Buyer-Driven Endogenous Adoption of Improved Technologies

1. AnneleenVandeplasPostdoctoral researcher, LICOS, KULeuven 16th ICABR Conference – 128th EAAE Seminar Buyer-Driven Endogenous Adoption of Improved Technologies

2. Main focus of the paper • Technology adoption • Increased productivity • Direct income effects on farm households • Indirect income effects (labour markets, food prices) • Economic growth • How do new (improved) technologies reach smallholders? • How can local policymakers in developing countries encourage the transfer of technology to local farms (in a cost-efficient manner)? • What role does the private sector play?

3. Vertical coordination • Definition • Important channel of technology adoption • Dairy sector in India (Vandeplas et al., 2012) • Sugar, dairy, barley in Eastern Europe (Gow et al., 2000; Dries andSwinnen, 2004; Swinnen, 2006) • Broilers in Philippines and Thailand (Gulati et al., 2005) • Hog sector in the US (Key and McBride, 2003) • Horticultural crops for export in SSA • Drivers?

4. Relevance • Thorough understanding of conditions under which VC emerges important to policymakers • Competition policy in Indian dairy sector, in SSA cotton, in Central Asian cotton: support for regional monopsonies • Agricultural & food policies to increase productivity and ensure food security • Ensure food safety and quality

5. Related literature • Why do firms want to produce HQ goods? • Monopoly firms can ‘skim off’ consumer surplus through quality differentiation (e.g. Mussa & Rosen, 1978) • Even with identical preferences, consumers choose different products based on differences in income level (Gabszewicz and Thisse, 1979) • Price competition between firms can be ‘relaxed’ through product differentiation; HQ firm will earn higher profits • If quality production costs are zero (Shaked & Sutton, 1982) • If quality production costs are positive (Motta, 1993) • If quality choice is sequential, first mover will always choose high quality (Lehman-Grube, 1997)

6. Related literature • How do firms produce HQ? • If consumers are prepared to pay for quality (income growth  price premium)… • but farmers are capital-constrained … • and buyers of agricultural products (agrifood processors or retailers) are labour-constrained or land-constrained … • Buyers will vertically coordinate with farmers, investing in technology transfer to farmers through interlinked contracts (input & output markets) • E.g. World Bank 2006; Dries and Swinnen 2004; Swinnen and Vandeplas 2011;

7. Contracting in dairy vs GDP Source: Swinnen et al. (2011)

8. But VC may break down… • Competition increases producer prices, but: • Price competition may remove incentive to produce quality (Kranton, 2003) • Price competition and lacking quality premium lead VC to break down (Swinnen and Vandeplas, 2011; Poulton et al., 2004) • With too much competition and/or too low quality premium: • Diversion of cotton inputs in Ghana (Poulton, 1998) • Sideselling of horticultural products in Kenya and Zambia (Ruotsi, 2003) • Input diversion and sideselling of barley under contract in SSA (Wangwe &Lwakatare, 2004; Jaffee, 1994) • … • Trade off between equity and efficiency

9. Motivation of the paper • Observations: Indian dairy sector • Price competition • No quality differentiation/premium (no WTP for HQ) • Still … some firms (the big ones!) engage in VC programs; others don’t • Does this conflict with theory? • How can VC programs persist in competitive equilibrium? • No guarantee on credit recovery • VC = increased production cost – these firms should be driven out of the market by more ‘efficient’ firms • What are the conditions for VC to emerge?

10. Main argument • Argue that VC can emerge/be sustained under • High competition • Lack of price premium • if • Dynamic view: • quality upgrading with time lag • promise of quality premium in future (high income growth) • Large market size (sales volume) • Firm sufficiently forward-looking & patient • Facilitated by firm strategic advantage in HQ provision (access to technology; HQ reputation-facilitating characteristics)

11. Model: consumer side Utility increasing in quality; concave in remaining income (Tirole, 1988: 97) Demand for HQ products increasing in income

12. Model: processor side • Two-period model • Period 1: • Sales volume q • No rewards to quality (Homogeneous producer price pPand consumer price pC) • Constant or increasing returns to scale • Competitive equilibrium: pC= pP+ MC(q) • Firm chooses whether or not to invest in HQ potential for next period at fixed cost • With X: relevant firmcharacteristics: internationalreputation, access totechnology, branding, ... • Weak contract enforcement: firmscannotrecoverfixedcosts VC frommilkprocurementprice

13. Model • Period 2: • Consumer price premium for quality • Marginal costs of producing: • Fixed costs of procuring quality: • With X: relevant firmcharacteristics: internationalreputation, access totechnology

14. Decision process Period 1: Period 2: Objective function:

15. Decision process If > O  increase quality If < O  reduce quality

16. Decision process • Firm invests in HQ if • Expected price premium HQ larger (higher income growth) • Expected demand shift to HQ larger • Market size larger (sales volume) • Marginal costs of procuring quality lower • Fixed costs of quality production lower (access to knowledge, technology, international reputation) • Firm heterogeneity: • Sales volume • Fixed costs of quality production

17. Policy recommendations • If not market power but market size matters: • Allow for market size expansion rather than local concentration (e.g. removing barriers between markets) • Efficiency does not need to be traded off against equity • With weak contract enforcement, rents from investments are not fully appropriable by investor • Recognize positive spillovers & public good characteristics from VC investments

18. Generalization • Same model can be applied to other sectors with • Time lag between fixed cost investment and returns to investment • Weak enforcement institutions (developing country context) • Sector-wide relevance for bio-economy