loans to Artima, but due to the lack of data, these benefits are not included. One Store’s Story: Resita With a population of about 93,000, Resita is the capital of Caras-Severin county (highlighted in the map to the right), located in the southwest region of Banat. Official unemployment in the province is 9.7 percent, higher than the regional average of 8.6 percent and the national average of 8.3 percent. It is difficult to estimate the true status of unemployment due to the dropping out of those who are no longer “actively searching,” but approximately 40 percent of the population is employed. This is largely due to the closing of many businesses in the iron and steel sector due to the restructuring of the economy and privatization. Resita was the first of the Artima stores to be built with the invested capital of the entrepreneur, Mr. Banu, as well as the know-how value received from an Austrian colleague who is a director of another supermarket chain in Eastern Europe. Although unemployment is high, several factors influenced the decision to build the store in Resita: the location that city authorities offered Artima was in the center of the city, the immediate catchment area is the densest of the city and, in Artima’s judgment, could support

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a supermarket, and the relatively high percentage of disposable income which the poor in Romania expend on FMCG. These factors have generally been used in evaluating all other locations for Artima. Resita Supermarket As part of the purchase agreement for the land, Artima promised the city that it would repave the paths in the central park and install lighting, which was intended to revitalize the city center and improve night-time safety. Artima was willing to undertake this investment because it was likely to increase traffic flow to the store. Although it is impossible to measure the effect of the improvement in sales without a test case, the store became profitable in the second full year of its operation In a relatively small city, the improvements undertaken and the new supermarket generated much publicity and interest. On opening day, the entrepreneur and his management team were unprepared for the reception they received. While the “official opening” with city officials and speeches was coming to an end in order to make way for the grand opening to the public, a large percentage of the city population had swarmed against the glass windows and doors to get in. Although there were no problems other than some theft due to security guards’ inability to see past the large number of people in the aisles, the managers were afraid that they would need help in crowd control when they first saw the public’s reception. The only retail experience of most of the population had been in poorly lit shops with limited selection, or in outdoor markets. The display, assortment, and even the shelving and cooling equipment were curiosities, which generated large traffic. Since then, Artima has worked to distribute flyers with promotional pricing which has gone some way toward improving sales. It is estimated that Artima has a 30 percent market share (perhaps 15 percent with the black market factored in), but makes up 80 percent of the market for all food stamps. Resita employs 44 people in the city (not including eight Zen security guards), 23 of which are skilled and 21 unskilled. The workforce, including at the corporate level, is relatively young, between 19 and 50 years old, and is predominately female, with 9 male and 35 female employees. The first two store managers in Resita’s history have been promoted internally in Artima and now work at the corporate level. The current store manager, O., was previously self-employed, and has some financial and investment background which has proven useful given the financial analysis performed at the store level to ensure that targets are met. O. stated that the competition for a job at Artima is very high with multitudes of applications per open position, but that hiring is actually very difficult at the skilled and unskilled levels due to the lack of a working culture among most of the applicants. Compared to many other businesses active in the region, Artima is seen as a large company that provides a sense of stability to employment. All the employees we spoke with state that the benefits of working in the official economy was the main reason they sought employment at Artima, with the assumption that it would also be at a higher salary, though in one case an employee did not know the size of her monthly wage until she received her first wage. The skills they have learned range from customer service, teamwork, to certain aspects of performance reporting that are then aggregated at the end of the month at the store and corporate level.

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Bolivia—Fideos Coronilla

Introduction Fideos Coronilla S.A. (Fideos) is located in Cochabamba, Bolivia. The company produces highly nutritious certified organic and gluten-free pasta and snack products using Andean grains mainly for export markets.

Bolivia, long one of the least developed Latin American countries, made considerable progress in the 1990s toward the development of a market-oriented economy. Successes under President Sanchez de Lozada (1993-97) included the signing of a free trade agreement with Mexico and becoming an associate member of the Southern Cone Common Market (Mercosur), as well as the privatization of the state airline, telephone, railroad, electric power, and oil company. The country also found rich reserves of natural gas ready for export. However, due in large part to the current political turmoil, Bolivia has not realized the potential latent in these achievements, and today, more than 60 percent of Bolivians live in poverty. Moreover, there is a high level of poverty inequality between the urban area (poverty rate of 53.94 percent) and the rural area (83.41 percent).1 The average adult gets only 7.7 years of schooling, and Bolivia has the highest infant mortality rate (58.4 deaths per 1000 births) in the region. The official national unemployment rate2 is 8.69 percent in 2002, but this figure is misleading, as the level of underemployment is extremely high.

Mr. Guillermo Wille founded Fideos Coronilla in 1972 to produce high-quality pasta for the Bolivian market. The company grew rapidly over the next fifteen years, tripling its production capacity. Since then, competition (especially from small, informal producers that do not pay taxes and social security payments) has increased significantly for wheat pastas, squeezing margins and leaving the relatively small plant unviable in this area. The company changed course in 1995 and began its research and development activities. Under the direction of Ms. Marta Eugenia Wille, the founder’s daughter, Fideos has developed its own methods of crystallizing gluten-free pastas and popping snacks. Fideos manufactures gluten-free products that are suitable for people who suffer from Celiac Disease, a serious allergy to the protein part of wheat, rye, barley, oats and related grains. People suffering from this disease can damage their small intestines if they consume gluten. Most pasta and snacks contain gluten. Therefore, Fideos’s products have a market niche, including Celiacs and other diet-conscious consumers, such as diabetes.

1 The World Bank—Technical Annex for a Development Credit for the Proposed Emergency Economic Recovery Project to the Republic of Bolivia—Report T7611 BO, December 8, 2003. 2 ILO Statistics on Employment—Online Data for 2002.

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In early 2002, Fideos received a capital investment from SEAF’s Fondo Capital Activo de Bolivia (FCAB), an investment fund that supports small and medium-sized Bolivian businesses with high growth potential. Marta Wille and Fideos’ other shareholders—all direct family members of the founder—chose to work with SEAF because they felt that the participation of an international institutional investor would increase the professionalism and business prospects of the family-run business. Aside from the attraction of receiving capital, the original shareholders also saw the opportunities offered by SEAF’s Business Development Unit (BDU), a sales and marketing group operating in Europe and the United States, to help market Fideos’s brand and expand its markets. Since SEAF’s involvement, accounting procedures have been dramatically improved and the company has achieved the transformation to a stock corporation. Following a SEAF analysis, the company discontinued the production of loss-making pasta lines for the local market and focused instead on producing for export markets. SEAF’s BDU assisted the company in improving its export sales strategy and entering the US market, while Fideos concentrated on an increase in local sales of selected lines of organic snacks. SEAF’s BDU also helped Fideos in repackaging and branding its products, an important component of its foray into various niche markets in the United States. Working through a US broker, SEAF has introduced the products also to more than 150 stores specializing in organic sales in the United States.

SEAF invested US$ 410,000 in Fideos to finance its working capital requirements, strengthen its administrative procedures, develop a marketing plan, and finance capital expenditures to improve its production process. SEAF also helped Fideos to obtain financing of about US$ 350,000 from Cordaid, a non-profit organization from the Netherlands.

Fideos’ organic pasta and snack products

Export to one of the stores in Maryland, USA

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Development Impacts The quantified results of SEAF’s development impact analysis are presented below.

The sections below describe the impacts on each stakeholder, which were quantified to reach the above.

Private Returns Fideos had a difficult time while switching from producing loss-making conventional pastas to produce organic products. After an initial decline in total sales, Fideos’s revenues are estimated to increase by 25 percent from before SEAF invested in the company, and the gross margin went from about 5 percent in 2001 to about 37 percent in 20033. However the real benefits of the investment are expected to come in the next few years as the company increases its exports to Europe and the United States.

Sales of natural and organic foods and beverages are growing worldwide at more than 12 percent, outpacing sales of conventional grocery products by more than 4 to 1. Organic products are experiencing natural growth while headline issues such as trans-fatty acids and the so-called obesity epidemic have challenged consumer confidence in mainstream goods.

Conventional food, drug and mass merchandise retailers now account for more than 75 percent of natural products sales, with these mainstream retailers aggressively adding natural products to their shelves in order to capture some of the rapid growth the industry has enjoyed for more than two decades. However, the natural supermarket channel is still the destination spot for consumers and manufacturers alike. The average sales per store in a natural products supermarket outpaced that seen in a conventional supermarket by as much as 20 to 1 across categories and brands.

SEAF’s BDU has assisted Fideos in developing and implementing a market entry strategy for its branded products in 2003. The BDU worked with Fideos’s clients and designers to develop appropriate packaging

3 The 2003 estimates are annualized based on actual results for the first three quarters.

2003 Statistical Data Revenues in 2003 (US$) 367,193 Gross margin (%) 37 Net margin (%) -26 No. of employees 29 % of low-skilled workers 64 Avg. wage for low-skilled (US$) 85/m SEAF investment to date (US$) 410,000 Realized proceeds to SEAF (US$) 42,880 Realized and Unrealized (US$) 350,379 Multiple of capital invested 0.85

Financial & Economic Benefits Financial rate of return (%) 21a Economic rate of return (%) 51b Benefit/cost ratio (0% discount) 11.73c Benefit/cost ratio (10% discount) 5.32c

areturn to the company breturn to society cadditional dollars generated for society from every dollar invested in the company in constant terms

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and advertising materials. In addition BDU located and brought on board a US distributor “Health Flavors” from Brewster, NY to carry Fideos’s products in natural food stores on the East Coast of the United States. The BDU has started an aggressive marketing plan to drive distributors’ initial sales via the Celiac community who are the niche consumers for Fideos’s products.

The company expects to reach the million-dollar mark by 2005, as increased marketing increases the demand for the product and the unit costs in the production of goods continue to decrease. The financial rate of return is projected at 21 percent over a ten-year period. Impact on Workers Wages and Benefits Fideos has a high proportion of low-skilled workers (64 percent of total employees), 95 percent of which are female. Low-skilled workers at Fideos receive a wage higher then the minimum wage in Bolivia. The minimum wage in Bolivia was approximately BS 430 per month (US$ 70) in 2003, whereas the worker earning the lowest monthly wage at the company received BS 500 (US$ 71). Most low-skilled workers at Fideos earn about BS 600 (US$ 85) per month. High-skilled workers are mainly managers and administrative staff. Fideos had to lay off about 12 workers in 2002 as the production of conventional pasta was terminated, which was a very difficult decision for the owner as most workers have been with the company from the beginning.

In addition to salary, workers receive significant benefits. Workers with children under the age of one receive milk subsidies at a cost to the company of about US$ 1,500 a year per employee. The long-term benefit of proper nutrition during the first year of life has a substantial impact on the health and welfare of children. The company also invites a medical student from a nearby hospital several times a year to speak to the workers about symptoms and prevention of various diseases. Workers are given vaccinations and pregnant women receive pre-natal education. As a result of this medical education program, the number of workers who miss work because of illnesses has decreased.

Fideos also contributes to social security and state health benefits for its workers. Increased wages and healthcare have made workers at Fideos healthier than the average Bolivian and have increased the chances for their children to lead healthier and more productive lives. Training Fideos’s owner, Marta Eugene Wille is very dedicated to the welfare of her employees. The company is a family business, and the employees feel like they are part of the family. One of the areas that distinguish the company from others is the owner’s dedication to improving the employees’ skills. She identifies good workers with a propensity to learn and helps them to further their formal education. This approach has resulted in her ability to retain good employees—most of the employees have been with the company for 8-10 years.

Fideos, together with a number of other SMEs in Cochabamba, contributes about one percent of its total payroll to a local organization called INFOCAL. INFOCAL offers technical training, including mechanical training, which is a very important part of Fideos’s production process. Some workers are also trained by IDEA and FUNDES, business support services in the region, which require Fideos to make a payment for their services. On average, Fideos has spent about US$ 3,600 per year on training its workforce, or about one percent of its gross sales in 2003.

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Training and Caring for Employees—The Story of FIDEOS The owner’s (Marta) commitment to her employees is demonstrated through an experience of one of the women who works at the company. This woman came to Fideos with no skills and got a job bagging finished products. Marta and her production manager started noticing that this worker was very interested in mechanics and was able to do some minor repair work on the machines. She encouraged the woman to enroll in a two-year technical engineer course and paid for her education. Now, this employee is earning a much higher wage and is able to educate her children. Marta is also very strict about quality and standards, which is extremely important in the food industry. Marta trains her employees in food hygiene regularly. In addition, she organizes weekly meetings on Saturdays to educate workers on various topics related to health and hygiene. Marta is also committed to investing in the human capital development of her workers’ families. She gives out yearly awards to her workers’ children to motivate them to excel in school. For the past two years she was proud to present the award to the daughter of an illiterate worker. Marta and the company strongly believe that when you educate a woman, you educate a nation, and she therefore dedicates a considerable amount of time and resources toward educating employees and promoting the education of her employees’ children.

Impact on Suppliers

Fideos’s basic raw material inputs (wheat, rice, quinoa, and cañawa) are produced in Bolivia by associations of low-income small farmers. Fideos purchases quinoa, a traditional Andean grain, from local cooperatives, benefiting about 6,800 farmers. Through these cooperatives, farmers receive 90 percent of the sales price, with the remaining ten percent reserved by the cooperative for administrative and marketing costs. Fideos also uses cañawa, a rare Andean grain that is grown only in a remote and isolated area. Prior to Fideos’ purchases, the grain was produced mainly for local consumption.

To purchase the products, the company’s representatives have to travel two hours by foot and donkey to reach the area. Currently, the amount purchased is relatively small, about two tons, but these purchases benefit at least 30 families. With export market expansion and the benefits of branding, however, it is expected that Fideos will be able to increase its purchases and help improve the living standards of even more of the poorest of the poor in Bolivia.

Fideos is a certified organic producer. Apart from products containing cañawa, which is not currently available grown organically, Fideos maintains organic certification for all its export products through Imo Control, a Swiss certifying organization. This certification requires strict quality control and the exclusive use of certified organic raw material in organic products. The certification also demands that the production facility produce no toxic residuals. In addition, Fideos is guided by HACCP (Hazard Analysis and Critical Control Point) norms. The owner has had to import organic rice as she is not able to purchase the product locally. However, she would like to be able to work with farmers to certify local rice production should grants be made available.

Fideos—Helping poor farmers to export quinoa and cañawa

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Impact on Consumers

Fideos’s products are virtually all exported and therefore we do not include the benefits to consumers in the analysis. Fideos began to experiment with selling organic snacks to school programs. However, this is relatively insignificant at this stage and therefore we do not take the benefits into account in the development tallies.

Impact on Competitors and New Entrants

Fideos does not currently face local competition although international competition is significant. The main challenge for Bolivian producers is the penetration of export markets, which is out of reach for many smaller producers without assistance from an international partner such as SEAF. The success of Fideos in selling organic snacks in domestic markets might encourage new entrants. However, benefits for these stakeholders are not included in the analysis.

Impact on the Rest of Society

Environment: IMO certification demands that a production facility have no toxic residuals. In accordance with this standard, Fideos does not have any residuals other than water to clean equipment and five percent of the raw materials that are sold as animal feed to local farmers.

Community development: Fideos provided resources to the local training facility INFOCAL (see page 13) which benefits her employees as well as other SMEs’ employees. Through various health training programs, Fideos has contributed to the employees’ welfare to a point beyond that needed to maintain a high standard for a food production company. Finally, the attention on health and education of her employees’ children has a longer lasting effect on poverty reduction.

Local taxes: Fideos paid approximately 28 percent of total revenues in various taxes. This is significant for a small company that has not made much profit for the last three years.

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Bulgaria—Ken-4 Introduction Ken-4, AD (Ken) is located in the lush countryside in central Bulgaria. Stara Zagora is a town of about 150,000 inhabitants, about 225 kilometers from the capital city of Sofia. In 2001, the average GDP per head of US$ 1,434 for the region of Stara Zagora was about US$ 300 less than the national average of US$ 1,718. The unemployment rate for the region is approximately 17 percent. Rumen Nonov, an engineer by training, established Ken, a meat processing facility, in 1992 and became its General Manager. Two friends, Rumen Kuzmanov, the Production Manager, and Plamen Isionov, the new company’s Sales Manager, joined Mr. Nonov. Mr. Kuzmanov is a trained veterinarian who had worked for a number of years as a veterinary inspector at a local pig farm and was the only one of the principals with some knowledge of meat processing. While Mr. Isionov had little practical experience at the time, he had traveled extensively internationally and had an engaging personality that helped to build good relations with clients and suppliers.

Ken was established in Stara Zagora and began operations in the early 1990s and grew rapidly with the infusion of capital from SEAF and the provision of technical assistance to develop its marketing and sales strategies. The company approached SEAF in 1995, when the entrepreneurs realized that they needed long-term capital to finance their bold business plan for the construction of a new sausage manufacturing facility to replace what they had built around a trailer and a shed. SEAF agreed to purchase 49 percent of the company shares for US$ 125,775, and additionally provided a loan of US$ 175,000. The objective of this investment was to acquire land, construct a new facility, and purchase additional processing equipment. The facility would allow the company to double its production capacity. Despite the clear plan, Ken experienced unforeseen difficulties in 1996 when Bulgaria entered into a period of severe political crisis and economic decline (GDP plummeted almost 10 percent in 1996 alone), hyper inflation, dramatic currency devaluations (the exchange rate went from 14 leva to the US dollar to 2300 leva to the US dollar over a two-year period), and a banking crisis that resulted in many bank liquidations. During this period, Ken focused on staying on top of its market and its finances. As a result, Ken did not build the new plant as planned. These many setbacks had to be financed with more loans and equity from SEAF. In July 1999, after its third round of financing, SEAF had invested almost US$ 600,000 in both equity and debt. Twelve months later, in June 2000, the processing plant was completed with a total of 2,800 square meters and a capacity to produce 12 tons of sausages and other processed meat products per day. In addition to providing the critically needed capital, SEAF provided technical assistance. SEAF arranged a visit from a marketing consultant from the Canadian volunteer executive organization to advise the company on its marketing and distribution strategy. SEAF provided a company with extensive help with its accounting and reporting systems. SEAF also arranged a visit by a German expert in meat processing

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and machinery to consult the company on organizing the production more efficiently, installing the necessary machines and equipment, and implementing better controls of materials and inventory. In March of 2001, SEAF exited from its investment in Ken, selling its shares and debt to the management for a total of US$ 1,113,759, which is almost twice the amount invested. This generated a financial rate of return of 26 percent, a commendable result given the economic conditions during most of SEAF’s investment period. As a testament to the strong relationship SEAF built with the company, the entrepreneurs provided SEAF with extensive data, even two years after the exit, for this case study. The rest of the case study focuses on the various development impacts of Ken, including a brief examination of the effect of Ken’s existence and business activities on poverty alleviation in Stara Zagora, Bulgaria. Development Impacts The quantified results of SEAF’s development impact analysis are presented below.

