Addressing the aggregation and coordination problems in smallholder-based value chains Emilie Cassou Andrew W. Shepherd WORLD BANK | 2018 1 Contents Contents .................................................................................................................................................. 2 Figures ................................................................................................................................................. 3 Tables .................................................................................................................................................. 3 Boxes ................................................................................................................................................... 3 Acknowledgments................................................................................................................................... 3 Purpose ................................................................................................................................................... 4 Summary ................................................................................................................................................. 4 1. Background and conceptual framework ............................................................................................. 8 Agricultural value chains in transformation........................................................................................ 8 Aggregation and coordination defined ............................................................................................... 9 Suitability of arrangements by market and product type ................................................................ 10 Major aggregation and coordination arrangements .......................................................................... 1 (a) Primary production aggregation and coordination ....................................................................... 2 (b) Value chain coordination and aggregation ................................................................................... 3 (c) Support for aggregation and coordination .................................................................................... 4 2. Primary production aggregation and coordination ............................................................................ 5 (a) Direct transactions between smallholders and traditional traders, mills and processors ............ 5 (b) Transactions between smallholders and traditional traders and processors, using producer organizations (POs) as intermediaries ................................................................................................ 8 (c) Land consolidation and cooperative farming .............................................................................. 12 3. Value chain coordination and aggregation ....................................................................................... 14 (a) Contract farming arrangements between companies and smallholders .................................... 15 (b) Vertical coordination between farmers and companies through POs, without contract farming .......................................................................................................................................................... 22 (c) Some additional observations ..................................................................................................... 25 4. Other developments contributing to successful aggregation and coordination .............................. 26 (a) Warehouse receipt finance (WRF)............................................................................................... 26 (b) Other approaches to value chain finance.................................................................................... 28 (c) Information and communication technologies (ICTs) ................................................................. 28 (d) Multi-stakeholder platforms ....................................................................................................... 30 5. The way forward for Indonesia ......................................................................................................... 31 (a) Modernizing the rice sector ......................................................................................................... 31 2 (b) Supporting the traditional trading sector .................................................................................... 32 (c) Promoting partnerships between producer organizations and the private sector ..................... 33 (d) Encouraging the development of contract farming .................................................................... 33 (e) Creating an enabling environment .............................................................................................. 34 6. Summary of the main issues ............................................................................................................. 35 References .............................................................................................................................................. 0 Figures Figure 1: Types of market linkages for smallholders ............................................................................ 10 Figure 2: Types of value chain linkages employing aggregation and coordination ................................ 2 Figure 3: Rice contract farming system proposed for Cambodia ......................................................... 20 Tables Table 1: Ways of improving aggregation and coordination for different commodities ......................... 1 Table 2: Summary of aggregation and coordination issues .................................................................. 36 Boxes Box 1: Recommendations: a five-pronged approach ............................................................................. 6 Box 2: The multiple functions of agricultural value chains ..................................................................... 8 Box 3: Community coordination and aggregation in Uganda ................................................................. 6 Box 4: Lead farmer aggregation in Thailand ........................................................................................... 7 Box 5: Lead farmers for supermarket supply in Central America ........................................................... 7 Box 6: Improved coordination between rice mills and paddy farmers in Lao PDR ................................ 8 Box 7: Cocoa aggregation and coordination in West Sulawesi ............................................................... 9 Box 8: Basmati Rice Contract Farming in India ..................................................................................... 21 Box 9: The dangers of political interference ......................................................................................... 