SOE 2007 Policy Brief - Pro-Poor Agri-Business Models

Institute of Policy Studies of Sri Lanka Sri Lanka: State of the Economy 2007 Empowerment of the Poor
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9.
Pro Poor Agri-Business Models: Revitalizing Small Holder Spice Cultivation
9.1 Introduction Historically, the spice sector consisting mainly of cinnamon, pepper, cloves, cardamoms, nutmeg and mace has played a key role in the Sri Lankan economy. At present, over 80,000 ha of land (6 per cent of land under perennial crops) is under spice cultivation. Annual production of spices has expanded from 27,000 mt. to 37,000 mt. over the last decade. Sri Lanka is the largest producer of cinnamon in the world and contributes to over 80 per cent of total global production. In the case of pepper, around 3 per cent of the world demand for pepper is supplied by Sri Lanka. In terms of earnings from exports, the value of spice exports is typically equivalent to 1.5 per cent of total exports and 8 per cent of agricultural exports with a sectoral contribution of around 0.8 per cent to GDP. The spice sector has a small farm orientation with over 200,000 small scale growers involved in spice cultivation where 70 per cent of production comes from small holder farm units of less than 1 ha of land. Over the last couple of decades, spices have become the main cash earning enterprise of many farmers in the major spice growing areas.1 Around 50,000 spice cultivators depend on spices as their main family income. Given the nature of small farming in this sector, it has significant implications in terms of providing a source of livelihood and in addressing poverty in rural farming communities. The sector nonetheless faces considerable challenges. Both domestic and export agri-food systems are undergoing rapid and continuous transformation. Changes are being observed all over the world, and in all segments of value chains. These can be attributed to increased quality due to the development of high quality retail markets, bulk procurement by domestic manufacturing firms, and increase in quality awareness of both domestic and world markets. This phenomenon has been influenced further by urbanization, rising income, increased migration of citizens, the rise in the participation of women in the labour force, etc. In turn, these developments have created new demand patterns, shifting the focus towards continuous supply of high
More specifically, cinnamon is found around the low country wet zone, while cardamoms are found in the up country wet zone and mid and up country intermediate zones, and pepper, cloves and nutmeg are found in the mid country wet zone.
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quality, value added products with improved processing, packaging and labelling requirements. The impact of modern and restructured markets has a number of repercussions on small scale producers who are unable to compete in the emerging marketing environment. This has necessitated a need to enable the transformation and competitiveness of small farmers and ensure their participation in the emerging agri-business systems. This chapter attempts to identify new innovative practices of the private sector agro-industries in improving the farmers ability to face restructured market conditions, and derive policy lessons for public and private sector actors in supporting greater participation in agroindustry markets. The main focus of the discussion will be confined to private sector agribusiness models and related supply chains of the spices sector in Sri Lanka.
9.2 Small Farmer Susceptibility There are a number of interrelated issues and challenges in the Sri Lankan spice sector related to cultivation practices, technology and marketing. Small scale cultivation, high cost of labour, inferior quality, sanitary and phyto-sanitary measures, lack of research and technology and unorganized markets have been the most important issues of concern. Since spice cultivation has been traditionally characterized by small scale operations, lacking adequate knowledge of management practices, it inherits various problems related to non-commercial agriculture. Subsistence oriented attitudes of growers have moved them away from quality consciousness and market-focused production. Further, farmers lack credit worthiness needed by commercial banks, while government and other institutional intervention policies have had limited impact. Below optimal management ignoring recommended improved practices due to inadequate knowledge practice of mixed cropping and lack of financial resources have led to serious constraints on productivity and the sustainability of the sector. Minimal input use and lack of constant replacement of soil nutrients together with leaching due to heavy rains have been the main contributory factors for the low soil fertility. Plant density is below the recommended level with farmers not paying sufficient attention to replanting and gap filling. Adoption of productivity improvement
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programmes such as land and soil conservation, shade management and agronomic practices have been hindered by the lack of knowledge and awareness on the part of farmers. These have a considerable negative impact on regularity of supply of spices in the country. Inferior quality of farm gate spice products has been a serious issue in the context of high demand for product quality. A large proportion of the spices that leave the farm gate are of poor quality that is far below expected levels at the high end of the supply chain. High moisture retention, contamination by micro-organisms such as moulds and the presence of extraneous matter are common problems affecting the quality of spices. They are mainly attributed to poor weather conditions, low cost processing technology, poor storage facilities and early harvesting habits and small scale nature of the production. Poor quality leads to a direct loss of potential exports and foreign exchange earnings. Many producers do not have proper processing facilities and are also not aware of the quality parameters. Since farm gate quality does not match with any accredited standard quality, a considerable amount of cleaning and processing is carried out throughout the marketing channel adding to costs. The most important constraint in the spice sector from the side of small holder farmers is the poor market link between farmers and exporters. The market structure of the minor export crops sector of Sri