The sections below describe the impacts on each stakeholder, which were quantified to reach the above. Private Returns The project has been successful in terms of both private and broader economic returns. Ken has survived a severe economic crisis and has become a profitable small venture. Since late 1995, when SEAF became its partner, the company’s capacity has increased almost tenfold. The company is the leader in Stara Zagora in modernization of production facilities for sausages. Before Ken was established, sausages were produced either in the big and inefficient (and unprofitable) state-owned meat processing enterprises, or in the basements of individual micro-entrepreneurs. In both cases, either the quality of the product or its price, or even both, were compromised. Due to the new capital and

2003 Statistical Data Revenues in 2003 (US$) 5,952,381 Gross margin (%) 25.6 Net margin (%) 14 No. of employees 125 % of low-skilled workers 88 Avg. wage for low-skilled (US$) 105/m SEAF investment to date (US$) 594,299 Realized proceeds to SEAF (US$) 1,113,759 Realized and unrealized (US$) 1,113,759 Multiple of capital invested 1.87

Financial & Economic Benefits Financial rate of return (%) 26a Economic rate of return (%) 37b Benefit/cost ratio (0% discount) 16c Benefit/cost ratio (10% discount) 5.94c

aReturn to the company breturn to society cadditional dollars generated for society from every dollar invested in the company in constant terms

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the strategic technical assistance from SEAF, as well as the entrepreneurial spirit of the managers, Ken became competitive in both quality and price. As a result, Ken was able to realize rapid growth. Ken’s products are mainly fresh sausages and fresh cuts of beef and pork. Ken also produces and sells small quantities of deli durable (smoked/cooked) sausages.

Impacts on Labor SEAF’s investment was not only profitable financially, but also socially. The total employment in Ken increased from 16-17 people in 1995-1996 to 125 and more employees in 2002. The increase was driven primarily by an increase in employees in the unskilled labor category. Around 70 percent of the employees can be categorized as unskilled, i.e., the lowest paid employees. Their primary responsibilities are loading and unloading trucks, cleaning the plant facility, shaping sausages, and packing the prepared sausages in cases. The remaining workers are semi-skilled or skilled. The company’s employees are equally divided between men and women. In addition to its full-time employees, the company also hires seasonal or temporary workers. Based on past data, we have estimated that the wage bill of the full-time workers represents 50 percent of the total wage bill of the company.

In 2002, Ken employed 125 employees, most of whom were relatively young (95 percent were less than 45 years old). There are three layers of personnel in Ken’s human resource structure: The top management consists of five key managers, who are responsible for the strategy, marketing, finance, and general day-to-day management. Below them are 40 supervisors who manage 80 unskilled and semi-skilled workers (who are referred to as common workers and workers directly involved in the production process). The General Manager explained that they need manual labor to stuff and cut the sausages in order to preserve the high quality.

Table 1: Ken’s Employment Growth 1996 2002

number of employees Skilled 3 10 Semi-Skilled 1 27 Unskilled 12 88 Total Full-Time 16 125

Ken's Product overview

Sausage95%

Deli 4%Meat cuts

1%

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None of the employees interviewed had an education level lower than high school. The employee turnover rate is extremely low—one to two percent of the total workforce for the period 1996-2002 (excluding employees who were let go during the trial period). The high unemployment rate in the region and the better-than-average labor conditions, including stable and even increasing salaries at Ken, were responsible for the low employee turnover at Ken. Ken posts information about open positions in local head hunting companies and at the municipal department of labor. Many employees had heard about Ken before applying to the advertised open positions from family and friends. There is a one-month trial period for the new hires during which the supervisor assesses their skills. If the employee is approved, the company invests in training the new hire for a semi-skilled position.

Wages and Benefits The company’s wage bill represents about 90 percent of its SG&A, and we have assumed that 50 percent of the wage bill is attributable to the full-time employees. However, in the overall cost structure of the company, the labor cost is a small fraction representing approximately five percent of the total cost of production, with utilities and materials making up the rest. In 2002, Ken spent US$ 294,000 on salaries, social security and benefits—six percent of the total production cost (materials, administration, utilities) of US$ 4.7 million. Ken paid considerably higher salaries in 2002 than the market, and has had a history of increasing its wage level rapidly (see Table 2). In 2002, the skilled workers were paid on average BGL 1,000 (US$ 476) per month, the semi-skilled were paid BGL 800 (US$ 381) per month, and the unskilled were paid BGL 220 (US$ 105) per month. The weighted average monthly salary paid to employees in Ken is estimated at BGL 778 (US$ 371), which is almost three times higher than both the national average monthly salary of BGL 272 (US$ 130) and seven times the national minimum salary of BGL 110 (US$ 52) in 2002. Ken’s policy of systematically training the best of its employees to become semi-skilled or even skilled employees has not only raised a number of individuals and their families from poverty; but has also allowed the company to grow its employees’ skill base as the company has grown itself. Ken exemplifies what SEAF has seen in many of its other investments: an SME is often unable to hire the best of the labor market, but will hire initially unskilled labor, which it will then work to train, and will then pay increasing salaries to in order to retain valuable employees.

In addition to wages, workers at Ken receive a number of non-wage benefits, determined by law or by the labor agreement. Some benefits are unique to Ken only. For example, each worker receives sausages and other meat products produced at Ken. Given the structure of household consumption in Bulgaria where

Low-skilled employees at Ken

Table 2: Average Annual Wage 1996 2002

in constant USD Skilled 898 5712 Semi-Skilled 659 4572 Unskilled 552 1260

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about half of the wages are spent for food, this non-salary benefit is significant (valued at about 4-5 percent of the unskilled labor wage). Training Ken applies high hygienic standards at its meat processing facility. Thus, hygiene and sanitation training is one of the key elements of all new employee training. The training is provided in-house and is part of the supervisors’ responsibilities. The rest of the training program consists of equipment use and maintenance, as well as actual sausage making. Despite Ken’s investment in state-of-the art meat processing technology, the making of sausages is perceived to be an art and is done manually so that the high quality and good aesthetic appearance are preserved. This practice explains the high proportion of low-skilled employees (70 percent of total employees) in the company. In addition to the in-house training, Ken provides some of the skilled personnel, in particular accounting staff, with formal training. This training is provided by outside consulting agencies at a rate of BGL 5,000 (US$ 2,500) per person. In 2002, the company dedicated BGL 10,000-12,000 for the training of its skilled personnel. Except for the skilled personnel training, it is difficult to estimate the value of the training for the unskilled, and especially what the employees perceive as the value. The accountants stated that the training is extremely valuable because they would not be able to maintain their professional knowledge about developments in Bulgarian accounting laws and regulations without it. Similarly, the unskilled workers, especially the ones at the lowest end of the pay scale, have expressed similar opinions, that the training and knowledge received gave them marketable technical skills. Ken has a very high reputation in Stara Zagora, and former experience at Ken is considered a powerful aid in finding employment at other manufacturing facilities. Given the above findings through interviews and surveys, we attribute a value of 50 percent of unskilled wages for the skill mobility premium in the analysis. Impacts on Consumers According to the Bulgarian National Statistical Institute (NSI), food is the largest expenditure for the average Bulgarian consumer. In 2002, approximately 50 percent of household income was devoted to purchases of food. The diet of Bulgarians traditionally has consisted of domestically produced bread, vegetables, cheese, yogurt, meat and meat products. During the 50-year period of socialist government, the Bulgarian diet changed to include different types of processed meat from large state-owned meat processing factories. However, during the transition to a market economy, the consumer purchasing power diminished significantly and the production and supply of meat and sausages declined. As shown in the table below, the consumption of meat declined by 28 percent, from 31.4 kilograms in 1992 to 22.6 kilograms in 1998 per person—demonstrating the depths of Bulgaria’s economic difficulties. Even more dramatic was the collapse in meat products consumption, which plummeted by 40 percent during the same period. Table 3: Meat and Meat Products Consumption

Source: NSI, Sofia, Bulgaria

1992 1993 1994 1995 1996 1997 1998Meat (kg) 31.4 30.2 25.8 25.3 24.9 17.3 22.6Meat Products (kg) 18.1 15.9 15 12.9 11.9 8.1 10.8

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Furthermore, the patterns of consumer demand became more varied, being heavily influenced by family income. Wealthier people demanded higher quality, durable sausages, which the poorer people could afford on special occasions only. The private meat processing industry grew from virtually nothing in 1997 to almost 70 percent of the total processed meat supply in 1998, and Ken was a big part of this movement. The company had positioned itself to create brand recognition within the Stara Zagora region. With added advertising and an expanded distribution network, Ken captured market share in other regions such as Plovdiv, the second largest city in Bulgaria with a population of 600,000 people. Ken has also added sausages with different flavorings, adding a dimension of choice to Bulgaria’s consumers. The total impact on consumers is difficult to quantify with precision, but consumers benefited from increased quality and variety of sausages and other meat products, as well as a readily available supply after years of shortage. Impacts on Suppliers Ken sources its raw materials both locally and internationally. Ken had four local suppliers, which supplied Ken with fresh meat within a day of Ken’s requests. Ken also purchased frozen meat in bulk quantities from South America and the United States at a lower cost, depending upon Ken’s working capital availability to finance bulk purchases. However, in 2000-2001 Ken switched to buying the bulk of its meat (frozen meat, casings, spices and other materials) from local importers. While there wa s a positive impact on the local importing firms—the annual expenditure for raw materials in 2002 was BGL9.3 million (or over US$ 4.4 million)—the withdrawal of Ken as a major customer of local suppliers of fresh meat, spices and other materials could have had a negative impact on local suppliers. It can be argued that local suppliers were therefore induced to produce higher quality meat products as a market requirement, and Ken needed such higher quality meat to serve its market. Moreover, Ken relies entirely on local and national distributors for the distribution of its sausages. Thus, Ken is an important source of revenue for these distribution companies. While it is obvious that Ken benefited local supply chain participants by representing a sophisticated and reliable purchaser of their products and services, due to the lack of data, the net impact on the suppliers has not been quantified.

Impacts on Competitors and New Entrants The Bulgarian meat processing industry is fragmented, with many small family-owned meat-processing operations. Overall, meat-processing capacity is greater than the market demand. There are two potential new entrants, both of them in northern Bulgaria, with a green-field investment in a Ken-type sausage factory.

The total sales volume of meat products in Ken’s market in Stara Zagora and Plovdiv is about 50 tons per day according to the Ministry of Agriculture. According to Ken’s management, Ken has 80 percent of the market for fresh sausages in the area and is expanding to surrounding markets. Table 4: Ken’s Major Competitors

Sources: SEAF research, company sources

CompetitorCapacity

(tons/day)Sales per (tons/day) Notes

Rokar OOD 3-5 1 Has own pig farms; produces short and long shelf life sausages.

Trapezitsa OOD 6 1.5 Produces all meat products.Sinanitsa OOD 5-6 2 Produces all meat products.Piko OOD 7-8 4-5 Specializes in chicken-based

sausages and smoked meat cuts.

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In addition to the above competitors, Ken has two major competitors that are national players with average daily sales in the range of 20-60 tons. Ken can potentially capture market share from its competitors, and therefore can be viewed as having a negative impact on competitors. However, Ken’s dedication to quality and customer service as a way of capturing market share cannot be viewed as producing a negative impact on the competitors. Instead, Ken provides a good example of how a thoughtful business plan, dedicated management team, excellent marketing strategy, and a modicum of risk capital can lead to leadership in the market and profits for the owners and stakeholders of a small company. Ken’s leadership is furthermore demonstrated by the fact that it has not cut its prices to take market share from its competitors. On the contrary Ken has introduced products that are five percent more expensive than the products offered by its competitors and has focused on its quality and building its brand. We have not estimated any impact on competitors, due to the lack of data on Ken’s demonstration effect (positive) and increased market share effect (negative), albeit it in a growing market. Impacts on Neighbors Environment Although Ken is located in the industrial zone of Stara Zagora, away from the major residential areas, it is still a light manufacturing enterprise with some potential to have impact on the environment. However, Ken’s production facility complies with Bulgarian laws and minimizes this potential for impact. Furthermore, the factory’s proximity to a working class neighborhood, where many of its employees live, reduces the pollution that might be associated with the employees’ commuting. More generally, we do not have sufficient data to quantify the net impact. Community On the positive side, Ken has invested in a water sewage system and infrastructure for electricity that is used by three to four other companies (total of 300 employees) along the road in the industrial zone. Ken’s total investment in this infrastructure was BGL 150,000 (approximately US$ 75,000) over two years. The estimated positive value per year over 10 years is US$ 7,500 and is included in the analysis. Impacts on the Rest of Society Bulgaria began the road to a European market economy on November 11, 1989. The Bulgarian economy transitioned through multiple governments with substantially different economic policies and views on private sector development. The agriculture and food processing sectors were hit hardest by the resulting uncertainties. The meat processing industry in particular suffered, with many state-owned meat packing and meat processing plants shutting down due to a lack of a raw materials supply, high debt loads, the lack of capital, and poor management.

In this setting, Ken emerged as a successful and dynamic private meat processing plant. The success of Ken not only benefited its financiers and employees, but also the national and local governments.

Ken pays a 24 percent profit tax to the government out of its annual earnings. In addition, Ken pays up to 45 percent social security tax on the annual gross salary of its employees. The payment covers employees’ health insurance, pension fund, and unemployment fund. We have included these benefits in the analysis.

Poverty Impact Ken’s existence has impacted the poverty in the region in two ways. The first is the impact of steady and even increasing wages on local poverty. Ken’s growth and development has a required high level of

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unskilled labor, while at the same time it has afforded a significant number of its unskilled workers the opportunity to become semi-skilled and even skilled workers. The company has hired unskilled labor, identified promising workers in their trial period and pays them almost twice the national minimum wage in order to retain them. Ken has also invested in training the unskilled (and other) employees and has given them new, valuable and marketable skills as explained in the section on training on page 20. The second way Ken has impacted poverty in the region is by providing workers with formal employment, which has given employees and their families access to health and social security. The average household size in Bulgaria is 3-4 people. Many people live in the urban areas in small apartments with their extended families so that they are closer to employment opportunities. Ken employees use their wages and benefits to support family members and to buy the goods and services offered in their communities. We have not quantified these benefits to society in our study. Therefore, the real economic benefits are likely to be significantly greater than those that we have quantified on page 17, which are already substantial. Employment in a Transition Economy—A Story from an Employee Poverty in Bulgaria has taken on a very subtle face after the fall of communism. Previously, most people had an apartment and a good education, but could not convert their property and intellectual assets into capital easily. SEAF came to the market as a risk-sharing partner to help entrepreneurial people turn existing assets into capital and create sustainable jobs and livelihoods for their neighbors. This was the case of Ken, a start-up venture by three friends that grew into a regional player in the meat processing industry and gave employment and hope to over 120 workers in an economically depressed region. After finishing vocational school/college, Rose (real name not disclosed), a native of Stara Zagora, was forced to relocate to Northern Bulgaria in order to get a job at the nuclear power plant in Kolzoduy. But the state-owned nuclear power plant cut back on its administrative personnel and Rose was laid off. Three months later, Rose came back to her hometown with no job and no savings. Rose had two years of professional training after high school, but could not find a permanent job opportunity. She was trying to make ends meet by selling vegetables at the local market and by working as a waitress and a bartender. But most of her jobs lasted for three months on average and she had to go back and register with the Local Labor Exchange again and again with no real success. In 1999, Rose was interviewed at Ken, where she was offered an entry-level factory job as a common laborer. That was four years ago. Now, at the age of 32, she is a shift supervisor of a team of 15 sausage production workers. She takes pride in her work and in the factory that is recognized by the town’s business community as a model employer. Ken provided her with on-the-job training and mentoring to ensure both the quality of the factory’s products and her development as an employee. Rose received training in meat processing technology, food safety, and hygiene. And now she herself trains the new employees in these skills. With her monthly take-home salary of BGL 750, well above the average for the country, Rose is able to support herself as well as her mother who lives with her in a small apartment in the city. Although Rose is not married, she would like some day to have a family and is using her savings to buy an apartment. Rose says that her job at Ken has had an impact that extends beyond a sustainable livelihood in terms of employment security, good pay, and social benefits. “Ken gave me a community of people who cared for each other, a positive philosophy for life, and self-esteem.”

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Peru—Molino

Introduction Agroindustria Molinera Señor de Huanca S.A. (Molino) is located in Ayacucho, Perú. Felix Ramos and Pelagia Cayo, a husband and wife, who had extensive experience in milling grains, founded the company in 1978 as a joint stock company that was majority-owned by Mr. Ramos. In 1999, the ownership was transferred to Mr. Jamie Marroquin, an Ayacucho entrepreneur, who now owns about 45 percent of the company’s shares.

Ayacucho is 2,400 meters above sea level in the Central Andes, 575 kilometers east of Lima. The city has a population of approximately 550,000. The province is dedicated primarily to agriculture, including crops such as wheat and barley, as well as livestock. An airport and a good network of paved roads serve Ayacucho.

After a period of severe economic distress in the 1970s and 1980s, Peru has grown modestly from a very low base since 1996, with a few dips and uncertainties. In 2002, the overall Peruvian economy attained GDP growth of 5.2 percent and was expected to grow by 4-4.5 percent in 2003 (EIU August, 2003). Despite the country’s growth, Ayacucho remains one of the poorest regions in the country. Average per capita GDP in 2002 was less than US$ 865 compared to the national average of US$ 2,030. In addition, health services and education in Ayacucho lag significantly behind the rest of Peru. Chronic malnutrition plagued 64.2 percent of the population in 2000 and there were only 1.3 doctors per 100,000 inhabitants, while the rest of Peru had 55.6 doctors per 100,000 people. The share of the local population with un-met basic needs was 83.3 percent in 2002 compared to the national share of 56.8 percent. More than 50 percent of the Ayacucho population lives in extreme poverty1compared to 28 percent of the total Peruvian population. The official national unemployment rate was 8.9 percent in 2002 and 9.4 percent in 2003. However, these figures do not include underemployment, which constitutes a serious problem.

1 Extreme poverty is defined as less than one US dollar a day per capita.

Farms supplying products to Molino in Ayacucho Cooking lunches for farmers in Ayacucho

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The Company

Molino’s founder, Mr. Ramos, learned the milling trade from his father and had a reasonably solid entrepreneurial and business background, having operated his own businesses for over 20 years before SEAF’s first Peru fund invested in his company. From 1982-1984, Mr. Ramos’s mill supplied a large number of clients and became one of the largest grain mills in the region. Tragically, however, Ayacucho was devastated in the succeeding period by the terrorist movement (the Shining Path or sendero luminosa). The death squads and the lack of protection from the armed forces drove most of the local population away. Industry and infrastructure throughout the province were destroyed, and the terrorists disrupted all social and economic activity. Entrepreneurs such as Mr. Ramos were threatened with death, and in fact Mr. Ramos’s right eye was blinded by a stray shot fired in one of the incursions by the terrorists.