27 Box 10: Matching smallholders to buyers by cell phone ...................................................................... 29 Box 11: A Dairy MSP in Tanzania........................................................................................................... 30 Acknowledgments This report was written by Andrew W. Shephard (consultant), with guidance and inputs from Jean- Joseph Cadilhon; Jonathan Coulter; Carlos Da Silva; Muriel Figuie; Eva Galvez-Nogales; Jon Hellin; Mark Lundy; Paule Moustier; Thomas Reardon; Bill Vorley; Jan-Joost Nihoff; Steven Jaffee; and Emilie Cassou. 3 Purpose Smallholder production predominates in many areas of primary food production in Indonesia. Yet, outside of oil palm and poultry, contract farming is rare as are other forms of collective action or vertical coordination. Fragmented production and market interfaces give rise to high transaction costs and problems in matching supply with downstream or consumer requirements. Yet, there is a growing body of international experience promoting multiple models to help realize some economies of scale within smallholder-based production systems and effectively addressing the aggregation and market- matching problems.1 These include different forms of joint farming operations, shared services, farmer organizations, contracting arrangements or partnerships with agro-enterprises, and other models. Their suitability and need for public enabling support varies depending upon the underlying circumstances. This note synthesizes experiences, lessons learned, and success factors with potential relevance for Indonesian staple food crop and horticultural production. Summary Agricultural production in Indonesia is dominated by smallholders. Farm sizes are small and, as a consequence, quantities produced by individual farmers are also small. This leads to considerable inefficiencies in the operation of value chains, causing high unit costs. Despite some long-term relationships between traders and farmers, sales by farmers are largely ad hoc, meaning that production is based on what farmers want to produce, not what buyers may want to buy. This lack of coordination within value chains leads to production that is often unrelated to market demand (in terms of varieties, quality, quantities supplied, harvest times, etc.) and the chains provide little incentive to those involved to make improvements. There is considerable international experience on ways of aggregating small-scale production to achieve economies of scale in marketing. Similarly, there is much to be learnt from the experience of other countries in coordinating value chains to both better link production to consumer demand and enable farmers to take advantage of new market opportunities, such as horticultural exports, markets for certified products and sales to supermarkets. This note sets out to identify the main developments of relevance to Indonesia and to explore the steps that government needs to take to promote their use in the country. The Paper stresses the need for Indonesia to move away from direct subsidies to agriculture, particularly the rice sector, towards a policy environment that encourages the private sector to take advantage of the possibilities provided by market opportunities. Indonesia produces a wide range of commodities. Possible approaches to improving their value chains vary according to the nature of the particular products. The types of aggregation and coordination required depend on such factors as the perishability of the product, quality requirements, the value of a raw material in relation to its weight or volume, the speed with which processing is required and the economies of scale in processing. For example, milk is perishable and needs to be kept cool throughout the chain to preserve quality. For this reason cooperatives have been successful in carrying 1 E. Verhofstadt et al (2015) Smallholder Participation in Transforming Agri-food Supply Chains in East Asia; WB (2016) Linking Farmers to Markets Through Productive Alliances: An Assessment of the World Bank Experience in Latin America.; IFAD (2017) Lessons from IFAD’s East and Southern Africa Portfolio: Tackling Rural Poverty Through Output Markets. 4 out aggregation of milk because they can offer a vital service to link farmers with the large dairies. On the other hand, the role played by cooperatives in paddy value chains is negligible because there are multiple other buyers competing for the farmers’ paddy and because farmers have no great urgency to sell paddy once it has been dried. For quality reasons, oil palm, green tea, and sugar cane all require processing soon after harvest and all have a high volume in relation to the weight of the final product, which makes transporting the raw material over long distances unviable. The oil palm to palm oil conversion rate is about 20%, sugar cane to sugar is around 12% and green tea to black tea about 25%. For these reasons large processing facilities are invariably situated close to the farms and the commodities are often considered suitable for contract farming. However, export commodities such as coffee and cocoa beans do not require rapid processing after basic farm-level primary processing, and final processing (such as converting parchment coffee to green bean) does not lead to significant weight loss. Thus factories are often situated close to the point of export. However, there are strong arguments to improve quality by upgrading rural primary processing of these commodities, with processing being carried out by cooperatives or the private sector rather than by individual farmers. Traditional trading relationships involve traders visiting farmers at their farms or, for vegetables in particular, purchasing farmers’ produce at rural assembly markets. There are several ways in which these arrangements can be improved. For example, the growth of cell phones now enables traders to contact farmers in advance to agree a price and a location where purchases can take place. Farmers can also group together to aggregate their products to provide visiting traders with economies of scale or to take produce to market. There are also good examples of where “farmer leaders” have organized neighbouring farmers to jointly supply buyers, such as supermarkets, or to jointly purchase inputs. At a more formal level, producer organizations (POs) can also play an active role in bulking up produce or in carrying out primary processing, such as paddy drying. Economies of scale and greater efficiency in production can be achieved through land consolidation, which can also be considered a form of aggregation. The limited land available to individual small- scale farmers is often fragmented into several parcels and spread over a considerable area. There is experience in some countries with formal land exchange that enables farmers to farm land that is of the same area as held before but is contiguous rather than being fragmented. Ideally the restructured parcels should be rectangular to facilitate mechanization. While beneficial, this restructuring