Lanka is characterized by its traditionality at the domestic level and rather high degree of sophistication at the exporters level. The traditional supply chain of spices in Sri Lanka is characterized by decentralized purchasing, low quality product trade and the presence of a large number of intermediaries without essential functions (Figure 9.1). Those intermediaries or commonly known as middlemen take advantage of this situation by buying the farmers products at lower prices and selling them at higher prices creating a large gap between the price received by the farmers and the auction /FOB price.2 The traditional perception on the role of the middlemen is negative since they are seen as unnecessary agents in the supply chain, increasing marketing costs and capturing parts of the rents accruable to farmers. Thus, the involvement of a large number of non-essential intermediaries has ultimately resulted in high wastage, low farm prices and high consumer prices. Even where the farmers
2
The middleman constitutes mainly of travelling collector, village trader, wholesale buyer, commission agent and the auction broker.
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produce a better quality product, there are no attractive and differentiated farm gate prices for such better quality products. These result in low value added in the chain, low incentives to the farmers and sluggish growth of the sector.
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Figure 9.1: Schematic Presentations of a Traditional and a Modern Supply Chain Traditional
Small/medium scale producers Large scale producers
Modern
Farmers/ Producers
Village Trader
Travelling Collector Brokers
Procurement Centre Regional Wholesaler
Town traders
Factory (Wholesaler/ Assembler/ Processor)
Satellite Farmers
Export
Distillery/Confectionery owners
Commission agents/ Colombo wholesalers
Auction
Manufacturing Companies Outstation wholesalers Exporter
Super markets
Hotels/Restaurants/ Catering services
Retailer
Domestic Consumers
Local consumer
9.3 Can Small Farmers Survive in a Globalized World? Small holder producers play a vital role in rural development as improvements in productivity and income tends to spread the benefits throughout poor rural communities. With the liberalization of agricultural sectors and the withdrawal of the state from many essential functions including in the provision of marketing services small holder farmers access to markets and ancillary services decreased. Small farmers become marginalized due to supply-side and infrastructural constraints and the structural weaknesses mentioned previously. The market potential for Sri Lankan spice exports mainly depends on the tariff structure and sanitary and phyto-sanitary requirements demanded by world markets. The most intractable issue arising from world trade is quality since quality standards like ISO 9000 certification and Hazard Analysis and Critical Control Point (HACCP) have become essential parameters in the food industry. In addition, international trade agreements such as the WTO Agreements on Agriculture (AoA), Sanitary and Phyto-sanitary Measures (SPS), and Technical Barriers to Trade (TBT) show evidence of some inhibitive effects on Sri Lankan spice trade. For example, the TBT agreement creates the basis for various
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constraints in generating value added products in spices and organic spice products. Production constraints, strict quality, certification and accreditation issues, national and regional standards and importing procedures, organic labelling, and stiff competition from other producers are the main obstacles imposed by these agreements. Consequently, suppliers are faced with strict contractual requirements and increasing cost of compliance. The absence of adequate infrastructure including transportation and storage has become a major obstacle in rural areas, increasing transaction cost and introducing unnecessary risks. Exorbitant transaction cost has a significant impact on income and competitiveness while poor storage has become a major source of inefficiency. The growth of the modern supply chains which is largely based on supermarkets, coupled with the above weaknesses tends to concentrate power in a relatively small group of large purchasers making the survival of the small holders uncertain. Nonetheless, the potential for expanding this sector is high if government, private sector and other related institutions pay more attention to these issues. Increasing competitiveness and/or strengthening their linkages with agri-business firms which ultimately improve the capacity for participating in modern supply mechanisms will be useful in creating a conducive production environment for small farmers. 9.4 Private Sector ProPoor Business Model: A Possible Alternative An innovation which is basically a business model change with limited collective action strategies by farmers that enables fulfilling consumer demands while effectively integrating the farmers in the supply chain has been attempted in a few cases (see Box 9.1). This innovation introduces a package of activities and strategies that can generate changes in technological, managerial, organizational and financial aspects of the supply chain. First, the company has to shift its focus from a decentralized procurement system to a centralized procurement system. This centralization process increases the efficiency of procurement through the reduction of the coordination cost and number of officers required for the procurement. The procurement system is centralized on the basis of regional collection centre/s which is further responsible for the backward integration of the companys activities in the supply chain and for delivering the social responsibilities to the region as well (Figure 9.1). It is responsible for providing extension services to the farmers with regard to training and technical assistance in production, record keeping and
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post-harvest practices, organic certification, supply of high quality planting material and intermediation of commercial credit from banks. It assures continuous supply of raw material at the right time in right quantity and quality and eliminates non-essential intermediaries from their supply chain. It can eventually result in improved information flow among the supply chain segments while reducing the marketing risk faced by both the company and farmers.
Box 9.1: Private Sector Business Models3

