Dynamics of Agri-food Supply Chains in Transition Countries Johan F.M. Swinnen The World Bank

1. Dynamics of Agri-food Supply Chains in Transition CountriesJohan F.M. SwinnenThe World Bank Sarajevo ConferenceMay 24-26, 2004

2. Background • Breakdown of the relationships of farms with input suppliers and output markets. • Contracting and vertical coordination in supply chain emerging to overcome these obstacles • Processes have been an engine of growth in most advanced ECA countries.

3. Key Issues / Questions • How important / general is this process ? • Which models ? • Which conditions are required ? • Effects ? • Who gets the benefits ? (What about small farmers ?) • Which role does FDI play ? • Implications for government policy and international organizations ?

4. Series of case studies, interviews and surveys Different sectors (dairy, cotton, fruits & vegetables, …) Different countries across ECA Methodology

5. 1. Important ? Yes.

6. Farm Comp. Family Farms Hungary 1997 94 17 Czech 1999 98 46 Slovak 1999 96 35 Farms selling on contract in Central Europe (% of all)

7. Dairy in North Poland • ALL dairy companies assist suppliers (farms) through : • Input supply programs • Credit programs • Extension services • PART : Bank loan guarantee programs • Programs for SMALL and LARGE suppliers

8. Dairy in Bulgaria, Slovakia, Poland

9. CIS • 5 country study : 40% of agri-food processors offers credit to suppliers • Kazakhstan cotton : 71% of cotton farmers contracts with ginner, with assistance packages

11. How Important ? • Sugar sector : 80 – 90 % of CEEC sugar sector is FDI, using contracts & farm assistance programs • Dairy& oilseeds sector : significant FDI, and most companies implement programs, with strong spillover effects on domestic companies • Supermarkets : Some, but not generally • After 1998 : VC in Russian food chain by domestic investments from outside agriculture • Kazakhstan : grain trading companies investing upstream; cotton ginning : contracting mostly with small farms, ...

12. 2. Multiple Models & Motivations • Commodity specific • Transition-stage specific • Securing basic supplies • Quality ! • Many constructions (simple & complex) • Key is “Non-traditional” design (also e.g. Warehouse Receipt Systems)

13. Czech Slovak Hung Contract price higher 12 10 10 Avoid price uncertainty 6 21 33 Guaranteed sales 60 50 43 Immediate payment 7 11 3 Easier to get credit 0 0 9 Contract - inputs or TA 10 6 2 Other 4 2 0 Reasons for Contracting – CEE

14. Reasons for Contracting Kazak Cotton Farmers

15. Agri-business Motivations for Vertical Integration • Early stage : Securing basic supplies (ex: pre-finance, inputs, …) • Advanced : Upgrading quality of supplies (ex: technical and management assistance, investment loans, loan guarantees, …)

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

17. Transition Region is Special • Collapse of farm output and livestock numbers creates discrepancy between processing capacity and supply • History of poor quality • This makes it a “SUPPLIER’s MARKET” (compared to other regions)

18. Some Examples of More Complex Models

19. Integrating Multiple Stages : INTERBREW (Brewing Multinational) • Core business = brewing • Forced to vertically integrate to ensure quality malt/barley/seed • General strategy applied differently in different countries b/c of local conditions • Bring in co-foreign investors to assist with non-core activities and set up farm assistance programs • Programs interlink markets Brewing Co. Malting Co. Barley farm Seed supply

20. Proces./Retail – guaranteed supplier loans: JUHOSUKOR in Slovakia & KONZUM in Croatia • Retailer/processor provides loan guarantees for bank loans to suppliers Retail/Processing Co. Farm Bank

21. Dairy Processor Becomes Financial Institution: DANONE in Romania • Processor takes on banking function: • provides loans to farms • based on business plans • takes collateral • Provides payment guarantee for input suppliers Processing Farm Input Supplier Bank

22. Lending with distributed risk: RABOBANK - SPVs • Financial institution is foreign investor • Special purpose vehicle (SPV) to distribute risk equally among partners • Ex. where group of small farmers formed cooperative to participate in SPV Processing co. SPV Farm Bank Input Supplier

23. 3. Contract Enforcementis essential for ANY model • Crucial to make VC sustainable • Not obvious: Many cases and stories where contract enforcement problems undermines VC • Private enforcement mechanisms can be more important than public institutions

24. 4. Effects • Important Direct Effects : • Enhanced QUALITY (& higher prices) • Increased PRODUCTIVITY • (eg CIS study) • Important Indirect Effects: Spillovers • Contract replication by other companies • Farm assistance replication • Household level spillovers