does not increase the overall land area available to a farmer. To increase the size of landholdings China has issued land certificates to facilitate the sale or lease of land by people wishing to migrate to cities. As part of the same program the government also operates land transfer centres to bring buyers and sellers together. In Vietnam farmers can join a “big tenant, small landlord” program in which small farmers lease their land to cooperatives or private enterprises. An alternative approach is for farmers to continue to farm their land but to do so as part of one large field in which they plant the same paddy variety at the same time. Vertical coordination in value chains can have many benefits. Exporters and processors can coordinate with producers to ensure that the quantities and qualities they supply meet domestic and overseas buyers’ requirements. They are likely to specify varieties and inputs to be used and, in the case of contract farming, will often supply those inputs, as well as provide technical assistance and other support. Coordination with farmers also involves logistics, as companies need to ensure a regular and manageable flow of export crops or of raw materials for factories. Lacking the necessary skills to work directly with farmers, many companies link with smallholders through producer organizations (POs) who function as intermediaries between company and farmer, although this is not essential. 5 This note considers some of the ways in which such coordination can be organized. Contract farming allows companies to obtain consistent supplies on a timely basis and also to control the quality and safety of the products they purchase. It facilitates certification and traceability, both of which are increasingly being required by export markets. From the point of view of farmers, contractual arrangements reduce the risk of being unable to sell their products at harvest time or having to sell at a low price. Contract farming can help overcome the problems of lack of credit and difficulties in obtaining inputs. It can also provide access to extension advice from the company. In Indonesia there is some contract farming for seed rice, as well as for seed corn, poultry, tobacco, oil palm, and aquaculture. However, in comparison with some other countries its use is rather limited. The potential for contract farming in the rice sector is constrained by the fact that there are numerous buyers for paddy and thus side-selling by farmers is likely to take place. In other countries contract farming for paddy is largely limited to seed production and the production of paddy crops for which a premium can be paid (mainly aromatic varieties and organic paddy) and there are few or no competing buyers. Recent years have seen considerable efforts by some governments and development organizations to improve linkages between farmers and companies without using contract farming. The support provided by companies is largely limited to advice on varieties and qualities required rather than the physical provision of inputs and other assistance. These arrangements invariably involve producer organizations as the intermediary. In many cases the initiative for the linkage comes from the PO rather than from the company. A major example is the Productive Alliance program in Latin America. Under this program, a business agreement is signed between the agency in charge of project implementation (e.g. a ministry), a commercial partner, a service provider, and the PO. Activities are supported by World Bank grants for infrastructure and technical assistance. The basic aim is to increase smallholders’ access to more-rewarding markets, reduce their transaction costs, and improve their capacity to provide goods of consistent quality. As with contract farming, the productive alliance approach is not really suitable for the poorest smallholders. To be considered, smallholders must already be engaged in market-oriented production. The recommendations made to the Government of Indonesia involve a five-pronged approach (see Box 1). They address the modernization of the rice sector, and four cross-cutting areas (supporting the traditional trading sector; supporting partnerships between farmers and the private sector; encouraging the development of contract farming; and ensuring an enabling environment). Box 1: Recommendations: a five-pronged approach  First, with regard to the rice sector the existing structure that involves 100,000 small mills is inefficient and unsustainable. It is necessary to encourage the development of larger and more modern mills, in part through facilitating improved aggregation and coordination.  Second, more attention needs to be paid to assisting the traditional trading sector, which tends to be neglected in favor of support to cooperatives but remains responsible for the great majority of agricultural marketing.  Third, drawing on the productive alliance model, partnerships between producers (including through producer organizations) and the private sector need to be promoted to develop better- coordinated value chains that can improve the quality and quantity of commodity exports, and processed and fresh foods available on the domestic market.  Fourth and similarly, where appropriate to the commodity and location, development of contract farming should be encouraged, recognizing that such contracts should always be dictated by commercial principles.  Finally, the government needs to ensure that the general enabling environment is supportive of efforts to improve aggregation and value chain coordination. 6 (1) Support to the rice sector should emphasize efficiency improvements, rather than subsidies to farmers. In Indonesia there are over 100,000 rice mills that use outdated equipment, achieve poor paddy-rice conversion factors and, because of their small size, have poor economies of scale. This inefficiency limits returns available to farmers from paddy cultivation. Areas for improvement include: increasing the average farm size through facilitating leasing of land; supporting producer organizations to aggregate their members’ paddy and to standardize varieties produced in order to supply larger, more-efficient mills; encouraging improvements in direct linkages between mills and farmers; promoting investments in upgrading milling equipment; and supporting multi-stakeholder meetings in all parts of the country in order to encourage improved communications within the sector. (2) The traditional small-scale trading sector is still responsible for purchasing the great majority of all products sold by smallholders. The sector has a potentially important role to play in upgrading value chains through improved aggregation and coordination. Areas in which government can support traders include: countering the negativity towards them and encouraging government departments to view traders as potential partners in development activities; encouraging traders to form associations to provide them with a voice in policy discussions; promoting