MAS Foods MAS Tropical Food Processing (Pvt.) Limited, established in 1987, is a family owned spice processing enterprise based in the Matale District. The business has advanced over time beyond the status of a manufacturing unit and built up a corporate image as a leading processor of spices and spice based products including spices, seasonings, sauces, chutneys, pickles and ready-to-eat foods. MAS Foods possesses an exclusive marketing programme to cater to their different markets. It basically operates on three markets covering a wide variety of consumer groups both locally and internationally, namely national food manufacturing companies/restaurants like Nestle, Unilever & Sri Lankan Airlines, supermarket chains like Cargills and Keels and the export market. MAS Foods is an internationally certified company of SQF 2000 and HACCP quality standards and supplying and processing of organic spices. Procurement has been centralized by Regional Agri-business and Perennial Initiative and Development (RAPID) which is responsible for the backward integration of the companys activities in the supply chain and for delivering the social responsibilities to the operating region as well. Further, it is responsible for providing extension services to the farmers with regard to training and technical assistance in production, record keeping and post-harvest practices, organic certification, supply of high quality planting material and intermediation of commercial credit from banks while ensuring full traceability on to farm level. It assures continuous supply of raw material at the right time in right quantity and quality and eliminates non-essential intermediaries from their supply chain. It has resulted in improved information flow among the supply chain segments while reducing the marketing risk faced by both the company and farmers. Hayleys Agro The Hayleys Group of Companies is one of the oldest and longstanding private sector conglomerates to be in operation in Sri Lanka at present. The company is Sri Lankas sole exporter of gherkins to the international market today while employing thousands of people through its out-grower and subcontractor network. It offers a wide array of agricultural inputs combining business with the large agricultural establishments and farmers spread across the
3
MAS is a private sector business model in the spice sector while Hayleys Agro is mainly involved in the gherkin sector.
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country. The diverse nature of the businesses it holds has enabled Hayleys Limited to set up hundreds of production centres in many parts of the country, most of them in rural areas. As a result, the company has been able to form an important link between Sri Lankas rural hinterland and its global customer base, and has been able to penetrate and make use of the valuable resources that are available in the countrys rural areas. The companys factories and production centres set up in underdeveloped areas have made two important contributions towards the Sri Lankan economy, namely by increasing the income generation capacity of people living in different parts of the country (creating employment opportunities for thousands of rural workers) and by enhancing the local value addition of manufactured goods due to the use of domestic raw materials and other inputs. Further, the use of local inputs can also have a positive effect on the economy by saving foreign exchange. Moreover, it has been involved in a number of infrastructure projects as a result of the relationship it has built up with its employees in rural areas.
The company set, own private standards facilitates the standardization of the products procured from different suppliers and differentiates the companys products from competitors. Further, they offer a considerable adjustment period to bring the produce up to the standards and premium prices to farmers who meet those standards. Moving towards logistic improvements in the supply chain is focused on by introducing new operations not in existence earlier, in the areas of grading, processing, packaging, labelling, trade marking, etc. Such practices make the business entities more competitive in the local and international markets, enabling the company products to satisfy newly emerged trends in consumer preferences. Adoption of organizational innovations comprises a shift from reliance on traditional wholesale markets and brokers toward use of specialized wholesalers, namely satellite farmers. These satellite farmers are specialized in supplying spices in bulk quantities and dedicated to their main clients. Several measures can also be adopted to ensure that locally and internationally established basic process standards such as Good Manufacturing Practices (GMP), SQF 2000 and HACCP quality along the value chain are met in order to prevent the risk of products supplied to the restructured market not complying with legal and ethical norms and consumer demand. These are supported by fully equipped, modern, in-house laboratories which enable the physical inspection, organic certification and chemical and microbiological analysis in order to maintain the established standards. Tracking and traceability is assured through a well documented and computerized procedure. Activities fulfilling corporate social responsibility on the workers (free meal, lodging, training, etc.)