In November 1984, the mill closed its doors, and its owners fled from the Shining Path to the town of Abancay. Despite having lost everything they had, the principals managed to raise enough capital to buy new equipment and begin milling in their new town. Their products were sold locally as well as in cities as far as 800 kilometers away including Cuzco, Huancayo, and Ica. Mr. and Mrs. Ramos transported the product themselves using their own 40-ton truck, supplying other former inhabitants of the Ayacucho province who grew up consuming these grains but who had also been displaced by the Shining Path. With the beginning of pacification under President Fujimori, the principals moved back to Ayacucho. They began operating Molino there in July of 1993. In 1997, the owners came to SEAF to seek financing to purchase land and complete construction of a new factory, as well as to renovate an existing building into a modern, sanitary, rationalized production facility. SEAF began investing in the company in 1997 with both equity and debt (US$ 313,000) and held about 64.6 percent of the shares. The investment allowed the company to increase its production and market share by providing a high quality product that was processed under sanitary conditions. In addition, the new factory was built on a road that affords the company convenient access to both the main rural market and the stores through which the products are sold.

After some initial difficulties in the building process and implementation of financial and other controls designed to give the business a necessary degree of transparency, SEAF and Mr. Ramos agreed to the sale of Mr. Ramos’s shares in 1999 to Mr. Marroquin, the manager of another local milling operation. In addition to milling activities, the new owner has diversified the business to food processing and targeted the local government’s food program to feed school children and the local undernourished population. This line of business provides the company with an alternative stable source of income, and at the same time makes the company vulnerable to political interference. The government’s emphasis on local production as a preference criterion for contract award, however, has given Molino a competitive edge over competitors from outside the Ayacucho area.

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Development Impacts

The quantified results of SEAF’s development impact analysis are presented below.

The sections below describe the impacts on each stakeholder, which were quantified to reach the above.

Private Returns

In spite of the difficulty in operating in an unstable environment, the company has been profitable. The gross margin was approximately 30 percent and the net margin was between 13 and 17 percent for the last three years. The future of Molino depends on the government contracts, and thus a very conservative growth projection is used for the analysis. The projected financial rate of return is approximately 6 percent. However, the company has a significant economic impact on the lives of the farming community in Ayacucho as described below. Impact on Workers SEAF’s investment has not only allowed Molino to increase its production and profitability, but it has also had a positive impact on people in Ayacucho. The number of employees has increased significantly, from one person on the payroll and non-paid family members in 1998 to 25 employees in 2003. Most of the workers at Molino are low skilled because the production technique is simple. Even though the company has four distinct product lines (flour, flakes, split grains, and peeled grains), each is produced using the same basic processes: sieving, toasting, mixing, peeling, polishing and milling (except peeled grains). Low-skilled workers at Molino

2003 Statistical Data Revenues in 2003 (US$) 350,385 Gross margin (%) 29 Net margin (%) 13.2 No. of employees 26 % of low-skilled workers 72 Avg. wage for low-skilled (US$) 142/m SEAF investment to date (US$) 312,921 Realized proceeds to SEAF (US$) 215,991 Realized and unrealized (US$) 368,488 Multiple of capital invested 1.17 *at December 2001 when SEAF exited the fund

Financial & Economic Benefits Financial rate of return (%) 6a Economic rate of return (%) 40b Benefit/cost ratio (0% discount) 4.23c Benefit/cost ratio (10% discount) 2.54c

areturn to the company breturn to society cadditional dollars generated for society from every dollar invested in the company in constant terms

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The unskilled workers earn approximately the minimum wage, but the wage premium is actually higher than the minimum wage because the opportunity cost of the workers’ employment is extremely low. Ayacucho has one of the highest unemployment rates in Peru; unemployment and underemployment are estimated at 55.5 percent of the active work force. Therefore, most of the workers at Molino would either be unemployed or barely subsisting in the informal sector were they not employed with the company. Interviews with contract workers indicate that employment opportunities are extremely limited, and many mention that the illicit drug trade and prostitution are the only possible alternatives. In addition to their wages, employees of the company receive health benefits and meals at work. For the analysis of the Molino investment impact, therefore, the national minimum wage has been discounted by 50 percent to reflect the opportunity cost. Molino also uses contract workers for production to meet the variable demand. During peak time, the number of contract workers can be as high as 40 people working in two shifts. Again, given the extremely high unemployment rate in the area, contract workers can be easily mobilized. SEAF interviewed a well-educated woman who works as a grain sorter and earns less than minimum wage as a contract worker. She has a college degree in fisheries; however, she is happy to be employed even on a contract basis doing menial jobs. The number of contract workers varies based upon the requirements of contracts received from the government. Because it is difficult to project for the future, the benefits to contract workers have not been quantified in the analysis. Therefore, Molino’s positive impact on local employment is in all likelihood substantially underestimated.

Molino employs seven high-skilled employees in charge of the administrative end of production. They are paid the market wage and therefore the incremental benefits to them are not included in the analysis. Molino has treated its employees well. In real terms, the wage increase is about 20 percent since 1999 (lack of data prevents SEAF from carrying out the analysis since its investment in 1997). It is also not possible to break down the wage increase by high-skilled and low-skilled categories.

Wage increase (constant US$) 1999 2003

Number of Employees 4 26 Average Wage 838 1,003

Wage increase 1999-2003 20%

Impact on Consumers Consumers in Ayacucho are accustomed to buying milled products at the outdoor markets—in bulk, unpacked, without registered trademarks or brand names, and of questionable quality and purity. Grains were typically sold loose from 50-kilogram sacks and weighed by hand to the customer’s desired

Life of a Contract Worker Ms. E. has been a contract worker for Molino for the last five years. She sifts flour and keeps the factory clean during the down time. She was attending junior high school when her father died and she had to go to work to take care of her mother, and now a seven-year old daughter. She is paid by the hour at about US$ 4 a day, and could earn up to US$ 170 per month during peak periods. She has thought about starting her own micro-business but is afraid to venture in this direction, because she needs regular income. Being a contract worker, she does not have health insurance, and must use her own money or borrow from friends to pay for health costs. Although she would like to have a regular job, she feels fortunate to have found a job with Molino. “The company pays, and pays well, compared to others in town,” she said.

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quantity. The unsanitary conditions found at the milling stage continue through to the actual sale to the end-user. About 30 percent of the small grocery shops in Ayacucho also sold the products in the same manner.

To this practice, variable in quality and convenience, Molino offers local consumers an attractive alternative in providing consistent quality, packaged sanitary products. The products are made from grains cultivated in the region and are a staple of the Andean diet. These products are typically used on a daily basis as ingredients in a variety of dishes and meals. Flour can be milled from one single grain such as wheat or bean, or it can be made from a mixture of different grains. One of the most widely used flour products in the region is siete semillas, which is milled from a combination of seven grains: corn, pea, barley, bean, chickpea, kinua, and kiwicha. Siete semillas is most commonly eaten at breakfast, either plain or dissolved in a hot or cold beverage. It is also used as an ingredient in soups. Single-grain flours are used as ingredients to prepare a variety of foods including soups, baked goods, and bread (for example, a popular bread, chafla, that is made using pea flour).

The flour products provide a healthy source of proteins, vitamins and carbohydrates to consumers whose diets otherwise often lack essential nutrients. Siete semillas, for example, contains between 16 and 18 percent protein. The customary use of these products has created a demand wherever Andean people have relocated after the destruction wrought by the Shining Path. Tens of thousands of Andeans fled to the southern coast of Peru (Ica, Pisco, Nazca, Chincha), where they currently lack access to the milled products they were used to consuming in the Ayacucho province. Since it is not possible to quantify the benefits to consumers from Molino’s production of nutritious and quality finished products, the quantified economic return of the Molino investment is understated.

The company also participates in a program that feeds 100,000 children at school. If these children were not fed at school, it would cost their families about US$1 per day to feed them. This program offers a real incentive for children to go to school, which will have a long-term positive impact on their life. Children in developing countries who have completed primary and secondary levels of education are much more likely to go on to skilled employment and, therefore, receive higher wages than children who drop out.

The benefits for school children in terms of costs to their families have been quantified, but the positive impact of their education has not. Therefore, again, the quantified economic benefits of Molino are understated.

Impact on Suppliers

Molino had a significantly positive impact on local suppliers. The company buys wheat and other grains from local farmers. It deals with approximately 100 brokers and farmers; each broker represents 15-20 farmers. Molino’s purchase constitutes a market receivable, which can then be used as collateral to obtain agricultural loans to increase production. Interviews with farmers indicate that without these orders, they would have sufficient capital to produce only for self-consumption. With the surplus marketed to Molino, the farmers make on average about five percent profit after deducting all interest and fees due to the bank—profits that directly improve the lives of the farmers and their families. The

Farmer’s house in Ayacuho after producing for sales to Molino

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profits on marketable surplus for farmers are counted in the development impact tallies. Although we have not been able to interview the farmers, a Molino representative pointed out to us the improved housing condition of one of the farmers working with Molino as shown in the picture on the previous page. Impact on Competitors

Molino faces some competition from both regional producers and imports. Non-regional competitors procure imported grains inexpensively in large quantity for breweries, and use the surplus to compete with small producers for the government’s food program. Despite the presence of these larger importers, Molino is now the second largest producer in the Ayacucho region, although its supply only accounts for a small part (about two to five percent) of the government’s food program. While Molino’s focus on this segment and Molino’s reliability as a purchaser of local grains are positive impacts, we have not assumed any positive or negative impact on competitors because its market share is still small.

Impact on the Rest of Society

Only taxes paid on earnings have been included in this analysis. No data is available to quantify other impacts. SEAF and its investors in Peru have helped to bring capital to an area recently devastated by local terrorism. In addition, SEAF’s investments have made it possible for rural banks and development institutions to provide loans to the company. Molino’s purchase of farmers’ grains has increased the volume of agricultural loans to farmers from micro-lenders, such as CARE.

The company activities are not harmful to environment. Instead, the business actually creates a sustainable demand for indigenous crops cultivated in the region. The crops do not compete with wild life. However, no benefit has been quantified in this respect for this study. All the machinery is powered by electricity, except the grain toaster, which requires propane gas in addition to the electrical supply. These processes do not produce harmful wastes and pose little or no environmental harm.

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Poland–PPZP

Introduction

Przybkowo Integrated Pig Farm (PPZP) is situated in the village of Przybkowo, 3.5 kilometers Southwest of Barwice. This area is heavily agricultural, and because this territory was formerly German, there is a significant amount of state-owned agriculture. In the wake of Poland’s transition, in 1991, the Przybkowo pig operations separated from the arable portion of the Barwice State Farm, led by the three existing managers, who have been operating PPZP as an independent enterprise since then.

The company’s business thesis was that Polish pig production pre-1992 was inefficient, and that by contracting with a large improved pig genetics breeding company (Pig Improvement Company or PIC, a subsidiary of Dalgety PLC), as well as by implementing careful cost controls, PPZP could breed leaner (less fatty) and healthier (disease resistant) pigs. These pigs could be sold to smaller Polish pig farmers, who could substantially improve their productivity, while benefiting the Polish consumer by turning out a healthier product. Today, PPZP is the third largest pig breeding company in Poland, producing more than 48,000 pigs in 2003.

SEAF made an initial investment in 1992 of US$ 180,000 for 18 percent of the company’s equity, and subsequently made an additional US$ 300,000 equity investment, to take a total of 45 percent of the company’s equity. SEAF helped the principals negotiate the contract with PIC/Dalgety, and at various times has brought in technical and business experts, who have helped the company in cost control and calculation of contributions, as well as various planning functions. SEAF has also arranged visits to EU producers and slaughterers to the factory, which helped PPZP to prepare for the EU accession. SEAF also loaned a substantial amount of money to PPZP at various key points in the company’s existence, for a total investment of US$ 1,194,455.

The village of Przybkowo in Poland

PPZP— a pig farming company

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Development Impacts The quantified results of SEAF’s development impact analysis are presented below.

Note: Because the PPZP case study was conducted in early 2003, figures for 2003 are estimated. The sections below describe the impacts on each stakeholder, which were quantified to reach the above. Private Returns PPZP has been consistently profitable since 1994. Annual revenues have increased steadily from US$ 5 million in 1994 to about US$ 10-11 million in each of the past three years. Net cash flows have increased from less than US$ 1 million in the early/mid 1990s to the range of US$ 1-2 million in recent years. Gross margins have been fluctuating between 30 percent and 46 percent while the average net margin during the period 1994 to 2003 is around 13 percent. The financial rate of return on the project is estimated at 32 percent for the period 1993-2008 based on a conservative baseline forecast. Impacts on Labor The company started, or perhaps more accurately stated, “re-started” in 1993 with 82 workers and has expanded to its current labor forces of 205 workers. Most of the workers are male and the average age is 29, with the youngest worker at 19 and the oldest at 53 years old. 155 workers are unskilled and low-skilled (76 percent of total employees) and about 80 workers (40 percent of employees) receive slightly more than the minimum wage. Their responsibilities are to maintain the farm and to assist their supervisors with various operations. The remaining 50 skilled workers are mid-level managers and supervisors, who manage the pig farm and operate the feed mill and the abattoir. The three main general partners are professionals in the industry. One of the three general partners has a doctoral degree in pig farming and was a visiting professor at Iowa State University. Most of the workers start at the lowest level, usually as temporary workers. After six months, the new hire obtains a permanent position. After receiving further training and demonstrating his or her abilities, the

2003 Statistical Data Revenues in 2003 (US$) 10,446,453 Gross margin (%) 36.9 Net margin (%) 13.5 No. of employees 205 % of low-skilled workers 40 Avg. wage for low-skilled (US$) 234/m SEAF investment to date (US$) 1,194,455 Realized proceeds to SEAF (US$) 1,751,547 Realized and unrealized (US$) 6,235,752 Multiple of capital invested 5.2

Financial & Economic Benefits Financial rate of return (%) 32a

Economic rate of return (%) 54b Benefit/cost ratio (0% discount) 14.19c Benefit/cost ratio (10% discount) 4.89c

areturn to the company breturn to society cadditional dollars generated for society from every dollar invested in the company in constant terms

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new hire is promoted to a skilled position with a higher salary. Mid-level managers and supervisors are trained either by PIC or by the three general partners. Among the attributes that management looks for in new hires are respect for the animals, energy, flexibility, a high school education, and a reputation for no stealing or drinking. They also need to pass a medical examination. Almost all workers live in Przybkowo or its surrounding villages, which have a combined population of about 4,000. Since the employment situation in the area has been dire (present local unemployment is at more than 40 percent compared to a national average of slightly more than 18 percent), workers do not leave the company voluntarily. Nor does the company have any difficulty hiring new workers or retaining existing ones. Wages and Benefits In 2002, PPZP paid a monthly salary of about 900 zloty (US$ 225) for a low/unskilled worker and 1,400 zloty (US$ 350) for a skilled worker. Net monthly income after income tax and social security for a low-skilled worker equals 600 zloty (US$ 150) and for a skilled worker is approximately 1,000 zloty (US$ 250). At the lower end of the wage scale are low-skilled workers who are paid more than the nation’s minimum wage. In contrast, at the higher end of wage scale are skilled workers who are paid below the national average wage in the agricultural sector, but comparatively well for the local region. In 2002, the national average wage for a skilled worker in the agricultural sector was about 1,865 zloty per month while the minimum wage was 800 zloty per month. The opportunity cost this study seeks to measure is the foregone income that workers could have received from other employers. We are using as a proxy for the opportunity cost the nation’s minimum wage. However, the employment situation in Przybkowo area is much more difficult than at the national level. There are virtually no new jobs and the existing jobs may be fragile. Skilled people have a difficult time finding jobs that pay more than the average wage. Low-skilled employees at PPZP are paid higher than the minimum wage. The difference between the average wage low-skilled employees at PPZP and the minimum wage (discounted at the relatively high discount rate of 50 percent given the high unemployment rate in the region) is captured as the benefit for low-skilled workers. As the high-skilled workers are paid near the market wage, no incremental benefits are attributed to this category of workers. In addition to the wages, the company sets aside approximately 100 zloty (US$ 25) per month for each worker for fringe benefits such as discounted products, clothes, transportation subsidies and emergencies. To avoid conflicts of interest and also to prevent external diseases from reaching the pig farm, workers are not allowed to raise pigs at home. Instead, each worker is entitled to purchase two kilograms of meat at discounted prices every month. This benefit is quantified and included in the study. The company also provides clothes for workers to wear at the farm. Since, for disease control reasons, outside vehicles are not allowed to enter the pig unit, a daily bus is available to transport workers to the farm in the morning and back in the afternoon. The company also has a special arrangement with a local health clinic. Hospital bills are extremely high and not affordable for most of the workers. The company set up an assistance fund for workers in need. In the past, the company paid for major operations for a number of its workers. While these benefits are significant, it is not possible to quantify them and therefore, we believe that the study understates the economic return. Similar to other Polish companies, PPZP must make monthly income tax payments, as well as social security and pension contributions to the government for each of its workers. Upon retirement, workers receive social security payments from the government. The contribution is proportional to workers’ salaries. On average, the company’s contribution for low/unskilled workers (who receive the lowest wage) is 350 zloty (US$ 75) per month to the government. For skilled workers, the company contributes approximately 400 zloty to the government. Overall, the costs for the company are 1,300 zloty (US $325)

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per month for a low-skilled worker and 1,800 zloty (US$ 355) for a skilled worker. These benefits are tallied in the analysis. Training When the three general partners bought the pig farm from the government, they adopted a proprietary method of raising pigs from a UK-based company, Pig Improvement Company (PIC). Part of the proprietary technology is based on computerized budget and production control systems that sets targets for each sector of the farm and highlights any deviation on a weekly and monthly basis. With accurate and timely information, prompt corrective actions are taken when negative deviations are noted. The effect of these improvements is to increase the number of animals sold annually while maintaining the same level of fixed costs and lowering feed costs per kilogram of the live-weight meat produced. As a form of training, young managers from UK farms are sent to Przybkowo for short-term assignments to assist with the implementation of new stock management practices. As per the contract negotiated by the principals and SEAF with PIC, PIC has provided training to mid- and senior-level managers. The estimated value of these training programs over the past 10 years is US$1 million. It is difficult to quantify the value of training for the workers, because most of the training is related to tasks specific to PPZP. However, employment in a factory setting, working with machinery and equipment, and developing a work ethic are valuable skills that workers can develop at PPZP. The general partners of the company indicated that they would offer a premium of up to 50 percent above the starting salary to a new worker with previous experience. To be conservative, we have estimated the value of the training only for the skilled workers. The value of the training is estimated to be equal to 10 percent of the skilled workers’ wages. In this analysis, we are assuming that only a small portion (10 percent) of all the skilled workers will have the opportunity to find a new job with the training that they receive from PPZP. Impacts on Customers Pork is a major staple in Poland and the Polish pig market is one of the largest in Europe. Pork accounts for 60 percent of per capita meat consumption (approximately 33-36 kilograms per year). A company can have quantifiable and non-quantifiable impacts on consumers via different channels, such as a reduction in price, an increase in quantity of demand and a higher quality product. Short-term prices for pigs move with the business cycle and fluctuate along the price trend. The long-term trend of pig prices, both in terms of the zloty and the US dollar, has been rising over the past three cycles. However, after adjusting for inflationary and cyclical effects, pig prices have been relatively flat to mildly increasing over the past decade. Prices of feed and grain are expected to be relatively stable over the next few years. Therefore, prices for pigs and carcasses should also remain fairly steady in the foreseen future. Since prices are not expected to change substantially in the near future, the price effects are therefore minimal, relatively speaking. Pork consumption per capita as a percentage of total meat consumption is already high and we therefore do not assume a significant increase in pork consumption as a result of PPZP’s production in the near future, although this does not take into account the additional pork produced by the sows bred by PPZP and sold to Polish farmers over the past 10 years. While the quantifiable impact on consumers is insignificant in our analysis, in fact it is likely to be substantial albeit difficult to quantify. There are other, non-quantifiable impacts on consumers, including the fact that new technology has led to a higher quality of pork. Indeed, PPZP is the first pig farm to adopt the new technology to improve the quality of pigs in Poland. One of the goals of the pig improvement process is the improvement of carcass