multi-stakeholder platforms and ensuring trader involvement; funding infrastructure such as roads and markets to improve linkages between farmers and traders; providing training on post-harvest handling; and working with banks to explore financing options for traders. (3) The promotion of partnerships between producer organizations and the private sector seems essential if value chain coordination is to be improved as, in many cases, companies do not have the capacity to work directly with farmers. Such promotion can include: coordinating government and donor support to ensure that it emphasizes value chain development; ensuring that products produced are based on commercial principles rather than on bureaucratic decisions; drawing on lessons from other countries, such as the experiences with the Productive Alliance program; ensuring that legislation governing producer organizations facilitates their involvement in value chains; and upgrading research and extension support to agribusiness activities. Finally, it is important to avoid using the cooperative structure for the distribution of subsidized inputs. The government should concentrate on developing POs to collaborate on commercial principles with the private sector, by strengthening their management and negotiating skills. (4) Encouragement of contract farming shows considerable potential as the lack of suitable land for estate-based production means companies will have to work more closely with farmers. Areas in which the government can promote this include: setting up a unit in the MoA to work with companies interested in investing in contract farming in order to identify suitable locations and smallholders; carrying out “due diligence” on companies wishing to invest to ensure that they have adequate management skills and necessary financial resources; advising farmers on contract terms and conditions; ensuring that the necessary regulations are in place for contracts to work properly; developing arrangements for dispute resolution or arbitration; and encouraging POs to work with contract farming companies. In promoting contract farming it is essential that government recognize that contract farming must be the result of a commercial decision by both parties. It should avoid trying to dictate to companies the terms of a contract, such as the price to be paid, should ensure that national and local officials are fully aware of how contract farming works, and should train extension staff so that they are able to support farmers to work with companies. (5) A suitable enabling environment is essential for all agricultural value chains to function properly. To create this, government needs to have a full understanding of the way the private sector in agriculture functions. Components of an enabling environment requiring attention include: ensuring that national and local legislation fully safeguards private property, in order to encourage investment; 7 ensuring that all contracts can be enforced; in association with the private sector, establishing grades and standards, addressing food safety requirements, and ensuring bio-safety; investing in rural roads that provide farm-to-market access; avoiding trade-distorting policies such as import and export bans; and, together with banks, exploring ways in which access to finance for value chains can be enhanced. 1. Background and conceptual framework Agricultural value chains in transformation In Indonesia as in the rest of the region, demands on the agricultural sector are changing. As incomes increase and urbanization progresses, food consumption is changing. Demand is growing for fruits and vegetables, animal products and oils. Consumers are also becoming more demanding in terms of food quality and safety. Demographic and income trends are leading more-affluent consumers to demand convenience foods, such as frozen, pre-cut, pre-cooked and ready-to-eat items and production, processing and distribution systems are gradually adapting to reflect this. Related is the trend towards “globalization”: in many countries consumers no longer rely on local seasonal products but expect year-round supply of their favourite fruits and vegetables, providing export opportunities for developing countries. In many Asian countries, these and other structural changes have brought about notable transformations in the functioning of agricultural value chains, across their multiple functions (see Box 2). At the farm level, many developing countries are seeing increases in land consolidation and mechanization. Rural people are leaving agriculture, and the productivity of those who remain is increasing. Responding to market signals, farmers are diversifying production. Further down the value chain, many developing countries are seeing concentration increase in agricultural processing, trading, marketing and retailing. And new linkages are developing among buyers and smallholders. The traditional way in which food is being produced, without farmers having a clear advance idea of when, to whom and at what price they are going to sell their crops, is gradually being replaced by practices that involve far greater aggregation and coordination. Although the system of ad hoc sales still remains the dominant practice, farmers are increasingly working together and with buyers to meet their requirements. Box 2: The multiple functions of agricultural value chains Agricultural value chains can carry out a range of functions. Not only do they provide the transport to ensure that produce is moved from producer to consumer but it is also common for them to sort and grade to facilitate onward sale to commodity buyers, processors and retail consumers. Storage is often an essential function of value chains given that much agricultural production is seasonal whereas consumer and processor demand is more or less the same year round. Value chains also process: this may be as simple as drying and milling paddy or as complex as using cocoa beans to produce a box of chocolates. Additionally, chains often carry out activities that are not directly related to the handling of the product. For example, both large contract farming companies and some small-scale traders make loans to farmers, either in cash or, more likely, as farm inputs. Finally, value chains are important sources of information to farmers. In the case of the small-scale sector this may be limited to providing price information but larger companies may also specify qualities required and provide information on production techniques. In Indonesia, despite rapid urbanization, value chains seem to be transforming comparatively slowly in response to structural changes. Smallholders predominate in most areas of primary food and cash crop production in Indonesia. Production and marketing are fragmented, and production and 8 marketing costs tend to be high. Meanwhile, the food and agricultural policy debate has tended to focus on rice, despite the fact that rice only accounts for around 15% of consumer food budgets. As