change. If market prices rise above the agreed level and if alternative buy- ers exist for the agricultural products grown under the contract, then farmers might be enticed to renege on their contractual obligations and sell to the highest bidder as shown in Box 3.4.
Although not specifi cally documented, it is noted that contract farming has been most prevalent in sectors and market niches where side-selling is less of an option. This is the case, for instance, with sugar cane where the cost of a sugar mill and transport are so high there are few alternatives for side-selling by producers. The same can hold true for market niches, especially when the price premium is high compared to alternative markets. On the other hand, commodities such as maize with multiple producers and buyers and high price competition pose more risks of side-selling, hence the use of contract farming is not prevalent in these sectors.
Much can be done to help achieve the success factors indicated above. Devel- opment agencies can be instrumental in not only promoting capacity building and improved legislation, but in order to reduce risks in contract farming, they can support the building of transparent, equitable and well-functioning value chains. The form of risks will be different according to the context, and there- fore risk mitigation strategies must adapt to fi t the needs of the value chain and its stakeholders. As this facilitating role by implementing agencies is so impor- tant and growing in prevalence, it is treated as one of the business models for value chain development as described in the following section.
at subsistence levels. Facilitation by development organizations, both NGOs and government agencies, has demonstrated that external support can open up opportunities for smallholder value chain integration and fi nancing.
Larger buyers and wholesale chains often seek out large-scale suppliers due to a number of factors that are challenging when dealing with small-scale farmers who:
• May not be well organized.
• Have not demonstrated commitment.
• Require higher transaction costs to be served.
• Often pose increased risks such as side-selling.
• Lack both technical capacity and the technologies to reliably produce the high quality and quantity required in a consistent manner.
• Tend to lack organizational capacity and resources to deliver the re- quired products in a timely fashion.
Consequently, the costs of organizing and training small producers can be deemed too high to be taken on by a large company.
Development agencies and others with a social mission can provide support to facilitate the integration of small famers and agro-enterprises into commer- cial value chains. Successful facilitation models for value chain development have been developed around the world. With proper organization and train- ing, incomes can be improved, for example:
In Uganda, ARUDESI has been able to work with 8,000 farmers to organize 600 farmer groups consisting of 30 farmers per group. These farmers were able to market a total of 1,200 metric tonnes of green coffee in the last 3 years, increasing income of an average of 40 per cent over equivalent green coffee at farm gate price. (Mrema, 2007)
Many contract farming or other value chain linkage models which involve small producers are able to thrive in part due to the facilitation and/or services provided or initiated by not-for-profi t or government agencies. In some cases, the agencies facilitate relationships including those between producers and fi - nancial institutions. In others, the agencies themselves enter into contractual arrangements (including guarantees), and provide direct technical services and fi nance. TechnoServe, a not-for-profi t development agency that works in agricultural value chains around the world, demonstrates how an external agency, acting as a market developer, can facilitate the development of a chain through interventions at various levels. See Box 3.6.
A guiding principle of TechnoServe facilitation in all of their development activities is to incorporate a private sector focused business model as a means of building sustainability. In fi nancing, this involves such things as direct involvement of banks, commercial investors and private equity funds for as- set fi nance needs. For working capital needs, fi nancing from banks and buyers can be available if there is customized technical assistance. This is especially the case for start-ups and early stage expansion of agribusinesses.
Box 3.6 Facilitating chain development in Malawi and Tanzania
TechnoServe utilizes various business models to enhance smallholder incomes through processing business, supply business and out-grower models. In Malawi, TechnoServe is facilitating the seed industry value chain in response to severe fi nancing gaps in agribusi- ness in southern Africa which is characterized by asset fi nance needs and working capital needs. The reasons for a lack of access to fi nance, especially by start-up seed businesses and early stage expansions, have mainly been shortage of risk capital and poor busi- ness management capacity. TechnoServe developed the following three-pronged business model to address the needs in the seed chain:
• Processing businesses – facilitating enhanced value addition and farmer linkages.
• Input supply businesses – facilitating improved seed, access to fertilizer and produc- tion technology.
• Farmer businesses – facilitating farmer integration into the seed production, processing and marketing chain through farmer organization, training and out-grower contracts.