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quality. Back fat levels have been falling and carcasses have become leaner. The quality of the pigs PPZP breeds with PIC genetic stock and the resultant quality of pork from PPZP is much higher than its competitors. The quality is measured by the percentage of the carcass that is usable meat. In Poland the average meat percentage in the pigs’ carcass is 50 percent, while in PPZP this percentage is 58 percent, which is comparable to the quality of meat in Western European countries. In addition, the company has adopted a new technology to improve the quality of pig rations in the feed mill. The company aims to mill and mix almost all rations from basic raw materials using a least-cost formulation and to use only mineral and vitamin pre-mixes. These improvements allow a doubling of finished feed production, approximately half of which is used on the farm and the remainder of which is sold to the other pig farmers. We have, however, not included in our analysis of benefits either the cost savings that accrue to these other farmers, or the benefits to consumers’ health from improved products. Impacts on Suppliers PPZP’s suppliers have enjoyed an increased demand for the goods and services they provide and hence higher profits. Almost all suppliers to the pig farm are Polish producers, and therefore the externalities that are generated by the pig farm are confined in large part to the Polish economy. With a few minor exceptions, the total cost of goods sold (COGS) has been steady at around 65 percent of total sales in the past decade. The largest cost item for the pig unit is feed, which accounts for between 75 and 80 percent of COGS. The rest of COGS are administration related costs, including veterinary services, energy, fuel, repairs/renovations, and other miscellaneous costs. The company has increased its revenues from less than US$ 1 million in 1993, when PPZP was first separated from the Barwice State Farm, to more than US$ 10 million in 2002-03. Expenditures on direct inputs to raise pigs increased from five million zloty to around 28 million zloty per year. Improvements to the feed mill and in slaughtering techniques have required additional construction. For example, to improve the quality of feed and the efficiency of the feed mill, the company purchased new equipment, including a grain dryer, and built a new operations plant. The expansion of PPZP affects not only direct suppliers but also other indirect suppliers in Poland. An increase in pork consumption reduces the demand for substitute products and raises the demand for complementary products. Since food expenditure is a significant portion of total expenditure in Polish households, an increase in meat consumption would reduce consumption of other primary food products such as cheese and milk, when adjusted for the increase in the population. While producers of substitute products might suffer, profits of suppliers of complementary products might increase. For example, more sausage casings are needed to make sausages, and more herbs and other condiments are needed to cook pork. The increase in wages above opportunity costs of additional workers employed by the suppliers should also be counted. In theory, the chain can continue to the suppliers of the suppliers. However, in practice, it is very difficult to estimate such indirect impact. In our analytical framework, we quantify the direct impact on the suppliers since it is substantially larger than the indirect impact. The complexity of indirect impact measures is beyond the scope of this study and is not counted. We have estimated the impact of the company on direct suppliers as additional profits that those companies generate as result of PPZP’s demand for goods and services. We assume that 80 percent of COGS for PPZP count as sales for the suppliers’ companies. However, only a percentage of these sales should be considered as a benefit from PPZP’s activity. We assume that 25 percent of the sales that PPZP generates for its suppliers are incremental. Thus, we apply a 10 percent profit margin for the 25 percent of 80 percent of COGS to capture the profits of PPZP’s suppliers.

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Impacts on Competitors and New Entrants There are approximately 3 million farms in Poland, of which roughly half are involved in pig production. Most pig farms are small and family-owned. These account for 80 to 90 percent of annual pork sales in Poland. Industrial farms capture only 10 percent of the pork market. PPZP is the third largest of these farms. The Polish pig market is one of the largest in Europe. It has the potential to be in direct competition with other European countries’ markets such as of Denmark and Norway. Poland has a number of state-owned large and well-equipped pig farms that have been privatized, and several of them are vertically integrated with feed mills, pig slaughtering and processing plants. In addition, Poland enjoys its geographic location as a gateway to other Eastern European and Central Asian countries. However, the level and efficiency of pig production in Poland is low compared to Western European countries. Pigs weaned per sow per year average 12-14 and the whole herd feed conversion is over 5 kilograms of feed used per kilogram of liveweight produced. Mortality from birth to slaughter is over 20 percent. Carcasses tend to be fatter than elsewhere in Western Europe, with backfat between 25 and 35 millimeters. As a result, the proportion of lean meat in Polish pig carcasses is relatively low at around 46-50 percent. The United Kingdom serves as an interesting comparison: pigs weaned per sow are 21, feed conversion is 3.2, mortality is 13 percent, backfat is 13 millimeters and lean meat percentage is 56 percent. PPZP currently has three operations: a farm for meat production and propagation, a feed mill, and a small abattoir. The pig farm has 30,000 pigs in stock compared to about 18 million pigs in the country. The company faces industrial farm competitors such as Smithfield and Poldanor. Smithfield, a US-based company, entered the Polish market in 1999 to expand into the European Union. Today, Smithfield captures around 20 percent of the pork market and about 10 percent of the pig breeding market1. Poldanor, a Polish-Norwegian-Danish joint venture industrial pig farm, at one point had 15,000 sows but had to close the business due to a decline in its market share2. While competing with other industrial farms on input costs, PPZP competes with other small family-owned farms on the quality of meat. The company maintains a quality of 58 percent lean meat compared to 46-50 percent on average in Poland and better than the 56 percent average in the United Kingdom. This is one of the advantages. PPZP looks at various factors—production/inventory coefficient, weight increase/year/pig/generation ratio, unification of the group of animals for sale, how much weight of the animal is lost on the way to the slaughterhouse—while its competitors measure few of these results. Both the feed mill and the abattoir are small by western industry standards. The feed mill has a potential capacity of 30,000 tons of finished feed per year, although the feed production equipment is simple. Currently, the feed mill operates below full capacity and is used mostly for the pig farm. The abattoir is located near the pig units and has the capacity to slaughter 50 head per day. It is also operating below its full capacity. Products, either sausages or carcasses, are sold locally.

1 Interestingly, in a article entitled “Polish Farmers Raise a Stink Over US Agricultural Giant; Critics say Smithfield Overwhelms Resources, Family Operations” in The Washington Post on February 2, 2004, Smithfield’s Polish pig-producing farms were strongly criticized as polluting the air and water of the villages surrounding the operations, with the benefits of the facility considered very meager. 2 Poldanor has also been in trouble with the Polish tax authorities for manipulating its operations so as to evade taxes otherwise due to the Polish state.

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We use the number of breeding pigs that PPZP is selling to other farms to project the profits of those farms as a proxy for the impact of new entrants. The company has increased its sales of breeding pigs from two to four percent of total annual pig sales. Although we estimate the profits impact on new entrants, we cannot quantify the impact that the Company has on competitors and new entrants through its demonstration effect. PPZP has undoubtedly raised the bar in the domestic industry with respect to health standards, efficiency, and higher quality of the production through usage of the computerized equipments. Recently, PPZP also won a prize to participate in a pig project in Bosnia under the program sponsored by PHARE.3 Impacts on Neighbors Environment Pig farming can have a negative impact on the environment: pollution of water and soil, emission of odors, loss of genetic diversity, and lowering of groundwater levels. At the time of this study, there was no specific European legislation on environmental standards for pig farming. The pig unit in PPZP’s facilities has a slurry-based manure disposal system. Two settlement tanks outside the perimeter fence are used to deposit most of the solids suspended in the slurry. Supernatant liquid is then pumped up into spray guns and spread on 650 hectares of unused land belonging to the Barwice State Farm. Water sampling in the area has shown no serious problems with nitrates or phosphates. The company complies with all applicable local laws. PPZP recently produced an audit by a consultant veterinarian from the United Kingdom that indicated that the health status of the unit is suitable for the distribution of breeding stock. No major pathogens that might necessitate depopulation of the herd are present. Discussions with the Chief Veterinary Officer of the voyvodship (district) indicated that no serious pig diseases were present in other herds in the region or in pig populations. Community Activities Other positive externalities that the PPZP provides to the community include a well for clean water and some cultivatable hectares of land, which the company leases from the farmers, and various cash contributions to local charities. The company has a well on its property and allows neighborhood families to access the well water for free. There are 150 households who frequently use the well. An average of monthly bill for a household of four is 40 zloty (US$ 10) for water, 150 zloty for electricity and 60 zloty for gas. These costs could account for 50 percent of the take home pay of a low-skilled worker in the community. The company is also active in community charity activities. Its annual donations to the community are roughly 12,000 zloty (US$ 3000) for local churches, drug centers and hospitals.

Cultivated Land The arable private land of approximately 170 hectares, located next to the farm, is being used by PPZP to cultivate the ingredients used for the feed. As mentioned above, this land is rented from the farmers in the area. The tax on the land is 10 percent of its value. The value of one hectare is 1,000–1,500 zloty. The company pays the tax to the government on behalf of the farmers. This is a direct benefit to the local farmers. PPZP pays the farmers rent for the land, which is 15 percent of its value. Thus, the overall benefit that the farmers receive is 25 percent of the land value.

3 The PHARE program is one of the three pre-accession instruments financed by the European Community to assist the applicant countries of central Europe in their preparations for joining the European Union.

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Impacts on Rest of Society Local and Federal Government As an agricultural company, PPZP is exempt from income tax. For non-agricultural companies, the current corporate tax rate is 27 percent in Poland. The Polish government also refunds tax paid (VAT) for agricultural products that the company purchases as input materials. VAT rates range between seven and 22 percent. We take an average of 15 percent VAT and apply it to non-agricultural inputs (15 percent of COGS) as tax paid by the company on its input materials. Income tax paid by PPZP workers is another component that the company contributes to the society. An average monthly salary at PPZP is 1,200 zloty and an income tax rate of 19 percent is used to estimate the total income tax paid. In addition, the company pays an average of 100,000 zloty to the government in fees and other taxes. Financial Institutions The business activities of the company add benefits to local financial institutions. PPZP opened more than 200 checking accounts with local banks for its workers to deposit their salaries. Local banks gain profits from the spread (currently 13 percent) on the company’s cash balances in these bank accounts. In the last three years, the company’s outstanding balances in its bank accounts averaged 1.3 million zloty on a daily basis. Furthermore, local financial institutions benefit from the workers’ contributions to pension funds. Currently, Polish workers must contribute 14 percent of their salary to pension funds. Poverty Impact The economic situation of the Barwice area is dire. Almost half of the active labor force is unemployed and business opportunities are rare. The poverty level, as a consequence, is extremely high. Basic necessities become luxury commodities for residents. Extended family members have to share small apartments. Salaries of younger generations in many families are much lower than pension contributions of older people. Parents find it difficult to afford an education for their children. Although we cannot quantify the precise poverty alleviation impact of the company for the local residents, our interviews indicated that employment at PPZP has significantly improved the workers’ lives. Workers saved enough money to improve their homes, repair their cars, start families, help support relatives and elderly parents, and pay for their children’s education.

A PPZP employee delivering piglets

A PPZP employee who purchased a house and a car with his income

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Conclusion As the interview with one employee who has been with the company since 1993 indicates, it is possible to move out of poverty with security and sustainable employment. This employee came to work for the company as a low-skilled laborer to clean pig stalls. He received training, and currently is responsible for delivering piglets. He has been able to save money over time and has used his savings to buy a home and a car. His currently salary is about US$ 300 a month, not including non-wage benefits, approximately 50 percent higher than the minimum wage. PPZP is an example of the potentially far-reaching impact of a successful agribusiness investment in a remote rural area where unemployment is high. Not only is the financial return impressive, but also the impact of the company on the local economy has exceeded expectations at more than US$ 14 of additional benefits generated for society for each US$1 invested by SEAF. PPZP serves as a model of SME development strategies.

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Peru—Printop

Introduction Sociedad Química Alemana S.A. (Printop) was founded in 1991 as a manufacturer of silkscreen ink for textiles and garment industries in Lima, Peru. Printop has grown impressively from a one-man operation to a company with 67 employees. It has also diversified its products to include producing inks for plastic, vinyl and flexography printing. The company primarily supplies Peru’s domestic markets (about 80 to 90 percent of total sales), and in recent years, it has begun exporting its products to other markets such as Bolivia, Chile and Ecuador. The company estimates that it has about 70 percent of market share in Peru. The Peruvian economy was hit hard by El Niño (1997), the Asian Financial Crisis (1997), and the Russian Currency Crisis (1998), the effects of which were amplified by the subsequent liquidity crisis in most of Latin America. This negatively impacted Printop’s revenues because the company depends on the demand for inks from the garment and textile industry, which was severely depressed in 1997-1998. The Peruvian economy began to rebound by 2002, reaching 5.2 percent GDP growth in 2002. The economy is expected to reach 4-4.5 percent growth in 2003 (EIU August, 2003). Printop has responded with strong growth.

Table 1: Peru Economic Indicators

Printop’s initial stages of development were difficult due to a lack of resources and the recession that Peru was experiencing in 1991-1992. The principals gradually developed a careful sales strategy, promoting their high quality, low cost dyes and excellent customer service. The strategy, supported by a good trademark and business image, promoted through publicity, led to steadily increasing sales in a short period. The careful attention to quality led the largest enterprises in the market (producers of Adidas,

Selected Economic Indicators 2000 2001 2002 2003

GDP (current US$bn) 53.5 54.2 56.9 61.3GDP per capita (US$) 2063 2056 2126 2256GDP Growth (% of real change) 3.1 0.06 5.3 3.8

Exch. Rate Ns:US$ (Av.) 3.49 3.51 3.52 3.48

Population (m) 25.94 26.35 26.75 27.19Labor Force 7.69 8.27 8.44 8.63Unemployment rate 7.4 8.9 9.4

Printop—Lima, Peru

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Reebok, Nike, etc.) to choose Printop products over the imported competition. The company’s target customers include both large and small clients (each segment represents 50 percent of Printop’s sales). Management has focused its efforts toward the same high quality product and service, at the same price, to both segments. Its quality control, competitive prices, and customer service made Printop one of the market leaders in Peru. In 1994 Printop developed a complementary strategy that targeted market expansion through franchisees and sales agents in provinces outside of Lima. Printop currently has 12 franchisees: 4 in Lima and 8 in the provinces. The agents and their stores must meet certain requirements regarding personnel relations, signs, logos, etc. In exchange, Printop offers lower prices, technical handbooks, publicity materials, and continuous technical assistance. Moreover, free courses and seminars are routinely organized by Printop in the poorer neighborhoods of Lima to improve the customers’ (or prospective customers’) skills in screen-printing and to familiarize them with Printop products. In early 1998, SEAF invested US$ 250,000 in equity for 27 percent of Printop’s shares. Printop required new capital in order to purchase equipment and machinery, increase its working capital, renovate facilities, produce marketing materials and place a deposit on a parcel of land for a new production facility—all at a time when banks were sharply reducing their lending.

Printop’s sales fell in that first year due to the sluggish Peruvian economy resulting from the various emerging market financial crises and the lingering effects of El Niño in 1997. The company could no longer rely on its existing customers and product base. Working with SEAF, Printop began exploring other markets, including Argentina, Bolivia and Chile. In addition, they invested in a new product line that consisted of vinyl-based inks. These inks allowed the company to print on promotional plastic items, such as stickers and key rings. This strategy represented a diversification from Printop’s original array of inks, which only could be used on textiles. However, the company needed an additional inflow of capital in order to develop this new product line, as well as to update its customer database, target new clients, and market the new products. SEAF invested an additional US$ 120,000 to help the company develop a new product line and facility. SEAF worked closely with Printop’s principals in developing the overall business strategy, marketing, personnel training, and financial reporting.

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Development Impacts

The quantified results of SEAF’s development impact analysis are presented below.

The sections below describe the impacts on each stakeholder, which were quantified to reach the above. Private Returns SEAF’s investment in Printop has been moderately successful financially as shown above. The company, however, has a financial rate of return of 27 percent. In addition the company has had a significant impact on the lives of its employees and its consumers (micro-enterprises). The economic rate of return over a ten-year period is projected to be 70 percent. Impact on employees Wages and Benefits In 2003, the company’s wage bill represents 49 percent of SG&A expenses and 35 percent of the overall cost of goods. About two-thirds of the employees are in production, of which at least 80 percent are low-skilled workers, performing ink mixing, cleaning, and minor machine maintenance. The remaining employees are skilled in management, finance, information technology, and administration. Even the entry-level low-skilled workers are paid wages higher than the minimum wage. After a testing period of about six months,

Printop—Employees testing inks

2003 Statistical Data Revenues in 2003 (US$) 2,205,883 Gross margin (%) 48.7 Net margin (%) 7.5 No. of employees 51 % of low-skilled workers 41 Avg. wage for low-skilled (US$) 260/m SEAF investment to date (US$) 330,000 Realized proceeds to SEAF (US$) 105,267 Realized and unrealized* (US$) 385,137 Multiple of capital invested 1.17 *at December 2001 when SEAF exited the fund

Financial & Economic Benefits Financial rate of return (%) 27a Economic rate of return (%) 70b Benefit/cost ratio (0% discount) 10.14c Benefit/cost ratio (10% discount) 6.41c

areturn to the company breturn to society cadditional dollars generated for society from every dollar invested in the company in constant terms

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during which they receive training, the employees who perform well enough to stay with the company receive a salary increase that on average is about 40 percent higher than the minimum wage. Unsurprisingly, interviews with employees indicate that the higher wage is one of the attractive features of the company. Printop’s owners also believe that the high wage will help them select good workers, and that the company needs to increase wages over time to protect its investment in training employees not only in technical skills but also in work habits and the company’s culture. The difference between the average wage for 80 percent of Printop’s production workers and the national minimum wage is captured in the impact on employees. We have not included in our calculation the difference between wages of skilled workers and the wages these employees could earn elsewhere, as we do not have a suitable proxy for this category. However, high skilled workers at Printop have enjoyed a significant wage increase since the time of SEAF’s investment: over 240 percent in constant terms (see the table below). Interviews with some of the skilled workers indicate that after the first few years of struggling since the company’s establishment, they received their first wage increases and bonus checks in 1999 when the company was making good profits. The amount was so substantial that they thought the owners had made a mistake. The excellent treatment of workers was markedly noticeable during the interviews. One worker mentioned that she even turned down an offer from a large enterprise that would pay her a similar salary, because it did not have as good a working environment as Printop. The impact measured is accordingly very likely to be conservative.