a result of this policy focus, a significant proportion of public spending on agriculture has been used to subsidize fertilizer and other inputs, resulting in funds being unavailable for investment in the public goods vital to achieve the same level of transformation as seen in other countries. In this context, a growing body of international experience on ways of realizing some economies of scale and on better linking production to consumer demand offers some lessons for Indonesia. This paper specifically considers the role of aggregation and coordination in strengthening agricultural value chains. These concepts are defined and discussed below. Aggregation and coordination defined Smallholder farmers can market their products in various ways, resulting in a continuum of value chain configurations. Farmer access to value chains can be through what are known as “spot” markets, such as by sales to traders who visit the farm or buy at local markets or through sales to mills. Alternatively, they can be a result of contractual arrangements where agreements are made in advance with the buyer and produce collection is often organized by the buyer. These two approaches are not always clearly differentiated, however. Many contracts are very informal and differ only slightly from “spot” markets. It is therefore best to view possible linkages between farmers and value chains as a continuum from, at one end, the basic traditional approach of selling on an ad hoc basis to a visiting trader to, at the other, a detailed contract farming arrangement in which a company provides farmers with inputs, technical advice and, perhaps, land preparation, and organizes transport to its factory or warehouse. Within this marketing continuum there are a whole range of possible arrangements, involving varying degrees of aggregation and coordination. “Aggregation” has three usages in this context. On the one hand it can refer to the act of bringing together larger quantities of products in one place to enable economies of scale to be achieved in transportation, storage, processing, etc. By working together, smallholders are able to reduce the costs involved in accessing inputs and marketing outputs, obtaining market information, securing access to new technologies, and entering high-value markets. Aggregation is now also used to refer to the organization of farmers into groups of varying types, so they are better able to market their products. Finally, in some countries there are moves to consolidate small landholdings, and this is also a form of aggregation. “Coordination” in a value chain can be horizontal, vertical or both. Horizontal coordination takes place between chain actors at the same stage of the chain, such as when farmers join together to aggregate. Vertical coordination, on the other hand, refers to the organization of successive stages of production and marketing, with respect to quantity, quality, location and timing of product flows. This process entails significant flows of information and other resources. Often, vertically coordinated chains require horizontal coordination between farmers to be effective. Particularly in the case of food value chains, the absence of effective vertical coordination is likely to result in resource misallocation, inefficiencies, and increased production and marketing risks. One example of vertical coordination is contract farming, when companies arrange with farmers to grow specific varieties at a specific time and provide assistance for them to do so. Not only do companies coordinate the output of smallholders but they also often coordinate with the companies who, in turn, buy from them. Such buyers may provide detailed specifications of the products they require. 9 Various configurations of aggregation and coordination in smallholder marketing are shown in Figure 1. Figure 1: Types of market linkages for smallholders Suitability of arrangements by market and product type The most suitable types of marketing systems (or value chains), and the extent of aggregation and coordination required, vary by market and product types. Potential markets for smallholder production include local fruit and vegetable assembly markets that, in turn, supply urban wholesalers and retailers; itinerant traders that buy products at the farm gate; local rice mills, and larger mills that supply urban areas; other processors that use agricultural raw materials; and exporters of fresh produce and commodities. The nature of the product relates to the form in which it passes through the value chain and will eventually be marketed to the consumer and to its perishability. For example, there is a significant difference between value chains for vegetables that are sold in more or less the same form as they are harvested and those for oil palm which is marketed as the largely undifferentiated bulk commodity of palm oil. Perishability enhances risk of product loss or value (quality) decline during transport and storage, may require specialized transport and storage, can lead to contamination and limits potential for storage. In this regard the risks are usually far greater for fruits and vegetables than for commodities such as coffee and cocoa. Relevant approaches to improving aggregation and coordination are discussed below with reference to different products grown or reared in Indonesia. A summary of these is presented in Table 1 below. (1) Fruits and vegetables Markets for fruits and vegetables can be broadly categorized as the traditional domestic market, the supermarket sector, the processing sector and the export market. In Indonesia the traditional supply chain handles almost all produce supplied for retail sale. Aggregation is largely carried out by traders who either buy directly at the farm or at assembly markets and there is limited coordination in terms of planning of production or varieties to be grown. The potential for upgrading aggregation includes the use of group marketing and marketing by leading farmers. Supplies to supermarkets (and some 10 hotels and restaurants) require coordination in order to meet the companies’ requirements for food safety, traceability and quality control. These coordination needs are normally met by specialized intermediaries or lead farmers. Compared to countries such as Thailand and Malaysia, Indonesia’s exports of fresh produce are limited (primarily pineapple). Poor economies of scale resulting from small production units are given as one reason for this and improved aggregation, whether through land consolidation or coordinated marketing, seems essential if Indonesia is to compete on world markets. Coordinated marketing for both the most demanding domestic and export markets could follow the contract farming model, as done in many other countries. For example, a recent review of literature on contract farming in developing countries identified papers on examples such as potatoes in Peru; green beans in Madagascar, Kenya and Senegal; and watermelon and apples in China. 