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the local society (providing employment for the youth and handicapped) and the environment (waste management system to dispose both liquid and solid wastes) in fact become an investment to the company. It improves labour productivity, worker attitudes and the image of the company among their clients as well as society at large. Consequences of such innovation are clearly evident in improvements in corporate income, volume of trade, assets, farm income, employment creation and non-monetary benefits while ensuring greater degree of inclusion of small farmers to the new supply chain. The supplier base can been further strengthened by attracting organic farmers who get the organic certification with the full cooperation of the company. With the inclusion of the supply chain of the company, farmers received several benefits viz., achieving a premium price for better quality products, acquiring a stable price regardless of the price fluctuations in the market, spread of income throughout the year, services received (such as extension), credit facilities and marketing risk minimization. 9.5 Conclusion and Policy Recommendations The processes outlined above have not yet reached their potential capacity because only a very small number of companies are operating in Sri Lanka, while a large number of potential small farmers are left untouched. Thus, there are ample opportunities for other entities as well to follow this type of model not only for the same product but also for different product types taking on board their specific characteristics. This business model largely depends on market linkage development where contractual agreements and mutual understanding plays a major role, so that the model works well even with more than one buyer. It is well recognized that lack of technology, suitable infrastructure and information flow associated with rural poor act as major constraints to market linkage development. Thus, at a macro level, governments can play a regulatory and facilitative role to ensure long-term sustainability of the agri-business system. They can improve efficiency and competitiveness by providing necessary infrastructural services such as roads, and a suitable policy and legal environment especially in the areas of trade, land and labour. In seeking to do this, developing a facilitative policy and legal framework to reduce the transaction cost and time involved that can enable the private sector to function in a competitive way has to be given priority, including through incentives, flexible land and
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labour regulations, promotion of exports viz., trade agreements. Research and development policies and related programmes which are focused on agro-industries, market demand and economic feasibility of agricultural products are required in order to generate appropriate demand driven technology. One of the specific SPS related problems faced by Sri Lankan exporters and producers is that they do not have adequate and timely information about the standards, and health and sanitary regulations applicable to these products in the target markets. Sri Lanka does not at present have an adequate number of national enquiry points (NEPs) from which information could be obtained. Facilities for obtaining certificates of positive assurance from a recognized institution that the product is in conformity with the standards are still not conveniently available and the cost of the process is also not competitively affordable. Thus, other areas in which governments can contribute to providing an effective enabling environment include improved mechanisms for information flow such as Management Information Systems (MIS), regulations relating to pesticide use, food standards, seed quality and provision of arrangements to certify quality and Good Agricultural Practices (GAP). In general, the government has extremely limited resources and there are several competing demands on those resources. Given this reality, the best avenue is to utilize funds allocated for agricultural development to improve technology, rural infrastructure and building market linkages rather than using them for economically insignificant subsidies which have no long-term development impact. These can be accompanied by supportive policies at the macro level in areas such as trade, land, and labour policies as the second step towards capitalizing on the improvements achieved.
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SOE 2007 Policy Brief - Pro-Poor Agri-Business Models

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Institute of Policy Studies of Sri Lanka Sri Lanka: State of the Economy 2007 Empowerment of the Poor

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Pro Poor Agri-Business Models: Revitalizing Small Holder Spice Cultivation

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Travelling Collector Brokers

Procurement Centre Regional Wholesaler

Factory (Wholesaler/ Assembler/ Processor)

Commission agents/ Colombo wholesalers

Manufacturing Companies Outstation wholesalers Exporter

Hotels/Restaurants/ Catering services

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Box 9.1: Private Sector Business Models3

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