Average Annual Real Wages and Benefits

Worker Type 1997 2003 %-change in real wage Unskilled 2,006 2,372 18% Skilled 2,552 8,737 242% All 2,393 5,061 112%

In constant US$ (1995=base year) The high salary levels and the excellent working environment at Printop have translated into a very low turnover rate (about one percent). Most workers interviewed have been with the company for more than three years. Training Most of the training at Printop is conducted on the job. Workers who have been at the company for a considerable time and the founders of the company teach new employees the necessary skills for production. Printop sends its skilled employees to computer training and logistics courses. Some of the employees are also trained at a local technical school (SENATI). The cost of formal training is included in the analysis, but the on-the-job training costs are not included.

Non-salary benefits As salaried employees, the workers receive health insurance and social security contributions from the company, as required by law. These social charges amount to 64 percent of the average wage. In an interesting arrangement that benefits both the employees and the charitable organization, the company provides kitchen facilities to nuns from a convent to operate a kitchen that cooks and sells food to workers at a subsidized price. The amount is not significant and therefore is not included in the analysis.

Printop—Training in production

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Impact on Consumers Printop sells about 50 percent of its inks to micro-producers of T-shirts and other textiles. The company offers a free course, Start Your Own Business for $60, to low-income people that teaches them how to screen-print on textiles. The goal of the program is two-fold: a) for unemployed people to learn a trade that can be used for income generation; and b) to create relationships with potential clients. About five percent of the people who have bought the ink and followed the training course take up the business. We estimate that these individuals will make about five percent in profits. Printop’s principals have developed their own technology to produce screen-printing dyes and seek to stay aware of new techniques and improvements that can enhance Printop’s productive process. In order to get the best results, the company constantly trains its personnel. Printop’s agents and provincial sellers are also trained to handle the products and advise the clients about their effective use. While we estimate the profits made by the individual business operators, we do not estimate any incremental benefits for larger customers, as these customers could procure the ink products from importers or from other suppliers, and Printop’s supply is relatively small to make an impact on price. Impact on Suppliers Previously the company bought about 70 percent of its inputs locally. Limited inputs were imported directly or bought through an importer. Recently, Printop began buying in larger quantities and establishing long-term supply agreements with large enterprises in order to cut down on its costs. Printop’s purchases from these enterprises are relatively small and therefore do not significantly affect the prices or the profits of these suppliers. In addition, in an effort to reduce costs, the company is manufacturing more of its products in house than it did earlier in the company’s history. While the past benefit to local suppliers could therefore have been significant, the future projection for this benefit is uncertain. To be conservative, we have not counted any suppliers’ benefit in the analysis.

Printop Employee—Promoted from Low-skilled Worker to Production Manager Mr. T has been with the company for the last 10 years. He started as a warehouse clerkwith a salary of about 300 Peruvian Nuevo Soles (NS) in 1993. Currently he works as theproduction manager of 13 full-time workers and five contract workers. His salary hasincreased over the years with more responsibilities, and currently he earns NS 1600 (aboutUS$ 457) per month. He received his training mainly from working side-by-side with one ofthe company’s owners. He has set aside some of his income to build a house, using asmall loan from the same owner. He has three children, ages 14, 18, and 20. Theyoungest one is at a public school and the two older ones are at a university and atechnical school, for which he pays. Even with his substantial salary increase, paying forhis family’s basic needs and education is still a challenge. Nonetheless Mr. T is happy atPrintop. He feels that the continuous learning and trust he has received from themanagement and owners motivate him to work hard. He could find a better paid jobelsewhere but he says that the security of employment and the owners’ excellenttreatment of all staff working in Printop are much more valuable to him than a few extradollars.

Source: Employee’s interview—September 2003

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Impact on Complementary Goods

Printop actively participates in the supply chain of its product. The company buys screens and machinery used in screen-printing and sells these products as a bundled package with its inks. The costs of these products are approximately US$ 500,000 a year, and Printop earns between 10-12 percent commission on the sales of the screen-printing packages. However, these products are imported; to be conservative, these benefits are not included in the quantitative analysis. Printop’s packaging process, however, offers a unique product for small entrepreneurs, with the additional benefit of technical assistance as mentioned above. Moreover, the increase in demand for these complementary goods may at some stage stimulate the local production for such products. Nevertheless, we assume no benefit from this aspect of the stakeholder channels of impact. Impact on Competitors and New Entrants Competitors benefit from Printop’s high standards and the impressive quality of its products. Most of its competitors could not directly compete with Printop because they exist solely in the informal sector of the economy and are unable to meet the quantities and reliability demanded by Printop’s customers. Printop’s primary competitors in the Peruvian market are Química Suiza S.A. and Vaucolor S.A. Both are importers and offer broader product lines than Printop, but at higher prices. Printop has an opportunity to maintain its dominance in the local market, to expand its product lines, and to start exporting to other Andean countries. However, the demonstration effect of Printop’s high quality product and customer service is not easily quantifiable. Local Government and Community

Printop pays approximately 10 percent of its revenues in taxes, in the form of sales taxes and corporate taxes, while its employees pay approximately 19 percent of their wages for income taxes. The taxes paid are included in the analysis, as are the social security contributions for the employees. To support micro-enterprises and help generate employment, the owners are also working with the Ministry of Education in developing vocational training on screen-printing. The company’s representatives plan to donate their time in teaching courses in vocational schools in the community in connection with this activity. Poverty Impact Apart from employment generation and training, allowing a substantial increase in wages over time, Printop has made a significant contribution to poverty reduction. Its products can be easily used by textile micro-producers for less than US$ 100 of investment. The technical assistance and the customer service to these micro-consumers are noteworthy in helping these entrepreneurs to develop skills and high quality products.

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Poland—Symbio

Introduction

Symbio Impex Polska Sp.z.o.o. (Symbio), a Polish limited liability company, was created as a start-up in April 1998 with the majority of the investment coming from SEAF’s Poland Fund, CARESBAC-Polska. Symbio produces and distributes organically grown fruits, vegetables, grains, and herbs for export to the European Union as well as for the Polish market. Symbio currently has 330 farms under its management, effectively as franchisees. Among the value-added services that Symbio provides to its farmers is assisting them in securing Polish and European Union organic certification for their crops, as well as negotiating supply contracts with local and international customers that guarantee participating farmers minimum purchases and minimum prices for their organically grown products. In addition, Symbio provides agronomy assistance to farmers, trains them in organic farming methodology, markets their products, oversees all processing and distribution, and works with customers to undertake product development to fulfill customer needs and market niches. Symbio’s goal is to leverage the multitude of small Polish family farms and Poland’s rich natural endowments to provide the local and international markets with a reliable supply of high quality organic food. Poland is the only European Union Accession country with a majority of family-owned farms with indigenous knowledge of organic methods of cultivation. The conditions of Poland’s farms are favorable for organic farming. “Polish agriculture is so far behind the West, that in many ways it’s ahead of it,” said Mr. Steve Sperelakis, one of Symbio’s principals in an interview with the Financial Times on October 14, 2002.

SEAF invested initially in Symbio using funds from the IFC/Global Environment Facility’s (IFC/GEF) SME program, aimed at supporting environmentally friendly small businesses worldwide. This initial financing helped Symbio to expand its business and contract with its first farmers. With additional financing from CARESBAC-Polska and the North Fund, another SEAF investment fund in Poland supported by the Ford Foundation, and SEAF’s technical assistance in organic certification and production, Symbio has achieved a significant milestone of 300 farms under management in its fifth year of operations, and exports organic vegetables and food to the United Kingdom, the Netherlands, Germany, Switzerland, Belgium, Finland, France and the United States.

Symbio’s owners

Symbio’s agronomist training a farmer

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Symbio’s model As a sales and distribution company, Symbio currently employs seven people, including the three principals. All of these seven employees are skilled. In addition, Symbio signs exclusive contracts with farmers from 20 small regions in the districts of Lublin and Kielce. When choosing the farmers, Symbio considers primarily the location, as shipping is a major cost factor. Under their agreements, the quality of the product is carefully specified, and the farmers sell their fresh organic produce exclusively to Symbio. Symbio is obligated to pay the farmers only if they produce the quality required. Because the Polish government provides banks with a number of incentives to provide lines of credit to farmers, and because most farmers have collateral, they can obtain a credit line from Polish banks relatively easily. Therefore, while Symbio guarantees its farmers a minimum purchase, it does not prepay for the production. Symbio contracts with owners of 4-5 freezing facilities, where the fresh produce is processed and packaged. The processed food is sold to Symbio’s partners in Europe, who later sell it to Nestle or to other markets. Symbio has two types of arrangements with the freezing facilities: Symbio pays the freezing facility for the processing service and sells the finished goods as Symbio’s products; or Symbio sells organic products to the freezing facility, which processes the products according to its needs and on-sells them under its own arrangements. Freezing Facility—Fructosa SEAF interviewed staff at Fructosa, one of the freezing facilities working with Symbio. Fructosa employs 208 workers: 100 full-time, 75 seasonal (usually four months per year), and 30 administrative and management staff members. Fructosa has 40 suppliers of agricultural products. Symbio itself provides 12 to 15 percent of Fructosa’s COGS. The company exports 98 percent of its production to 6-15 clients who prefer organic products. The demand for organic products has been steadily increasing, while the demand for conventional products is uncertain. The freezing facility is located in the best area for growing raspberries and strawberries, which gives Fructosa an advantage over its competitors. However, Fructosa’s profits are relatively low, with a good year considered to be 5-10 percent net income on the sales. Due to the variable contribution that Symbio makes to Fructosa’s operations (as well as to other freezing facilities like Fructosa) and the complications of quantifying that contribution, we have not included the impact Symbio makes on these facilities in the quantitative analysis. However, Symbio’s supply of organic products clearly helps provide for stable employment for a significant number of freezing facility employees located in rural Poland. As the interview with an employee from Fructosa testifies, these facilities are regarded favorably by the workers. It is one of the few employment opportunities available for the people living in the neighboring villages.

Freezing Facility—Fructosa

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Development Impacts The quantified results of SEAF’s development impact analysis are presented below.

The sections below describe the impacts on each stakeholder, which were quantified to reach the above. Private Returns During the first three years of operation, Symbio identified and worked with farms to obtain the necessary organic certification, and negotiated supply contracts with European purchasers of organic fruits and vegetables. The number of farms under Symbio’s management has increased from 25 in 1998 to more than 300 currently, with a total of 3200 hectares under management. Symbio’s revenues have increased from US$ 80,000 in 1998 to more than US$ 1.5 million in 2003, with profits increasing consistently over the past four years. More than 90 percent of its products are exported to Europe and the United States, including to General Mills, Heinz, and Yoe Valley. Over this period, SEAF made additional loans and a small additional equity investment. While exit negotiations have not yet commenced, on the basis of the company’s performance and against relevant industry multiples, SEAF estimates the value of its investment conservatively to be at 43 percent IRR, with the value of the company forecast to yield, as of December 31, 2003, a multiple of 3.2 times the cost of SEAF’s investment. This forecast is in line with the initial projections. Impacts on Labor Employment Lublin has a population of 500,000 with a high unemployment rate—about 19 percent. The population in the eastern Polish town of Lublin is well educated, reflecting Lublin’s well-known university and position as a regional market and administrative center. There are relatively small discrepancies in the income distribution (not as large as in Warsaw), but the gap is increasing. The average wage paid to a Symbio

2003 Statistical Data Revenues in 2003(US$) 1,541,729 Gross margin (%) 35.3 Net margin (%) 4.9 No. of employees 4 % of low skilled workers 0 Avg. wage for low-skilled n/a SEAF investment to date (US$) 427,103 Realized proceeds to SEAF (US$) 178,455 Realized and unrealized (US$) 1,370,706 Multiple of capital invested 3.2

Financial & Economic Benefits Financial rate of return (%) 46a Economic rate of return (%) 245b Benefit/cost ratio (0% discount) 14.86c Benefit/cost ratio (10% discount) 10.90c areturn to the company breturn to society cadditional dollars generated for society from every dollar invested in the company in constant terms

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employee is 2,000 zloty (US$ 500) per month, but after factoring in the social security and tax costs, the real cost to the company is 3,500 zloty (US$ 700) per month. Because of the high unemployment in the area, employing workers is not very difficult. On the other hand, the organic industry is not very well developed in Poland, which makes hiring more difficult. The specialized agronomist that Symbio has hired is one of the best in Poland, and is a specialist in the organic industry. In order to recruit and retain employees of this caliber, Symbio has had to offer a compensation package that is 50 percent above the average market rate. Symbio’s employees are relatively young, and five of them have completed college or some form of higher education, while the other two have completed a program at a professional school in addition to high school. Salaries have increased as each employee has assumed more responsibility in Symbio’s growing business. According to the interview conducted with one of Symbio’s managers, his salary has quadrupled during the four years he has been with the company. It is important for Symbio to motivate and retain its employees. They become invaluable to the company after they receive the right training, which is later transformed into higher sales and profits. Given the company’s rapid growth, employees identify their success with the company’s success. Despite the premium wages paid for employees with the skills that Symbio needs, in view of the small number of employees, we did not include in the quantitative analysis any impact that Symbio’s growth has had on its employees. Training The organic market in Poland is not very developed, and knowledge about organic products and their cultivation is limited. There is a learning curve for the employees hired by Symbio with respect to understanding the organic farming industry. We estimate that the training the employees receive has a minimum value of 10 percent of their salaries. In addition to the internal training, Symbio sent its specialized agronomist abroad on four occasions to obtain experience from farmers in Germany, the Netherlands, and Denmark. Symbio also paid the expenses for college and English courses for the manager supervising the freezing facilities. While these expenditures are invaluable to the employees, we have not quantified their social impact. Therefore, Symbio’s overall social impact is significantly understated. Impact on Consumers Symbio exports all but a minor portion of its products (eggs and a small quantity of wheat), which is sold in the domestic market. “Focusing on ingredients for packaged foods, Symbio exports fruits and vegetables for use in processed organic products such as yogurt, jam, and baby food. Its biggest markets are Germany, the United Kingdom and the Netherlands and it shipped its first batch of strawberries to the United States last weekend,”—Financial Times (London) October 14, 2002. Demand for Symbio’s products abroad currently outstrips supply, and given the premium prices paid in the West, Symbio has not been very active in the domestic market. However, Symbio is planning to market organic products in Poland in the near future. Initially Symbio

Symbio—organic eggs sold on the domestic market

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plans to create a collection center and deliver fresh products to the customers directly by establishing a home delivery system. Currently, the company is selling eggs, milk, and other products in Polish stores to help develop Symbio’s brand domestically. According to Symbio’s market analysis, Polish supermarket chains are ready to expand their organic food offerings, if reliable supplies are available. Every year, Aleksander Kwasniewski, the President of Poland, hosts the “Eco-Festival” in the gardens of his palace. Symbio, together with some of its farmers, was invited to this gathering last year for the first time. In addition, Symbio was recently featured on television. Coupled with a long and favorable feature article in the October 14, 2002 edition of the Financial Times, this exposure is enhancing Symbio’s reputation, which will help in expanding its domestic operations. Pricing for organic products is on average 30 percent above the conventional price, which indicates that consumers perceive there to be a substantial benefit from consuming certified organic products. According to market research on fruits and vegetables in Poland (there was no data specifically on organic foods), demand for fresh fruits and vegetables (other than potatoes) is inelastic. In general, prices for fruits and vegetables are rising at a faster rate than inflation, yet the demand for fruits and vegetables on a per capita basis has also increased slightly. Overall, the increases in price do not appear to be negatively affecting purchases.

Price Sensitivity - Fruits & Vegetables (Total)

0

200

400

600

800

1000

1996 1998 2000 2002 2004 2006 2008

Year

Pric

e/Vo

lum

e

Volume (kg per cap)

Value (PLN per cap)

Despite what would appear to be future contributions to consumer welfare and premiums of 30 percent or more that consumers are paying for organic products like those supplied by Symbio, SEAF has not had sufficient data to quantify those contributions. We can assume, however, that the surplus values provided by Symbio’s products in the market will be substantial given the considerable increase in the number of farms, the number of hectares under management, and, consequently, the level of production. Therefore, the total developmental impact calculated for Symbio would appear to be substantially understated. Producers of Complementary Goods Symbio’s operations utilize at least three complementary products: (1) Organic fertilizer, (2) machinery needed for organic food processing (those used by the farmers, not the freezing facilities), (3) and certification services for organic food companies.

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Organic fertilizer will replace inorganic fertilizer. Machinery needed for organic food processing is different from that used in conventional farming. The impact on the economy differs for organic and conventional categories, and while organic fertilizer would have some significant environmental advantages versus conventional fertilizers, we are not able to quantify the net impact of these differences. Hence, we have not included the impact of these two complementary goods in the analysis. The only complementary product that generates a relatively unambiguous additional impact is the certification of organic food companies. There are three companies in Poland that provide this service: Association Agrobiotest, Company Bioekspert, and Association PTRE. The organic farms and processing units must meet the requirements set by the certifying organizations EKOLAND or PTRE. These requirements are called the “Standards for Organic Farming” and they apply to the growing and the processing of such organic products. PTRE, the Polish certification group, works in conjunction with BCS Oko-Guarantee of Germany. PTRE merges its inspection techniques and inspection reports with those of BCS, thereby improving the integrity of the certification obtained by Symbio’s farms. The German certification gives Symbio the legal right to sell organic products in Western Europe as well as the United States. The certification process involves on-site inspections including soil samples, field mapping, and visible inspection for chemical fertilizers or pesticides on the premises as well as techniques such as crop rotation. There is a one-to-three year waiting period necessary for any farm that wants to make the transition from a conventional producer to an organic one. The certification papers are held by Symbio, which enables it to ensure that its individual farmers are producing in accordance with organic guidelines at the same time as it helps prevent those farms from selling to other buyers in violation of their exclusive arrangement with Symbio. The certification costs for the 300 farms and four freezing facilities with which Symbio had contracted in 2003 was US$ 20,000. This figure is our basis for calculating the economic benefit of the complimentary products. As the number of contracted farms has increased, the certification costs have also increased. Profits of Local Suppliers The Change in Farmers’ Gross Profit after Conversion to Organic Farming In Symbio’s model, the suppliers are the farmers. Symbio helps farmers manage the production of organic products from start to finish, including technical assistance and training, acquisition and distribution of inputs, soil analysis, and growing and tending to starter plants. Polish organic inputs are currently impossible for the farmers to find. Symbio has secured exclusive distribution for those organic fertilizers and pesticides that have been approved by the Polish Import Authorities. Symbio has also organized the production of virus-free starter plants. These plants are sold to Symbio’s farmers. Symbio’s agronomists work closely with the farmers to prepare the ground for the planting of the starter plants. The goal is to double the overall output of the plants. In 2002, Symbio’s farmers provided 1,950 tons of products to Symbio. According to the analysis that was done on the farmers’ profitability before and after Symbio contracted with them, the increase in gross profit per hectare is 5,500 zloty (approximately US$ 1,600) for a very profitable plant—strawberries. In our analysis, we assume a 50 percent discount to this estimate to reflect the cultivation of an assortment of plants, some of which are less profitable. We also include other costs such as administration and transportation in the analysis to arrive at the net incremental margin estimate per hectare of PLN 1,360 (US$ 350).