2 As supermarkets continue to expand their role as fresh produce suppliers it is likely that the traditional marketing system will need to adapt as other retailers begin to demand produce of comparable quality. This may see the emergence of specialized intermediaries who supply non-supermarket retailers by coordinating with farmers in the same way as intermediaries presently working with supermarkets do, such as by specifying varieties and scheduling harvest times. In the long run this may reduce the importance of traders working through assembly and wholesale markets who, in turn, will be forced to adapt their practices by also coordinating more closely with farmers. Perishability is a major characteristic of most fruits and vegetables. The value chain has to be short in order to ensure that produce reaches the market with minimal delay. Existing channels are relatively successful in achieving this. For example, vegetables may be harvested in the Bandung area on Monday evening, sold at the assembly market early on Tuesday, transported to Jakarta for overnight sale and be in retail shops early on Wednesday. However, improved coordination that by-passes the assembly and wholesale markets could, in theory, have the products in shops on Tuesday morning, although the higher prices received may not cover the additional costs incurred. A potential role for producer organizations in coordinating farmers to facilitate improved linkages would need to be explored. While existing channels are able to minimise losses by speedily moving perishable produce along the chain, the traditional sector tends to be poor at post-harvest handling, resulting in both physical and quality losses. Trucks are often overfilled with badly packed products, leading to compression damage. Improved coordination and aggregation could reduce such losses by permitting the use of better packaging and facilitating training of both farmers and traders. Better coordination can also reduce losses by ensuring that farmers only harvest what can be sold. (2) Rice Markets for paddy in Indonesia also follow traditional lines. Farmers either sell to mills, to agents of those mills or to traders who will then sell to mills. Many smaller mills do not buy paddy but only carry out contract milling on behalf of the farmers, who then sell the rice or use it for family consumption. Mills tend to be inefficient and have low conversion rates. It seems essential that there be consolidation in the sector, with smaller inefficient mills being replaced by larger, modern mills, as has been seen in many other ASEAN countries. One advantage of having so many small mills in the country is that one is in easy reach of almost every farmer. Fewer, larger mills would tend to be more distant 2 Ton et al. 2016 11 and it would require improved aggregation to ensure they were supplied with paddy efficiently. POs could have a role to play here by acting as coordinating links between larger mills and their members. The characteristics of paddy and rice in Indonesia are such that better-quality mills would need to coordinate with farmers in order to guarantee the supply of the varieties they require. At present much production is based on farmer-retained seed of mixed varieties. Mills could consider supplying seed to POs or SMEs, with an agreement to buy farmers’ output as long as it was from those seeds. In general, however, rice is not particularly suitable for contract farming, given the ease with which farmers can find alternative markets. If contracting companies are to provide farmers with inputs, technical assistance and other support they need reasonable assurance that farmers will sell them the resulting crop. Thus, to date, the limited contract farming for rice worldwide has been when companies have been able to attract farmers with premium prices because they are buying specific high-value varieties (aromatics), organic rice or seeds. Even then, there have been a number of failures, given the tendency of farmers to sell elsewhere if they can obtain a better price. (3) Maize Maize or corn is the second most important cereal grown in Indonesia. Although it is by far the largest maize producer in Asia, the country remains an importer. Marketing practices are largely traditional: farmers either sell ears of corn immediately after harvest to visiting traders or dry and shell the ears before sale to traders. Seed used is mainly retained from the best ears of the previous year’s production. However, some millers do work on a contract basis with farmers. Unlike with paddy, they can afford to employ field staff to monitor compliance with the contracts as they find maize to be more profitable than rice. The bulk of corn use is for animal feed and biofuels. As a food for humans, maize is considered inferior, and is consumed disproportionately by the poor. Increasing affluence has led to a significant decline in its consumption as a food. While maize is a fairly generic product (with the exception of the differentiation between white and yellow varieties) that is available through traditional channels, the need for increased coordination may be limited, although there is a small seed corn contract operating in Bali. Examples of maize contract farming in other parts of Asia are few. There has been some cross-border contract farming in Laos, working with Thai companies. Recent attempts to also introduce this in Myanmar by the Thai company, CP, have met with only limited success. Introduction of improved coordination and aggregation in Indonesia is likely to depend on the extent to which animal feed companies see the need for supplies of reliable quantity and quality of maize in order to meet specific feed requirements. (4) Sugar Indonesia’s sugar industry has been on a decline. Like the rice sector, sugar suffers from low yields, ageing factories, and low extraction rates. However, recent policy decisions may see a reversal in its fortunes. These include a requirement that companies should work more closely with farmers. In general, sugar is a commodity that is very suitable for the aggregation and coordination that contract farming can provide and the bulk of sugar produced by smallholders worldwide is grown under such arrangements. Sugar cane is a bulky and relatively perishable product for which long-distance transportation would be inefficient. Thus a contractual arrangement whereby farmers can be sure of the price they will receive, and which facilitates aggregation from small farms and scheduling of deliveries to the factory has much to commend it. The approach is not without its problems, however, as sugar attracts frequent disputes over grading. Payment is based on the sucrose content of cane, which is measured when the cane arrives at the factory. Often the first notification farmers receive of their sucrose measurement is when they receive payment. 