By addressing the whole chain, TechnoServe is able to secure a market for the fl edgling seed businesses and a more secure repayment of the fi nancing, while stimulating income growth and development of the small producers. This approach for assisting small farmers is summed up in TechnoServe’s strategy to:
• Support a service provider to provide marketing and fi nancial linkages to farmer groups.
• Identify and organize farmer groups with potential to produce quality.
• Assist groups to invest in improving quality and production.
Kilicafe in Tanzania, an organization TechnoServe helped create that is now owned by 9,000 smallholder farmers, works with local and international fi nancial institutions to design fi nancial products that serve those in the value chain. These products range from short-term input credit and sales pre-fi nancing to multi-year loans used by farmers to invest in centralized processing facilities. Credit is guaranteed through a variety of innova- tive means, including private guarantee funds, warehouse receipts and forward sales to specialty coffee buyers. These included:
• Long-term fi nancing for processing infrastructure, secured by fi xed assets and market- ing agreements.
• Short-term fi nancing for working capital, advance payments to farmers and agro-input credit, secured by guarantee funds, warehouse receipts, marketing agreements and price risk management.
However, initially the local banks did not understand the business model, the risks, nor accept coffee as full collateral. The fi nancial arrangements built according to the value chain were only possible due to signifi cant initial support from TechnoServe to both the banks and the clients, developing business plans, monitoring performance and ongoing operational assistance, until credit-worthiness was fully established.
Source: S. Harris presentation in Kimathi et al. (2007)
In western Kenya, DrumNet provides an example of an innovative, multi- stakeholder facilitated value chain which links together farmers, input suppliers, buyers and banks through a fee-based facilitator hub that is coor- dinated through cell phone text messages. As facilitator, DrumNet provides the organization and capacity building of the farmers’ associations as well as the relationship and Internet linkages between the various parties involved (Campaigne, 2007). For further illustration, a DrumNet sunfl ower sector case study (see Case Study 4) is presented in detail at the end of chapter fi ve.
In addition to capacity building, successful facilitator models include three key aspects as highlighted by Odo (2007) from his vast experience in the fi eld of farmer organization and agricultural chain development. He states:
• Start with the market and work backwards.
• Aggregate producers and their goods.
• Use the value chain for obtaining fi nance, such as buyer credit secured by sales contracts.
A word of caution on facilitation is given by Marangu (2007) who notes that since value chains are dynamic and complex, a facilitator must care- fully prioritize interventions at key leverage points throughout the chain.
Moreover, facilitators must stay out of the supply chain and avoid direct provision of fi nancial services or subsidizing the cost of business. Such actions distort commercial signals.
Facilitation models can be proactive in identifying and developing value chains. For example, USAID’s technical assistance via the Peru Poverty Reduc- tion Assistance (PRA) project identifi es and facilitates value chain opportuni- ties such as artichoke cultivation for small farmers in the highlands of Peru (see Box 3.7). PRA identifi ed market opportunities, provided information, and brought together producers, processors and buyers to meet the needs of the market. Worldwide demand for processed artichokes has more than doubled over the past 20 years. Peru has been trying to capture part of the large Euro- pean market and is well positioned to do so, given its labour cost advantages.
Figure 3.2 represents the value chain for Peruvian artichokes described in Box 3.7. Arrows in the diagram indicate the direction of fi nancial fl ows in the value chain and the role of the formal fi nancial system in fi nancing the chain (Campion, 2006).
As noted above, fi nancing is both to and through the value chain for the export artichokes. In the less structured local wholesale market and super- markets there were no fi nancial fl ows within the chain. In the artichoke val- ue chain, inputs, secured markets, fi nancing, as well as technical assistance were all important ingredients – a complete service package – that enabled smallholder farmers to enter the market. Finance alone will rarely result in increased quality and sales.
With small producers, technical assistance and knowledge is often miss- ing on how to invest in a way that will increase production of high quality products and command higher prices. By addressing this issue and with the demonstrated success with artichokes, the sources of fi nance expanded from fi nancing from within the chain by suppliers and buyers to access from fi nan- cial institutions for those producers.
A pending issue to resolve on value chain facilitation is that of sustainabil- ity and payment of services, especially when dealing with small producers and processors. It appears that the private sector is not willing and/or able to take full responsibility for building this capacity. Is the required facilitation support a public good, as are many of the universities in developing countries that will require support from the government and development organizations?