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Seasonal Workers Hired by Symbio’s Farmers The farmers are grouped in four categories based on their production level and growth opportunity:

a. Large production and high growth rate; b. Large production and high opportunity to grow; c. Small production with possibilities to grow; and d. Small production that needs to be developed (their production is under the minimum level).

Symbio spends most of its time with the farms in categories b and c. As the farms’ output grows, the owners rent additional land from neighboring landowners. With more hectares of land to cultivate, the bigger owners need additional help outside their families. They hire seasonal workers, who are usually paid 3.5–4 zloty per hour. This additional workforce thus benefits from the investment in Symbio. However, the hourly salary is very low and comparable to the nation’s minimum wage. We have not counted benefits to seasonal workers as they could generally earn similar wages elsewhere. However, the economic impact is in all likelihood understated as one could argue that, given the high unemployment rate in the area, Symbio’s farm expansion generates additional incomes for these seasonal workers who might otherwise be unemployed. Training Symbio provides considerable training to its farmers. Symbio’s agronomist works regularly with farmers, explaining the new trends and methods of application, as well as verifying that the organic processes are implemented correctly. The farmers also attend two training sessions per month sponsored by Symbio. During these sessions, the farmers participate in discussions, benefiting from each other’s experience. Being part of a new industry like organic farming, these meetings are invaluable to Symbio’s farmers. Reading material is distributed and new technologies are discussed and explained to the farmers. Symbio has also organized trips to farms abroad for the Polish farmers, where they study methods of growing organic produce, such as building and using irrigation systems. One of these trips was organized by SEAF and sponsored by the Danish Government. Symbio and its German partner have sponsored two trips to Germany. A fourth trip to Norway was sponsored by the Danish government as part of a project that Symbio and a Danish consultant conducted. There is a center in Denmark, Organic Farmer, where Symbio has arranged for the children of four farmers to attend a 3-year study program at no cost to the families. The program started in April 2003 and was expanded in November 2003. While the training visits benefit farmers significantly, it is hard to measure this impact accurately. We included only the cost of training, using the salary of Symbio’s agronomist as a proxy for the benefit to the farmers. Therefore, once again, the total economic impact on suppliers is underestimated. Competition and New Entrants There are three main competitors in the Polish market:

1. Ekoland—This company is an association of organic farmers. They have 500-600 farmers enrolled with them. They have asked Symbio to cooperate with them, but their farmers are located throughout Poland, which makes it very difficult to manage and control the quality and the level of production. Ekoland has a very well known brand name in Poland, but its production has declined precipitously. Currently, Ekoland only sells domestically, and the quality of its products is low.

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2. AMB—This company has had problems with clients in France and Germany as its products frequently do not meet organic requirements.

3. Roleco—This company is primarily processing only soft food and strawberries, and not engaged in the growing business. Roleco exports all of its products.

There is always some risk that any of these competitors can lure Symbio’s farmers away. It is therefore important that Symbio retains and strengthens its farmers’ trust. Being a reliable partner for the farmers is the key to retaining them, although legal structures and contractual rights help as well. Symbio’s model is not a common one, and it would be difficult for others to replicate the six years of relationships that the company has built with its farmers. Another risk is that the farmers may bypass Symbio by selling directly to food producers. This is unlikely for the following reasons:

a. Individual farmers cultivate several products, and the small quantities make such sales unprofitable, and;

b. Certification and transportation costs are too high for the farmer to bear them alone. It is hard to measure Symbio’s impact on its competitors in the local markets, and even more difficult in the international market. The international organic food market is expanding rapidly, and Symbio’s market share is minimal. Therefore, we do not quantify either a negative or a positive impact on other organic producers, although as Poland’s leading organic food exporter, Symbio is likely to impact positively Poland’s reputation as a supplier of organic products. Neighbors/Community Development Other social benefits from Symbio include its financial contribution to the government and to local financial institutions. Symbio’s main contributions are the corporate tax (28 percent in 2002 reduced to 27 percent in 2003), export tariffs, and interest paid to the financial institutions. Ninety percent of Symbio’s business transactions flow through banks. The standard rates in Polish banks are 5-6 percent interest on zloty’s deposits, and 8-17 percent interest on the loans. Community Symbio’s impact on its communities is large. By positively affecting farmers’ lives, Symbio affects the lives of the entire community. The demonstration effect in the community is very strong. In some villages, once one farmer began growing organic products with good results, all the other farmers in the village followed. In Poland, farmers rarely cooperate with each other, or consult each other. It is accordingly notable that Symbio’s farmers meet with each other twice a month, exchange views and opinions, and discuss the trends. For example, the larger-scale farmer whom we visited, and who has been with Symbio since 1999, is helping one of the younger farmers that just joined Symbio with some equipment. Like farmers everywhere, Polish farmers are conservative; they do not jump immediately on new trends and production techniques. For them, to change from conventional farming to organic farming is a major shift, and they do not take the decision immediately. Given past success in meeting its targets for new farms, it is expected that a substantial number of neighbor farmers will look at Symbio’s farmers that are doing well, and convert their land to organic farms. Growing organic products has a major positive impact on the environment. The conventional fertilizers used in growing the traditional products pollute the underground waters to the rivers and the lakes. Organic fertilizer does not carry such negative impacts.

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Symbio is cooperating with the agricultural faculty of the University of Lublin. One of the scientists is doing research in cooperation with Symbio on a type of fungus that, when planted in the soil, can fight an insect that is very harmful for the plants. This is the most organic way to fight pests. If successful, it may help serve the entire organic industry. Symbio is also conducting research to examine the effect of fertilizer on meadows. As with the study above, the results may be of service to many farmers. Interview with Contract Farmers

As we approached the house, we noticed a few new tractors working in a large field (new tractors are not a common sight in Eastern Poland). There were many different crops in the field: onions, carrots, leeks, cauliflower, cucumbers, zucchini, and strawberries. The architecture of the house was not the same as the other farmhouses; built in red bricks, two stories, with several beautiful patios and balconies. Meticulous landscaping surrounded the house, and there was a small pond in the front yard. The owners’ attention to detail was immediately noticeable. Inside, everything was spotlessly clean, nicely furnished and decorated in a traditional Polish country style, and a delicious cooking smell hovered in the air. Later we learned that this house was featured on a Polish postcard. Over dinner with the owners, couple Piotr and Dorota, we talked about organic production and the related challenges. The owners spoke with passion and pride about their products. They invited us for dinner, which was cooked almost entirely with organic products. This farm is one of the largest among Symbio’s contracted farms, and its success was palpable. • Piotr and Dorota started with 15 hectares, and now they have 50. Some of this land is rented from

other farmers in the village. • They employ four full-time workers, and during the harvest time 30-40 seasonal employees. Until a

couple of years ago, their neighbors were not interested in working as temporary workers on their farm. Most of the time temporary workers from Ukraine were hired. Some consider it an embarrassment for Polish farmers to work as seasonal workers for other Polish farmers. Now, it is a common practice for the other small farmers in the village to work with them, and they are thankful for this opportunity at a time when the jobs and money are scarce.

• Since 1999, this farm has grown only organic products. Before, as in many other farms in the region,

they grew wheat and potatoes, and raised livestock. That type of production generated only enough revenue to support the family and farm, but they could not expand. It changed significantly after they cooperated with Symbio and started to cultivate organic products. In 2002, they harvested 260 tons of vegetables, and Piotr is forecasting 500 tons for the harvest in 2003.

• Piotr is thankful to Symbio for enabling him to visit organic farms in Germany, Norway, and

Denmark. He learned quite a lot from these visits, and this year he is implementing an irrigation

Symbio—Research with the university on fungus

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system. While visiting the farms in Germany, he realized the importance of an irrigation system (which is not very common in Poland), and he decided to purchase one during his trip to Germany. This system is predicted to a have a significant positive impact on the 2003 production.

• Piotr and Dorota can share with other farmers in their region the issues and concerns regarding the

organic product’s cultivation. They can learn from each other’s successes and failures. • Since Piotr has begun hiring workers, he has had to learn how to manage them as well—an important

skill he would not otherwise have acquired. He hires 30-40 workers from April to November, and pays them 3.5 zloty per hour (minimal wage).

• The majority of the profits from the operations go to the expansion of production and equipment

purchases. When we asked whether they are happy, they smiled and said that the only bad thing that came with the success is that they have not been able to take a vacation together. There is a lot of work that needs constant supervision. Conclusion Symbio represents a successful model in rural finance, whose benefits go well beyond the narrow financial success of the investment.

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Peru—Tambo Inca

Introduction

Deshidratadora Tambo Inca S.A.C. (Tambo Inca) was established in 1996. The company produces marigold flour obtained from the dehydration and milling of the marigold flower (Tagetes erecta L.). The flour is used as raw material for the production of saponified oleoresins and stabilized liquid pigments. Xanthophylls are the active pigments found in the oleoresins. These agents improve pigmentation to bring about the attractive gold color in the chicken’s skin, legs, bill and egg yolk. Additionally, lutein, which is becoming more popular as a health supplement, can also be obtained from xanthophylls. Like beta-carotene, lutein is a powerful antioxidant, which studies show can contribute to the protection of cells. The most promising application may be lutein’s beneficial influence on eyes, particularly in regard to macular degeneration. Tambo Inca’s business model is to locate, negotiate and contract with farmers for the harvest of marigold flowers and to provide a steady market for the product. Tambo Inca’s executive director plans yearly visits before harvest season to its main clients in Ecuador and Mexico, obtaining pre-purchase orders and establishing a referential price for the flour in that year. With this information, the company plans the total area to be cultivated and starts negotiations with the local farmers. Each farmer is responsible for the funds disbursed by Tambo Inca for the purchase of inputs (seeds, labor, fertilizers, etc), while Tambo Inca provides a referential price at which it will buy their production. Tambo Inca acts as an interface, first to the financial institution providing working capital to the farmers, and secondly by providing the link between the export clients and the farmers. Each farmer working with Tambo Inca must formalize its record keeping, provide invoices and maintain records of expenses. Tambo Inca manages, through a proprietary computerized software system, each farmer’s cultivated land, as an individual account in which it records the expenses incurred and the amount of flowers delivered by the farmer to Tambo Inca. Many of the farmers do not have the skills or resources for keeping the accounting on their own so Tambo Inca’s help has been invaluable, especially when presenting their summarized tax reports1 to the tax authorities. The start up year, 1996, was a promising one; the company earned a net income of approximately US$ 20,000 just by working one of two harvest campaigns. Unfortunately by 1997, the El Niño phenomenon hit the Peruvian agricultural industry in a year where the expectations for Tambo Inca’s growth were good. This phenomenon decreased the yields of fresh flowers per hectare and increased production costs. The results were an annual loss of approximately US$ 55,000. As a sequel to El Niño during 1998, high temperatures prevented any harvest by Tambo Inca. The company had to approach banks with the hope of both refinancing its loans and obtaining additional working capital. The banks understood the problems generated by El Niño and were open to refinancing the loans, but could not

1 Farmers with less than approximately US$ 40,000 in annual sales must provide a summarized report to the tax authorities.

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provide additional funds. In addition, the refinancing process required that additional capital be put into the business. The main partners appointed Mr. Popolizio, Tambo Inca’s executive director, to search for additional capital. Mr. Popolizio found SEAF while attending SEAF’s presentation at the Agro-Industry Association in Peru. SEAF’s fund originally structured its investment as a US$ 58,000 equity contribution for a 29 percent shareholding in the company and US$ 200,000 in debt. During the next three years, SEAF provided a revolving credit line of up to US$ 300,000 annually to Tambo Inca. The company went from sales of approximately US$ 800,000 in 1998 to US$ 3.3 million during 2002, accumulating a net profit of more than US$ 320,000 over the four years.

Tambo Inca managed to double its production from 1998 to 2002. It added a new dehydration line valued at around US$ 200,000, and cultivated, at its peak, up to 2,000 hectares. The company has also diversified geographically by shifting 40 percent of its production to the Viru Valley, located about a ten-hour drive from Piura. The diversification into two valleys has helped it cope with changes in weather conditions as well as pests, disease and drought. There have also been attempts to diversify to other crops such as paprika and organic cotton.

Tambo Inca faced yet another challenge in 2003. A major client that had agreed to purchase about 500 hectares worth of production was unable to issue its letter of credit, straining Tambo Inca’s working capital to the point that almost 400 hectares were not properly harvested. Additionally, the international price of flour dedicated to animal feed (major use of flour in the world) decreased. However, Tambo Inca’s strategy of shifting from production of flour for animal feed towards flour for health supplements (which generates a premium of approximately 80 percent on the price) reduced the impact of the loss.

In 2004 Tambo Inca planned to add 200 hectares of cotton and 300 hectares of wheat to its 600 hectares of marigold. For the harvest of cotton and wheat it has formed a strategic partnership with Creditex, a textile company in Peru, and with Inova, one of the leading traders of animal feed in Peru. Both partners have agreed to cover the expenses of the harvest while Tambo Inca will handle all field labor (contract with farmers, technical assistance, etc.), having a fifty-fifty sharing agreement on profits.

Future strategies for the company involve developing new and more productive varieties of marigold seeds (it initially imported them, later it developed two of its own varieties and now is involved in improving yields and xanthophylls content) and concentrating in the highly profitable niches of marigold flour (i.e., for human and pet health supplements). It has also decided to diversify into other crops (paprika, organic cotton) through partnerships, providing only its expertise in running the fields, thus avoiding any large investment risk.

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Development Impacts The quantified results of SEAF’s development impact analysis are presented below.

The sections below describe the impacts on each stakeholder, which were quantified to in the development impact analysis on the previous page.

Private Returns

Tambo Inca’s new investment plan calls for a specialization of crops in high margin niches, intermediation of financial resources to farmers, securing clients in the profitable niches through partnerships and finally establishing alliances to reduce its investment exposure. The shareholders want the company to become the leader in the agro-industry sector in Peru. Tambo Inca’s success factors are the accumulated agricultural experience of its management team and shareholders (more than 10 years each), the possibility of accessing financial resources from banks and other financial institutions, the knowledge of the export markets and its network of clients.

Financial Returns to Date

Tambo Inca has rapidly grown from US$ 775,000 in revenue for 1998 to approximately US$ 3.3 million in 2003. As the company grew and expanded the amount of land under cultivation it managed to sustain gross margins above the 20 percent range. SEAF’s loans totaling US$ 750,000 has been fully paid generating interest of approximately US$ 110,000. The equity investment of US$ 58,000 has a repurchase schedule with a down payment already made for US$ 14,000 to the fund. Unfortunately, due to the bad results in 2003, the full repurchase has been delayed. However, the shareholders still maintain their interest in repurchasing the shares.

Impacts on Labor

The agricultural sector plays a predominant role in employment for the country. According to Peru’s Ministry of Agriculture, about 26 percent of the population of working age is employed by the agricultural sector. Furthermore, about 65 percent of the rural population of working age is employed by the sector. Tambo Inca’s impact on labor is quite significant both due to the number of employees

2003 Statistical Data Revenues in 2003(US$) 2,506,838 Gross margin (%) 17.5 Net margin (%) -5.4 No. of employees 34 % of low skilled workers 76 Avg. wage for low-skilled (US$) 152/m SEAF investment to date (US$) 808,000 Realized proceeds to SEAF (US$) 994,791 Realized and unrealized (US$) 994,791 Multiple of capital invested 1.23 *at December 2001 when SEAF exited the fund

Financial & Economic Benefits Financial rate of return (%) 6a Economic rate of return (%) 90b Benefit/cost ratio (0% discount) 3.76c Benefit/cost ratio (10% discount) 2.28c

areturn to the company breturn to society cadditional dollars generated for society from every dollar invested in the company in constant terms

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hired directly (34 employees in 2002) and by the labor created indirectly. As an example, each hectare cultivated by Tambo Inca utilizes 125 days of wages. Considering that Tambo Inca has been cultivating an average of 1,500 hectares per year, and that the harvest period is about 4 months, we can conclude that Tambo Inca has mobilized approximately 1,500 workers per harvest.

The company has chosen its field officers by promoting crop pickers who demonstrate their skills in both harvesting and in the management of people.

Such is the case of Mr. Medardo Navarro, age 44. Back in the 1980s he began work with an individual who eventually became one of Tambo Inca’s main shareholders. Over the years, Mr. Navarro showed dedication to his work, honesty and increasing knowledge of the crops. When Tambo Inca began operations, Mr. Navarro was appointed as the field officer in charge of hundreds of hectares of land. His main responsibilities are to provide technical advice to farmers, to monitor their work, and to manage the personnel during harvest. Mr. Navarro works closely with the entomologists who visit the fields on a bi-weekly basis, and as a result he has acquired

extensive experience and a profound knowledge of the major pests and diseases attacking marigold flowers. Over the years, he, in turn, has shared his knowledge and experience with his assistants by working alongside them. Recently, one of these assistants was promoted to supervise the fields in the Viru valley. Employment Direct employment has grown from 20 employees in 1998 to 40 in 2003. Direct personnel costs were approximately 5 percent of revenue during 2002. The split between skilled and unskilled workers is about 75/25 with the need for more skilled workers (especially to study seed development) outpacing the need for unskilled workers. However, the production of marigold flour relies heavily on manual labor. The seeding and harvesting can only be done manually. This generates significant employment for local communities during harvest time. The cost of labor in harvest-related activities accounts for 43 percent of the cost of goods sold or 31 percent of sales. SEAF has accounted for these expenses as indirect labor quantifiable as community development (if Tambo Inca did not generate these jobs, the people in the small communities would have no other employment opportunities and would probably be forced to migrate to the city).