12 (5) Palm oil  Although contract farming through nucleus estates is widely used for oil palm in Indonesia (PLASMA) and is the only method of production in Papua New Guinea, it does not appear to play a dominant role in other leading oil palm producing countries, including Malaysia, Thailand, Southern America and Western Africa. Its importance in Indonesia and PNG may be because in both cases nucleus estates were tied to resettlement programs and thus the contractual arrangements were appropriate to support resettled people who would otherwise have had no livelihood source. The fact that there are many non-contracted oil palm producers in Indonesia may be because there is less incentive for smallholders to enter a contract when they already have established palms and limited incentive for companies to seek contracts with these farmers, particularly when there are competing buyers who could encourage side-selling. Thus, on the one hand, contract farming appears relevant for new developments but not for existing production. On the other, independent smallholders do not usually qualify for Roundtable on Sustainable Palm Oil (RSPO) and Indonesia Sustainable Palm Oil (ISPO) certification as they are not linked to a company to receive training and thus conversion of independent producers to contracts may be desirable. Section 4 discusses the World Bank’s productive alliances program in Latin America. There are examples from Colombia of where this program has been used to better link oil palm producers with factories, through producer organizations. (6) Rubber As with sugar and oil palm, rubber is a product that requires rapid processing after harvest. Thus farmers need to be situated relatively closely to the buyer’s factory and this has been found to be a suitable basis for contract farming to be developed. In theory, rubber could therefore be suitable for contract farming in Indonesia but, as with oil palm, it seems most relevant for new developments, as has been done in Liberia, for example. The best quality can be produced when fresh latex, in liquid form, is delivered directly to a factory for processing, which is the practice when rubber is produced on estates. However, this is not widely done for smallholder production, largely because latex coagulates quickly or requires addition of chemicals to prevent coagulation, and it is difficult to organize transport of smallholder quantities of fresh latex to factories. In Indonesia farmers tend to sell coagulant as cup lumps or slabs to traders for delivery to factories. Thailand has had some success with promoting small cooperatives to carry out village-level processing of liquid latex and there may also be potential for SMEs and POs to provide this service in Indonesia. (7) Coffee Unlike sugar and oil palm, coffee is a product that, after primary processing by farmers, does not require urgent secondary processing. Thus further processing can be carried out closer to the market, such as near export ports, particularly as there are negligible transport cost advantages to having the factory close to smallholders. There are relatively few examples of contract farming for coffee and, where it is used, this seems to be primarily for “organic” coffee, where the company has approached farmers and offered contracts if they will convert to organic production. In recent years companies have been placing greater emphasis on coffees that are marketed to consumers on the basis of their origin and, although it does not involve contract farming, are increasingly working to coordinate with producers to ensure both reliable quality and traceability. In all coffee-producing countries the quality of much smallholder-processed coffee has always been a cause for concern. Ways of addressing this include centralizing primary processing. In Papua New Guinea, for example, smallholders used to only sell parchment coffee to traders. However, it is now 13 common for farmers living close to estates to sell their Arabica cherries to the estates, leading to a lower workload for farmers and higher quality coffee resulting from centralized processing. There has also been a program to promote village wet-processing factories. In Indonesia there appears potential to develop small-scale PO or SME processing of coffee cherries, as suggested above for rubber. (8) Cocoa Cocoa production in Indonesia has declined considerably in recent years. However, there is concern around the world about a future decline in production levels, as a result of aging trees and aging farmers. Reduced production should lead to an increase in prices for Indonesian smallholders. A further way of increasing smallholder returns is by improving quality of beans marketed. Smallholder cocoa processing has several weaknesses, resulting in poor-quality beans that attract low prices. Aggregation of beans for centralized processing by either SMEs or POs could lead to higher prices as could better coordination between exporters and producers, as is already being done in one or two cases in Indonesia (see section 3). As with coffee, there is some limited contract farming around the world for cocoa, but this seems to be mainly where existing trees have been converted to organic. Also as with coffee, there is an increasing trend for the marketing of “origin” chocolates that stress the provenance of the cocoa used. To achieve this requires closer coordination between smallholders and bean exporters, as well as improved quality. (9) Poultry Seventy percent of broiler chicken production in Indonesia is carried out under contract by over 20,000 farms. Because of the investments required the farmers tend to be the more affluent and probably cannot be categorized as smallholders. Companies (known as integrators) supply Day-Old-Chicks, feed and medicines and give farmers a growing fee with a bonus for superior performance. Feed is produced making use, in part, of local maize (corn) production. However, only about 15% of production is actually sold to the companies: farmers market the remainder through traditional marketing systems.3 Birds sold to the integrators enter the supermarket cold chain and are also used for processing. The possibility of sales to traditional markets minimizes the risks inherent in contract rearing of poultry, in which the farmer makes a significant up-front investment that can only be used for one purpose (so-called “asset specificity”), and is thus vulnerable should the integrator go bankrupt, try to reduce prices paid or change quality criteria. Poultry consumption increases as incomes rise. Thus, Indonesia’s poultry industry is likely to expand, and this may be accompanied by demands for improved quality, for more ready-to-cook birds, and for pre-cut pieces. Such trends can be expected to result in a greater proportion of farmers’ output being sold through companies rather than on traditional markets. (10) Dairy The majority of cows in Indonesia are owned by individual farmers. However, corporate dairy farmers are playing an increasing role in East Java with total milk production from cows owned by corporations increasing at a faster rate than individual farmers. Most individual farmers are members of a Koperasi