25. Change in yields in Central Europe 1989-2000

26. Change in QualityDairy in North Poland 1996-2001

27. Household Spillover Effects • Reduced risk (guaranteed price for contracted crop) in absence of insurance markets • Improved access to credit (cash for contracted crop) with imperfect capital markets • Increased productivity of non-contracted activities, through improved management and better input use

28. 5. Foreign investment (FDI) • Conceptually, no need for FDI • Empirically: • FDI is driving force for contract innovations • Domesticspillovers are important • Several exceptions: FIG investments (Russia, Kaz), Cotton Kazakhstan • Crucial factor appears access to outside finance (and management strategy)

29. 6. Will small farms survive ? • Key concern • Lots of stories and intuition • Usually based on little evidence

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

31. The Key Concern Small farmers may ‘fail to make the grade’ because : • Fixed component in transaction costs makes it more costly to deal with many small farmers than with a few large farms • Small farms are constrained financially (internally and/or externally) for making necessary investments

32. Evidence ? • Many stories but little ‘hard evidence’ • What exists suggest that • We should take this concern seriously • But the reality is much more complex and nuanced than assumptions

33. Evidence – part 1 • Interviews with agri-food companies confirms preference for larger suppliers • Specialized wholesalers and supermarkets prefer to work with (relatively) large FFV producers in Croatia (Reardon et al 2003) • Danone and Megle in Bulgaria and Romania have strategy focused on >20 cow farms • CIS study finds 60% of processors have minimum size for some of its farm assistance programs

34. Evidence – part 2 • Examples of company programs to small farmers being quite successful. Eg. • Croatian F&V suppliers to supermarkets • Kazak cotton • Polish and Romanian dairy • e.g. Friesland Romania works with 40,000 small farms through 1,000 collection centers; contracts include farm assistance packages

35. Impact on Loans and Investment Small farms in Polish Dairy sector

36. Impact on small farms – Poland dairy

37. Evidence – part 2 • CIS study finds that processors do not discriminate on size for providing basic programs (agronomic support, physical inputs, prompt payments, …) • Both Polish dairy study and CIS study find that FDI companies are not more likely to cut small farms as suppliers (the opposite)

38. More importantly • Modern dairy companies focusing on high-quality market (incl retail sector) tend to assist small farms; compared to market channels targeted to informal and low quality sales which do not • In Lithuania, all credit which small dairy farms get is through the dairy companies (cannot get access to bank loans or public assistance, incl SAPARD)

39. Why work with small suppliers ? • In some cases processors have no choice : small farms represent most supply (eg Poland, many Balkan countries, Transcaucausus, Kyrgyz, …) • Eg. Romania: 95% of dairy farms have 1-2 cows. => Small Farm Paradox ? • “processing companies stressed that willingness to learn, take on board advise, and a professional attitude were more important than size in establishing fruitful farm-processor relationship” (CIS study)

40. Supply Chain Revolution or Evolution ? • Several factors suggest that the impact of the supermarket revolution on farmers, including small farmers, may be less dramatic in some contexts, and may have positive effects in transition countries

41. A. Supermarket is part of chain • For vast majority of farm output there is no direct link with supermarkets: FFV is 15-20% of ag output. Most farm produce (milk, grains, sugar, cotton, etc.) is processed before it reaches retail sector. The impact on these farms will be indirect through the food processing sector. • The effects may be more similar to that of FDI in food processing. These effects have been positive in several cases for small farms

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

43. C. Next step in major changes • Agricultural restructuring in transition countries (Output, trade, employment, FDI, food industry restructuring, ….) has been dramatic over past 15 years

44. Revolution or evolution ? Change in ag employment 1998-2001

45. Revolution or evolution ? EU – CEEC trade in ag and food products 1988-2001

46. D. Retailers and vertical coordination may play positive role for key weaknesses • Key weaknesses of ECA farms : • Shortage of finance for investments • Quality • Access to high value markets • Retail investments and coordination with supply chains may assist farms in these areas

47. 7. Implications for policy • Create right conditions for business investment • Competition policy !

48. Competition is VERY Important • Induces horizontal spillovers and the spread of farm assistance packages • Constrains (potential) rent extraction in chain • E.g. Kazak cotton story: competition among processors for suppliers induces assistance programs, collection center investments, etc.

49. Bad Policies are Worse than Bad Weather • VC may survive defaults due to unforeseen and one-time events (eg bad weather in Kazakhstan) • However, inappropriate government intervention may destroy VC • Eg Ukraine in 1990s

50. Implications for investments and projects • Traditional Public goods : eg • rural electricity (Azerbaijan), • rural roads (Romania), … • New instruments: Focus on • Chain Finance, • Quality & Bringing small farmers ‘on board’  Example