Wages Tambo Inca’s wages for its skilled labor are, on average, US$ 11,128 per annum compared to the national minimum wage of approximately US$ 4,000 (national minimum wage applies for both skilled and unskilled workers). Its unskilled labor wages are set at the minimum wage; however, Tambo Inca is one of the only sources of formal jobs in its region. Because Tambo Inca, unlike many of its competitors, operates in the official economy, it pays the necessary taxes associated with employment in Peru—an incremental payroll cost of almost 29 percent. Black market operators—which in Peru represent a high portion of the agricultural sector—avoid these taxes. A table of these taxes follows on the next page:

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Personnel Taxes: Levies on the Employer:

2.00% Solidarity tax 8.33% Unemployment Funds

18.38% Two annual bonuses required by law equal to 1 month salary 28.71% Total

Levies on the Employee: 11.15 % Pension Fund 9.00 % Health Insurance

20.15 % Total Quantifiable Non-Salary Benefits Tambo Inca’s employees receive cash bonuses based on performance. For its top management a bonus system of about 15 percent of profits is set above a certain benchmark. Tambo Inca also provides cash bonuses to its field workers for a successful harvest (total amount depends on size of fields under supervision). Training The top two managers of Tambo Inca have both been in the agricultural business for the past 16 years, both have MBA degrees and have attended and been lecturers in several seminars on marigold cultivation and export sales. Their understanding of the marigold world markets and the production process provide direction and constant training to all other employees. Additionally, the field officers receive training in Lima on pest and disease control and fertilization. In-house training is the major source of knowledge sharing within Tambo Inca. The knowledge of seeding, fertilization, irrigation, picking and pest control comes from the years of experience of the main field officers, the entomologists and the fertilization expert, all of which provide ongoing training to the people in the field.

The plant where the flowers are dried milled and packed as flour is headed by Mr. Cesar Arana. Mr. Arana holds a degree in mechanical engineering and began working for Tambo Inca shortly after finishing college. He began work as assistant plant manager in 1999, received on-the-job training, and was promoted in 2003 to a plant manager. In addition to Mr. Arana, each working shift maintains a production supervisor in charge of controlling the temperature, humidity and feeding of the dehydration line. There are currently four production supervisors for the two lines, Piura and Viru, none of who has a technical or college degree. In all cases, they received on-the-job training and were promoted based on the skills and knowledge that they had acquired regarding the production process. Their performance was measured by the high xanthophyll content obtained during their working shifts (up to 15 percent of the xanthophyll content in the flour can be lost if temperature and humidity are not precisely controlled during the dehydration process or if there are gaps in the feeding system).

Hiring decisions are based on an assessment of a potential employee’s capacity to become a productive and determined worker. Tambo Inca’s work culture measures quantifiable targets among its employees, such as productivity of flower yields in the fields, content of xanthophyll in the dehydration process or ability to negotiate favorable price and payment terms with clients. Because Tambo Inca uses these measurable targets and gauges the performance of the workers against them, productivity in the field and the xanthophyll content in the flour have increased by approximately 20 and 50 percent respectively since 1998.

Very conservative assumptions were used in the development impact model: 72 hours of direct training per year from top management, 144 hours of supervisors’ time and 64 hours from other employees. These assumptions were obtained by interviewing the staff. For example, Mr. Segundo Ojeda had just been promoted to production supervisor. During his interview he explained that for the past three years he had been receiving approximately two hours per week of training from his former boss in order to acquire the experience necessary to move into this position. Based on the assumptions made, we calculate that approximately 56 hours of on-the-job training per year is provided (based upon plant operations for seven-months per year). Like Mr. Ojeda, the two production managers for

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the Viru region had received continuous training before being deployed to that region. Therefore, the total developmental impact for Tambo Inca would appear to be understated. Impact on Consumers

The Marigold flour is a commodity product in the international market, with a stable demand and supply that can vary mainly due to climatologically conditions and entrance of lower labor market countries (China and India). Tambo Inca’s only comparative advantage against lower labor cost producers is the xanthophyll content in each kilogram of marigold flour. For Tambo Inca’s customers, the higher content signifies a reduction of costs in the extraction process, since they will have to process less flour for the same output of xanthophyll. Even though Tambo Inca has improved the content by almost 50 percent since 1998, the benefit to the consumer is not measurable due to the higher costs of Tambo Inca’s flour. Furthermore, Tambo Inca’s products are exported. In this context SEAF has not made any quantitative estimate for this factor.

Producers of Complementary Goods

Tambo Inca outsources such services as plant repair and maintenance and electricity maintenance to local suppliers in Piura, although it also utilizes its skilled workforce for minor repairs.

Servicios Generales Nole Mr. Cesar Nole established his business at about the same time that Tambo Inca was incorporated. Mr. Nole had been working as a self-employed metal technician providing services to Mr. Victor Garrido Lecca manager of Tambo Inca since 1993. Mr. Nole explained that Tambo Inca has been his major client, accounting for almost 75 percent of his company’s revenues over the past 10 years.

Mr. Nole built up his small business from a small shop outside of town to a small two-floor building in the city. The company currently employs four workers and has acquired, through bank leasing, two metal bending and cutting machines. If Mr. Nole could add one lathe and another bending machine, he would be able to increase his capacity to service other clients. Mr. Nole’s revenues in 2003 were approximately US$ 30,000 with a profit margin around 15 percent.

Local Suppliers

According to Tambo Inca’s records, about 1.5 percent of goods are purchased directly from local suppliers and approximately 53 percent of the cost of goods sold and come from national suppliers. The major inputs in the production process are diesel, plastic bags and santoquin (a preservative for the flour), all produced locally. The field fertilizers, weed killers, and pesticides are either imported or produced locally. The average contribution margin (to cover fixed costs) for the local suppliers has been calculated at 25 percent higher than the national suppliers, at 22 percent. Competition and New Entrants

When Tambo Inca initiated operations in 1996, three other operators (Agrodoral, Agromar and Poblete) were also actively harvesting marigold flower in Piura. Today, only Tambo Inca remains in the region. Two of its main competitors had to shut down as a result of financial problems in the aftermath of El Niño. The third operator has moved to Viru, with a smaller land area under cultivation. A new entrant in the market is Piveg, a company owned by Mexican interests, with

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oleoresin plants in Mexico. Before entering the market, Piveg was one of Tambo Inca’s smaller clients.

In 1998 approximately 4,600 hectares of Marigold were being cultivated in the Piura valley. During 2003, Tambo Inca was the only company cultivating, with approximately 1,000 hectares, in Piura. Unlike Piura, the Viru valley has experienced growth in the land area under marigold cultivation. Throughout 1998, only 1,000 hectares were cultivated in Viru, whereas in 2003, 4,500 hectares were under cultivation. Piveg Corporation harvested about 2,000 of these hectares (please, refer to adjacent chart for geographical location of the valleys).

As a result, the decrease of land under marigold cultivation in the Piura Valley is offset by the increase in land under cultivation in the Viru region. For this reason SEAF has not attributed any value to the externality effect on “Competition and New Entrants.”

Neighbors/Community Development (Indirect Job Creation)

Tambo Inca handles about 160 accounts (each corresponding to an individual farmer) in Piura and 120 in the Viru region. These 280 individual farmers benefit directly from working with Tambo Inca. The majority of the farmers would not be able to secure financing anywhere else and their land would probably go uncultivated. In addition to providing financial resources to the farmers, Tambo Inca has been also investing directly in improving the irrigation systems for the farmers with whom it has signed a long-term contract. An example of this is the cleaning and re-alignment of the riverbed in the Tambo Grande region, providing 300 hectares of land with irrigation. This project has been jointly financed by Tambo Inca, the municipality, and the local farmers (approximately US$ 46,000). Such investment would not have happened if Tambo Inca had not been willing to finance the farmers and provide them a steady market for the marigold. Unfortunately, not all of the developments made by Tambo Inca can be as clearly quantified. SEAF has classified as a major source of community development the indirect employment that it generates through the farmers that hire workers for the different activities in the fields. As mentioned before, the average hectare employs about 125 wage days in a period of about four months. The marigold flower cultivation generates one of the highest ratios of labor per hectare since most of the harvest activities need to be manual. Each worker receives an approximate salary of about 13 Nuevos Soles per day or about US$ 3.75. If we considered that on average Tambo Inca has been cultivating about 1,500 hectares per year, the total number of daily wages required is 187,500 Nuevos Soles or about US$ 703,000 per growing season. This is the amount that the company has paid indirectly to the field workers. SEAF has accounted for this job creation as a direct impact for the community.

Rest of the Society The main other social benefits from Tambo Inca’s business are its financial contribution to the government and to local financial institutions. As detailed in the model, Tambo Inca’s contribution to the government comes less from profit taxes than from sales tax and retentions from employees. Regarding the sales tax paid on purchases, Tambo Inca has, as an export company, the right to recover the tax a month later. For this reason, even though the government benefits from the use of this

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money for one month, SEAF has not included the amount in the total calculation, using it only as a reference. There are also benefits to local financial institutions that profit from loans made to Tambo Inca, which are later on lent to farmers. Due to the lack of data, however, these benefits are not included.

A Contract Farmer’s Story For the past 12 years, Mr. Rodrigo Garrido, age 42, has been harvesting primarily marigolds along with some cotton and wheat. During his interview, he mentioned that the local banks do not consider him a good candidate for credit, since they view agriculture as a high-risk industry. Mr. Garrido added that he has a clean credit record, 22 hectares of arable land, which he tried to use as collateral for the loan, but was not able to obtain US$ 10,000 loan from the banks. The problem that Mr. Garrido faces is common among the farmers in the Piura valleys. This was confirmed while

interviewing Mr. Maurio Nunez, manager of Banco Continental (Peru’s second largest bank) in Piura. Mr. Nunez mentioned that for the bank (and added that for the rest of banks operating in Piura) agriculture is “off limits”. Only very few selected clients (with interests in other business sectors) receive financing. His bank only has four clients in the agriculture sector, while their total portfolio is composed of about 100,000 corporate clients in the region. He also added that the banks are not putting any value on arable land, thus not taking it as collateral, mainly because during the 1997 El Niño Phenomenon they had to execute many guarantees, and now have sizeable amounts of land which they cannot divest (this land is not being cultivated by anyone, nor does the bank have any plan for resolving this problem).

In this context, Mr. Garrido’s only source of finance is Tambo Inca. When asked if he could cultivate any other crop without financing, using his own resources, he sadly noted that he could afford to do it only for personal consumption.

Mr. Garrido has benefited from receiving Tambo Inca’s financing, which allows him to harvest his full 22 hectares. In addition, he receives technical assistance from a field supervisor, who visits him every week, and an entomologist, who visits him once a month during harvest season. Mr. Garrido now generates work not only for himself, but also for four other people on a full-time basis, and during harvest (4-5 months) he employs approximately 25 more workers.

Mr. Garrido’s financial returns for every hectare cultivated are approximately US$400-500. Such results enable him to maintain himself and his family for the entire year. He has also made improvements both in his home and farm over the past 10 years. Mr. Garrido’s hope is to wait until the banking sector changes its policies and offers him the working capital needed to harvest wheat when not harvesting marigolds.

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Romania—Telezimex

Introduction Telezimex SRL, based in Cluj-Napoca, Romania, is a distributor of electronic components to the Romanian market. Cluj-Napoca, with a population of approximately 315,000, is the capital of the Transylvanian Region of Romania, which makes up approximately 50 percent of Romania’s total population of 22 million. The total electronic components market is difficult to assess, but could be about €15 million in 2003 based on management’s estimate of its own market share.

The president and entrepreneur, Mr. Zoltan Nagy owns 45 percent of the business, SEAF’s investment fund (TBRF) owns 10 percent, and two Dutch silent partners own the remaining 45 percent. SEAF invested in the company in 2001 when the company had an opportunity to expand but could not find any other sources of funds in the market. Since 2001, SEAF has invested in total about US$ 279,000 in both debt and equity. The majority of SEAF’s investment is in the form of a high-yield debt instrument, which has enabled the owner to retain de facto control of the business, while paying SEAF’s fund a consistent return of 30 percent in US dollars. The Entrepreneur Mr. Nagy typifies many entrepreneurs in Central and Eastern Europe who are socially oriented toward local job creation while achieving business success. Mr. Nagy, a member of Romania’s Hungarian minority population, is exceptional in his ability to create and spin off businesses that generate jobs (see section on business spin-off below). He also generally pays his employees above market rates in order to attract and retain the best of largely semi-skilled and low-skilled workers. Mr. Nagy also actively seeks to create an open and team-oriented business operation. As part of this team orientation, he has also successfully pioneered a charity program previously untried on the local SME level whereby employees voluntarily donate a portion of their wages to a local children welfare program. The Business The company’s core business is the import and distribution of electronic components and provision of after-sale and repair services. It is the exclusive importer and distributor of Kinzo (Do-It-Yourself tools) and Maxell (consumer media products), as well as a franchisee of ASWO, which offers a database of spare parts for consumer electronics and white goods, and a Euras information system for professional service technicians. The main service delivered by electronic components distributors is to serve as a one-stop shop for assemblers (manufacturers, repair workshops, and specialty clients). Because of the vast product range they manage, these retailers are an irreplaceable link in any economy’s supply chain. The company has a central location in Cluj and two branches in Bucharest and Timisoara. They also sell by mail (for components) or via resellers. The company handles a very large number of items: it currently has in stock about 30,000 items that have relatively constant demand, and a further 2.5 million items

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through ASWO. The company pays ASWO five percent of sales annually as franchise fees plus about € 2250 in handling costs. The company collects orders, records them in the computer database and prints the orders directly at the warehouse as a pick-up list. The items listed are then picked up and generally mailed to the client. Orders through ASWO arrive through weekly imports. The database Euras allows the company to distribute information related to repairs for various electronic products. This database is either accessible on-line, where it is permanently updated, or on CDs, which are updated quarterly. The company has about 20,000 active clients for components out of a total customer base of 54,000. Business Spin-Offs1 Until mid-2000, the company also had a small furniture manufacturing and export operation. The equipment was moved to an economically depressed area in the Northwest of the country to create employment in the entrepreneur’s hometown. In 2002, the company spun off other businesses that did not relate to its core activities including the largest network of repair/workshops in Romania called Dr. Video with 25 employees, a low-scale manufacturing business using mostly components recovered from old TV sets with five employees, and an IT company with three employees with which Telezimex now contracts. The drop in the number of employees at Telezimex since 2000 is largely due to these spin-offs rather than an actual loss of employment.

Development Impacts The quantified results of SEAF’s development impact analysis are presented below.

The sections following describe the impacts on each stakeholder, which were quantified to reach the above.

1 Although these businesses were formed by Telezimex, they are not included in the development impact model, as they are no longer directly related to the organization.

2003 Statistical Data Revenues in 2003 (US$) 3,653,475 Gross margin (%) 26.5 Net margin (%) 5 No. of employees 75 % of low-skilled workers 30 Avg. wage for low-skilled (US$) 200/m SEAF investment to date (US$) 279,312 Realized proceeds to SEAF (US$) 82,718 Realized and unrealized (US$) 367,283 Multiple of capital invested 1.31

Financial & Economic Benefits Financial rate of return (%) 9a Economic rate of return (%) 62b Benefit/cost ratio (0% discount) 24.17c Benefit/cost ratio (10% discount) 8.65c

areturn to the company breturn to society cadditional dollars generated for society from every dollar invested in the company in constant terms

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Private Returns Telezimex is a high-margin, fast growing company operating in a relatively new and expanding market. Growing at more than 50 percent a year, and 70 percent in the year after SEAF’s investment, Telezimex’s growth only slowed in 2003 due to the spin off of several of its operations. Gross margins over this period have been relatively steady at about 50 percent and Telezimex has kept a current ratio on average of at least 1.35, converting the majority of the company’s financing into long-term loans as the company matured. In contrast to the company’s actual historic rapid growth, for conservative purposes, this study has used projections that show an average of 10 percent organic market growth over the future period of study.

Telezimex’s success factors among its clientele are its wide assortment, its fast and reliable delivery, and its advice and support line for electronic components. It derives this value proposition through efficient inventory management, as well as its relationships with ASWO, Maxell, and Kinzo. The company is financially successful and expects to continue with a profitable trend in the future. Telezimex is already a profitable on-going concern when it sought financing from SEAF. SEAF’s financing allowed the company to expand at the time when it was difficult for Telezimex to get bank financing. The projected financial rate of return might be underestimated as we use a very conservative future growth rate compared to the actual historic growth as explained above. Impacts on Labor Mr. Nagy’s management style is heavily employee-focused and has a significant economic development impact on his employees. Interestingly enough, even though Telezimex pays wages that are on average at least twice the market rate, the company has continually improved employees’ productivity and lowered wages as a percentage of sales. In this regard, Telezimex is one of the few companies of its size to institute formal training programs and assist in external schooling costs. Employment From 1999-2002 employment grew by 36 percent, despite only a three percent increase in 2002 as the company began its restructuring. In 2003, employment fell by 39 percent (from 122 to 75 employees) as the company spun off many of its non-core businesses. The loss of 47 jobs at Telezimex has to be placed into the context of the spin-offs, as these alone accounted for 33 of the positions. The remaining 14 positions lost were largely managerial positions as the company sought to flatten the organization’s hierarchy and came to accept the recommendations of SEAF’s financial advice. From 1999-2002, the ratio of high-skilled to low-skilled employees evolved from 3:1 to 4:1 before the restructuring in the organization in 2003 when it changed to 2.8:1. High-skilled employees are those at the managerial level or those who are required to have technical or sales expertise, while low-skilled employees generally work on inventory through order fulfillment. Wages As previously mentioned, Telezimex’s direct wages are well above the market rate. From 1999-2002, Telezimex paid its skilled workers on average twice the national average wage, and four times the industry average wage. However, by 2002, the multiple of the national average wage decreased from 2.4 to 1.8. After the restructuring, skilled wages were raised to 2.45 times the national average wage and 6.3 times the industry average. Low-skilled employees averaged approximately three times the minimum wage, although this figure ranged from 3.5 to 2.75 in 2003 largely due to a sharp increase in the national minimum wage. Interviews with managers and employees indicate that the willingness of the owner to share wealth with workers is one of the main attractive features in hiring and retaining workers. The company’s employment strategy appears to be sustainable, but the restructuring was likely necessary to keep it so. Telezimex’s gross margins averaged above 50 percent through 2002, while its EBITDA

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margins fell from 12 to five percent, and net results deteriorated from three to 0.5 percent. After the restructuring, gross margins fell to 26 percent, while EBITDA rose to seven percent, and net results to two percent. During this time, direct wages fell from 16 percent of revenue to nine percent of revenue. It is on these latter, scaled back results that the projections of the employees’ benefits for this study are based.

Formal employment also generates significant taxes for both employer and employees as follows: Personnel Taxes

Levy on the Employer: 24.5% Social Insurance 3.5% Unemployment Funds

0.75% Working Book 7% Health Insurance

0.5% Risk Funds 36.25% Total

Levy on the Employee: 9.5% Social Insurance 6.5% Health Insurance 1.0% Unemployment Funds

17.0% Total Quantifiable Non-Salary Benefits In addition to the higher-than-market wages, Telezimex also provides a number of quantifiable non-salary benefits. These benefits include a €30 meal ticket for each employee, birthday and Christmas presents for both employees and their children, gifts used for incentive schemes, as well as personal allowances for automobiles, petrol, and mobile phone usage. Management estimates that these costs, exclusive of the meal tickets, represent about 7.5 percent of SG&A costs. Training Telezimex offers its employees a wide range of informal training opportunities, as well as more formalized classes. Skilled employees receive on-the-job training, as well as a two-week course held every winter, and those in managerial positions have the option to attend a three-tier MBA program (see below). On-the-job training ranges from the application of theoretical principles learned in formal school settings (either before or in conjunction with employment) to general computer skills that are in high demand but low supply in the region. The two-week course employs outside experts that the company hires to teach different modules such as communications, time management, and providing quality service. These courses are open to all employees in the company. The MBA program is administered in Romania through a partnership between the Center for Open Distance Education and the Open University. This is a three-year program for the MBA with certificate diplomas upon completion of each stage. The cost of the program begins at € 500 per course in the first year up to € 1000 in the third year. Telezimex pays the full cost of the program for each manager who chooses to register for the program. Unskilled workers primarily receive on-the-job training to increase their current skills, or develop new skills such as computer skills. However, they are also welcome to attend the two-week course though the modules are targeted toward skilled employees. In interviews, a few unskilled employees said that they would attend in order to upgrade their skills with a distant promotion in mind, but most stated a lack of interest that was compounded by the commitment of non-

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work time. The development impact model shows actual formal training costs from 1999-2003, which average approximately €63 per skilled employee and is projected at a stable €50 per skilled employee. Non-Quantifiable: Work Environment In 2003, as a part of the restructuring and to implement social innovation, Mr. Nagy hired a part-time director to focus on internal communications and employee motivation. The director produced a report that indicated that employees had the necessary skill level and welcomed a vision of mixed teamwork and competition but needed to be re-motivated after the restructuring, when some managers were laid off and other employees were transferred out of the company. The employees felt there needed to be better communication about the goals of the restructuring and did not know what to expect of the future. Another surprising observation was that more delegation was needed, i.e., there were “too many managers and not enough employees,” and that despite the talk of delegation, it was not executed. One manifestation of this was Mr. Nagy’s hands-on management style and disregard for hierarchy, which tended to narrow areas of responsibility and authority in the company. As a result, Mr. Nagy vested the General Manager, a young woman, with increasing responsibility for the company as he slowly disengaged himself from day-to-day management. Other initiatives were brown-bag lunches to promote e employee communication and socializing, and as an initiative to provide feedback at a positive to negative ratio of 80:20. As a result, the employees reported after 6 months that they felt highly motivated and had a high sense of job satisfaction, despite the layoffs earlier in the year and the reduction of management positions.

Impact on Consumers Telezimex targets four main consumer markets: large retail chains, independent retail shops, industrial and professional businesses that require specific replacement parts (e.g., TV stations), and workshops. Large retail chains and independent retailers comprise approximately 65 percent of Telezimex’s sales, workshops comprise 25-30 percent, and industrial businesses 10-15 percent. Mr. Nagy states that despite his exclusivity for such consumer media products such as Maxell, these products are readily replaceable, or there is a supplier that would be able to take over the contract if Telezimex failed to fulfill this market’s needs. Consumer media products are also largely priced by the market and require virtually no value-added services at the distributor level. Therefore, no consumer surplus was registered for this market in the development model. However, Telezimex provides value-added services to workshops that are often too small to supply their clients the necessary services for their operations. Mr. Nagy does not believe a competitor can easily replace his operations in this area. Telezimex provides the largest inventory among its competitors and is able to provide replacement parts that otherwise are difficult to obtain. As most manufacturers of brown and white goods focus on products rather than parts, they do not focus their businesses on providing these parts. The company has a competitive advantage in its ability to provide this service, among others, in order to ensure that it meets the complete needs of the workshops. Other value-added services are the free technical information hotline that often saves a workshop a full day’s costs by providing helpful and succinct information needed in the provision of their services, as well as generous 30-day credit terms or consignment sales when possible, whereas most of the market requires advance payment. Management estimates that this total service package represents a customer surplus of 10 percent. The model includes this 10 percent value the 25 percent of revenues that workshops represent, and on top of 30 percent, for projected years as the company focuses increasingly on them. Producers of Complementary Goods and Services Industrial and professional businesses, such as television stations and productions studios, represent approximately 10-15 percent of Telezimex’s revenue. These businesses save on purchases through

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Telezimex due to the company’s large inventory and service, provision of free technical information, and consistent availability of replacement parts otherwise hard to find on the open market due to franchising and the specialization of the trade. However, this impact is not easily quantifiable and is therefore not included in the impact assessment. Local Suppliers Telezimex estimates that only 10 percent of all the products it distributes are produced locally. The small-scale manufacturing businesses that were spun off from core operations potentially have impact on local suppliers; however, as they are separate entities, their impact is not included in the development impact figures for Telezimex.

Competition and New Entrants The barriers to entry in Telezimex’s business include the high level of investment required to develop a similar inventory and capacity, as well as the necessary contracts that are rarely provided to untested entrants. Telezimex has one direct competitor that attempts to mimic its sales strategy, marketing and product line. With SEAF’s encouragement, Mr. Nagy started to delegate most of the operations to the General Manager, and therefore has been able to spend more time building client loyalty and new customer relationships. Getting closer to his customers has made him feel less threatened by the competition and, in fact, he says that he is flattered by their imitation. Other niche providers (cables, remote controls, etc.) offer a small range of products and do not seriously compete in Telezimex’s market segment. The demonstration effect of Telezimex’s model is not easily quantified (and is therefore not included in the impact assessment) but its impact is important as Telezimex’s success is replicated in the market. Neighbors/Community Development Very few corporations in Romania actively sponsor charity operations with a portion of their proceeds, and even fewer in the SME sector have the free cash flow, leadership or the vision to do so. Telezimex is an exception. Mr. Nagy and a few other social entrepreneurs have joined together to promote social causes through their businesses. One of the newest ideas has been an employee-giving and matching program, where Telezimex’s employees opt to donate between €1-5 of their monthly wage to a local children’s foundation, Fundatie Romana pentru Copii, Comunitate si Familie (FRCCF). FRCCF provides local children with meals, tutors, vocational skills, and recreational activities in order to help working. The foundation helps the poor families to keep their children safe and provides learning opportunities. Employees contribute on average €3 a month and Telezimex matches these contributions. In addition, the company plans picnics and other outings with the foundation so that employees are able to see first-hand the impact they are having on the individual children they are assisting and on the community at large. Management credits this initiative with strong psychological benefits for its employees who have seen themselves largely as victims under Romania’s transition toward a market economy. Mr. Nagy

Telezimex—Employees participate in a payroll deduction program to support children’s programs in the community

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recognizes that this initiative fosters a sense of self-worth and confidence in the people, as well as pride in the local community. Rest of the Society The local government also benefits from Telezimex’s success. The contributions to the government include profit taxes, Value Added Taxes, import taxes, and other taxes, as well as contributions to the National Pension Fund and National Health Insurance Fund. As Telezimex imports most of its products, the import taxes are quite significant and can be easily measured. Telezimex paid almost 20 percent of its revenue in 2002 in various taxes. Telezimex also borrows from local financial institutions and the interest and fees paid amount on average to about €3,000 per month. In addition, Telezimex leases cars and vans amounting to about €3,000 per month. These quantifiable benefits are included in the quantified impact assessment.

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Peru—Victoria Classics

Introduction

Victoria Classics S.A. (Victoria) is located in Lima, Peru. Jaime Arrieta and his wife Marina Günter, started making children’s clothing in 1991. For some time, they were located in Miami and relied largely on importing finished products made according to their specifications from Peru. In order to qualify for an investment by SEAF’s first Peruvian fund, FAPE, they transformed the company into a limited liability company called Victoria Classics S.A.C. and moved to Peru. The company specializes in children’s embroidered clothing, using high quality Pima cotton from Peru. Victoria also imports decorative materials (e.g., laces and ribbons) from France, India, and Japan to add to the uniqueness of its high-end finished product. All production is exported to the United States. Victoria’s major clients are department stores (including Neiman Marcus), boutiques, specialty stores, and gift shops. One of its major export lines is “Victoria Kids,” a line of clothing for children from newborns to age three. SEAF began working with the entrepreneurs in 1998 and invested in the company in 1999. SEAF purchased a 33 percent stake in the company for an investment of US$ 245,000. The company has very little debt, and it has consistently maintained adequate levels of net income and liquidity. SEAF’s investment was used to purchase new machinery, provide sufficient working capital and finance an export promotion campaign. In addition to the much-needed capital, SEAF provided technical assistance in marketing Victoria’s products and market research to stay on top of the trends in the U.S. market. Victoria welcomed and benefited from marketing assistance from SEAF’s Business Development Unit (BDU) in Washington, D.C. and has recently contracted with SEAF’s BDU to evaluate and advise on its marketing and sales strategy, even though SEAF exited the company in 2001.

Victoria Classics’ modern factory in Lima, Peru

Inside the factory

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Development Impacts The quantified results of SEAF’s development impact analysis are presented below.

2003 Statistical Data Revenues in 2003 (US$) 2,803,049 Gross margin (%) 71.2 Net margin (%) 47.6 No. of employees 48 % of low-skilled workers 52 Avg. wage for low-skilled (US$) 220/m SEAF investment to date (US$) 245,000 Realized proceeds to SEAF (US$) 436,415 Realized & unrealized proceeds (US$) 436,416 Multiple of capital invested 1.78

Financial & Economic Benefits Financial rate of return (%) 45 Economic rate of return (%) 57 Benefit/cost ratio (0% discount) 4.54* Benefit/cost ratio (10% discount) 2.90* *additional dollars generated for society from every dollar invested in the company in constant terms

The sections below describe the impacts on each stakeholder, which were quantified to reach the above. Private Returns Victoria Classics is a successful company, which has continued to grow as a result of the combination of SEAF’s investment, technical assistance, and the principals’ good management practices. The company has grown sales from US$ 294,000 in 1994 to US$ 2.8 million in 2003, while the average price per unit costs of its clothing has increased from US$ 12.9 to US$ 19.1 in constant terms. The quantity of units sold more that quadrupled from 23,149 to 113,253. The company has an aggressive sales strategy, which includes a team of manufacturers’ representatives who solicit orders on the company’s behalf. These nine representatives are located New York City, Los Angeles, San Francisco, Dallas, Orlando, Atlanta, Miami, Philadelphia, and Denver. The representatives have a defined sales territory and are given full, current catalogues to expedite sales with clients. Victoria Classics also participates in four major trade shows every year in New York City and advertises in two trade magazines. SEAF exited the company after 18 months of investment at an IRR of 45 percent. The financial rate of return of the company is estimated at 45 percent. In 2003, the company saw that its market position would need to be strengthened in the United States and once again commissioned SEAF’s BDU to undertake a market survey to advise Victoria on its future overall business and marketing strategy. SEAF advised Victoria to consolidate its product lines, improve

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its design, and streamline the production process. In view of the company’s strong sales position in America and its potential to expand to Europe and Asia, we expect that Victoria will continue to perform well in the future.

Impacts on Labor Since SEAF’s investment in 1999, the total employment by the company has increased from 28 to 48. The number of highly skilled workers has increased from 16 to 25, and low-skilled workers from 10 to 23. In addition, the company also hires a significant number of piecework contract workers, most of whom work from their own homes often at significant distances from Lima. They travel periodically to pick up piecework and deliver their finished products. For the women living some distance from Victoria Classics, such piecework may represent one of the few employment opportunities available to them. There has been a dramatic increase in the number of contract workers from approximately 20 in 1998 to 162 workers in 2003. As the company continues to grow, it is expected that Victoria will continue to employ more low-skilled and contract workers. In addition, some of Victoria’s contract workers will be offered full-time positions, which include additional benefits, such as pension plans, health insurance, and training. Victoria Classics has shared its success with its employees. Low-skilled workers’ salaries are substantially higher (84 percent) than the national minimum wage. This is due to the fact that many of the low-skilled workers have been selected from the pool of contract workers who have been with the company for a long period of time. During this period, they have received training to upgrade their skills from two Victoria supervisors dedicated to screening and teaching contract workers how to improve their work in order to reduce their quality rejection rate. As such, these workers become semi-skilled by the time of their employment with Victoria. Real wage increase Real wages have also increased significantly since SEAF’s investment in 1999. Low skilled workers have seen their real wages increase by 108 percent and high skilled workers have experienced a 68 percent real wage increase as shown in the chart below:

:

Average Real Wages for Semi-skilled and High Skilled Workers in US$

0

1000

2000

3000

4000

5000

1999 2000 2001 2002 2003

Semi- Skilled Worker High Skilled Worker

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Skill Mobility In principle, most workers could transfer their skills elsewhere, but most tend to stay since alternative employment is relatively scarce in Lima. Victoria’s turnover rate is very low, with employees stating that this is mainly due to higher wages and better working conditions compared to other companies in the same industry. Interviews with workers indicate that the founding partners also care about the workers and have gone out of their way to help them in case of sickness and to make sure that they feel secure in their employment with the company. About 50 percent of interviewees did not believe that they could earn more elsewhere with the acquired skills. To be conservative, the economic analysis therefore does not take into account the skill mobility premium provided to Victoria’s workers. Non-salary benefits Employees of Victoria Classics receive a significant amount of non-salary benefits, equal to 60 percent of the average take-home pay. The company pays into a pension plan for all employees and provides them with health insurance, as required by law. Depending on the salary level and time in service, the employees also receive extra months of salary as a bonus. As paying for the employee benefits required by law is expensive, the company hires regular employees after they have gone through a testing period as piece-rate contract workers ranging from six months to a few years.

Household Impact—Asset Accumulation Most workers interviewed (80 percent low skilled, 20 percent high skilled) live with other family members in owned or rented house and share household expenditures. They have not been able to purchase new houses, but are saving for housing improvements and furniture purchases. Some were able to purchase land for future building. Less than 10 percent were saving for education, since public education is free. Those who save for education want to send their children to private schools or to get language training (English) as they believe that the knowledge and the skill will help their children to find better jobs and improve their lives. As payroll workers also get health benefits, all low-skilled workers do not pay for private health insurance, but some do pay for life insurance. High-skilled workers on the other hand pay for additional private health insurance as well as life insurance. Training Victoria Classics employs two women on a full-time basis to be in charge of training employees and contract workers. Training takes place on the job for low-skilled workers, helping them improve their basic embroidery and crochet skills according to the high standards set by the founders. The trainers are paid about NS 1,500 per month. The salaries of these two workers are included as the cost of training in the analysis. In addition, some formal training is also provided for skilled workers to acquire computer skills necessary for record keeping, processing orders, designing, and accounting. However, these benefits are not included in the analysis, as the company does not separately account for these training costs.

Transition from Contracting to Working as a Regular Employee Ms Y. started with Victoria 5 years ago as a contract worker, and was converted to a regular employee in September 2002. She now works for the company full-time as a quality control supervisor. She learned embroidery from her grandmother and at a convent school. When working as a contract worker, she earned on average about NS 500 a month, but now her salary is NS 700 a month, plus health insurance and other non-salary benefits. These benefits have become even more important for her as she has discovered she has breast cancer. Since health insurance does not cover all her treatment costs, the owners help her with the payments, and her colleagues organized a fund-raising event to help her cover expenses. In spite of her illness, she works and saves in an informal savings club and pays for her one child to go to private school (about NS 60 a month) to enable her to get a better education. Source: Employee’s interview, November 2003

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Impact on consumers As Victoria exports all of its products to the United States, the impact on local consumers is not counted. However, given Victoria’s extensive use of contract workers, it may be expected that the general skills level and quality standards are transferred to the market more generally in Lima. Impact on Suppliers The company has had a large impact on local suppliers since it uses many contract workers as well as local materials for the production of its clothing. The local component accounts for two-thirds of Cost of Goods Sold (COGS). Even though one can argue that contract workers could find work in other companies, it is clear that if Victoria did not employ them, they would not receive comparable wages or might not find work due to high competition. To be conservative in the analysis, however, we count the incremental benefits of only 50 percent of contract workers as the impact on local suppliers. We have also not included the skill premium that these workers got from working with Victoria. In addition to contract workers, Victoria also uses the services of micro-entrepreneurs to prepare high quality clothes that will be embroidered by the contract workers. However, we have not been able to quantify this benefit and therefore the impact on suppliers is understated. Impact on Producers of Complementary Goods As many contract workers must travel a considerable distance to come to Victoria’s factory to receive and to deliver orders, the company provides catered lunches. The cost of all of these lunches is about NS 550 per month or NS 6,600 per year. As the company grows and the number of piece-rate workers increases, this benefit to lunch caterers could become more significant and should then be counted in the analysis. Local Community Development Although Victoria does not support any community development programs, it feels responsible for generating employment and incomes for many poor women who are home bound and lack appropriate skills to compete for jobs in the market. Victoria is located in a relatively safe neighborhood in Lima, and the owners feel that it is necessary to have a secure work place for their employees and contract workers, who carry with them a substantial amount of cash and expensive clothing. Many of the contract workers come from less safe neighborhoods or long distances and prefer to spend time, when they are able to do so, at the factory. In addition to being safe, it is modern and comfortable and brings the workers together so that they can learn from each other. An additional benefit is that Victoria provides lunch for those who come. The safe working environment and the informal training they receive are not counted in the quantified development impact assessment, as it is not possible to quantify the value of these intangible benefits.

Victoria Classics: Linking micro-

Contract workers at Victoria Classics

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Impact on the Rest of Society Victoria pays corporate taxes, sales taxes and other miscellaneous taxes to the local government; these benefits are counted in the analysis. Victoria has not borrowed significantly from local financial institutions, but has expanded its business out of internal cash generated. However, the future expansion will require additional working capital and with a new building, Victoria will have the collateral necessary to obtain a loan from local financial institutions. However, we have not counted the benefits for local financial institutions in the analysis and therefore, the economic benefits are likely to be underestimated. Poverty Impact The most significant poverty reduction impact is the employment of female workers both as regular employees and as contract workers. More than two-thirds of Victoria’s workers are women. In addition to the straightforward poverty impact that comes from Victoria’s ability to pay its employees and contract workers sustainable and increasing wages, as it trains its workers and exports their products to higher value-added markets, Victoria’s employment of a substantial amount of women is likely to have an additional knock-on impact on poverty alleviation. Economic research has shown that a larger percentage of the incomes generated by women trickle down to the family, compared to incomes earned by men, and therefore helps alleviate poverty. We cannot confirm this hypothesis in this study, as we do not compare expenditure patterns between the incomes of men and women. However, as shown in many studies, the company’s employment of women who might not otherwise have such employment opportunities has a significant poverty reduction impact.

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