Unit Desa (KUD). There are about 220 KUDs in Indonesia involved in dairy, with almost 100,000 farmers as members. The KUDs provide a range of services to farmers including collecting the milk, checking the milk quality and paying the farmer. Price incentives are used to encourage better farm- 3 USAID, 2013 14 management practices and production of higher quality milk. Some of the KUDs have exclusive arrangements to supply a major milk processor while others have established their own brands for the local market. However, the processing industry consists mainly of major local and multinational companies. KUDs have several potential markets for their milk and may not always supply the same company, particularly in West Java where there are many potential outlets. In East Java the multinational, Nestlé, has a dominant position.4 As in many other countries, aggregation and coordination works reasonably well in the dairy sector. While there is considerable scope for improvements to production and marketing systems, the basic structure appears fit for purpose but lessons can be learned from other countries where the companies play an active role in promoting yield and quality improvements through existing structures. 4 IFC, 2011 15 Table 1: Ways of improving aggregation and coordination for different commodities Commodity Methods to improve aggregation and Selected commodity or value chain characteristics coordination Fruits and vegetables (1) For traditional domestic market  Informal group marketing  Perishable and fragile, and handling by non-specialized  Leading farmer marketing and coordination intermediaries results in higher rates of loss and damage  Coordination and aggregation by traders  Dominance of small, uncoordinated producers (2) For supermarkets, caterers, etc.  Specialized intermediaries  Coexistence of traditional, and high end domestic and  Coordination by buyers export market value chains  Alliances between producer organizations (POs) and buyers  Leading farmer marketing and coordination (3) For processing and export  Contract farming  Coordination by buyers  Coordination by traders  Alliances between POs and buyers Paddy (1) For small local mills  Group marketing  Requires centralized milling (2) For sale to larger mills  Group marketing  Dominance of small mills  Alliances between POs and buyers  Consolidation and modernization of milling can enhance  Coordination by buyers efficiency and quality but implies greater distance from (3) For paddy with clearly defined  Contract farming production characteristics  Alliances between POs and buyers  Some but limited opportunities for differentiation, except in the case of highly distinct varieties Maize or corn (1) For seed production  Contract farming  Seen as generic, inferior good; marketing is mostly (2) For animal feed market  Improved coordination by buyers traditional; small seed corn contract operating in Bali  Potential for differentiation is greater for feed Sugar, oil palm (1) For new developments  Contract farming with nucleus estates  Sugarcane: bulky and perishable, requires rapid and nearby processing; pricing is related to measured 1 Commodity Methods to improve aggregation and Selected commodity or value chain characteristics coordination sucralose content of the crop and often a source of disputes (2) For existing smallholders  Coordination by buyers  Oil palm: sellers’ market with a choice of buyers; tree  Alliances between POs and buyers crop implies a multiyear wait for a return on the initial investment in new plantations Rubber (1) For new developments  Contract farming with nucleus estates  Requires rapid and nearby processing, and processing (2) For existing smallholders  Village-level aggregation and processing of capacity and speed are key to quality and pricing fresh latex by POs or SMEs  Tree crop  Alliances between POs and buyers  Improved coordination by traders Coffee (1) For existing smallholders  Village-level aggregation and processing of  Relatively stable after initial on-farm processing, so that cherries by POs or SMEs secondary processing can occur far from production  Improved coordination by buyers and traders  Price sensitive to quality of processing, and price  Contract farming for organic and other premiums available for traceable and certified product specialized coffee  Tree crop Cocoa (1) For existing smallholders  Village-level aggregation and processing of  Tree crop, aging stock beans by POs or SMEs  Price is sensitive to quality of processing  Improved coordination by buyers and traders  Dominance of small processors  Contract farming for organic and other specialized cocoa Poultry (1) For existing farmers  Increased % of sales to integrators  Perishable (2) For new farmers  Contract rearing through integrators  Product takes on varied forms at retail (live or slaughtered, ready-to-cook, pre-cut)  Coexistence of traditional and supermarket value chains Dairy 2 Commodity Methods to improve aggregation and Selected commodity or value chain characteristics coordination (1) For existing farmers  Improved coordination between buyers and  Perishable POs  Processing industry consists mainly of major local and multinational companies 3 Major aggregation and coordination arrangements There are many different ways in which aggregation and, in particular, coordination can be achieved. For ease of presentation these are categorized in this paper as four broad types of arrangements that appear most relevant to Indonesia. The four types are divided according to whether aggregation and coordination take place at just one stage of the chain (primary production aggregation and coordination) or whether there are mechanisms used to link different stages of a value chain (value chain coordination and aggregation). Primary production aggregation and coordination mainly involves: 1. Direct transactions between farmers and traditional traders, millers and processors; 2. Transactions between farmers and traditional traders, etc. using producer organizations (POs) as intermediaries; Value chain coordination and aggregation involves: 3. Contract farming and other coordination arrangements between companies and smallholders; either directly or with support from a PO; 4. Vertical coordination between farmers and companies through POs, without contract farming. These four types are summarized in Figure 2 and in this rest of this section, which also includes a summary of recommendations to government. The issues are then discussed in more detail in sections 3 and 4, while section 5 looks at other factors contributing to successful aggregation and coordination, such as the use of ICTs. Section 6 summarizes the findings in tabular form and the note concludes with recommendations for value chain development in Indonesia. 1 Figure 2: Types of value chain linkages employing aggregation and coordination (a) Primary production aggregation and coordination Direct transactions between smallholders and traditional traders, millers and processors Although there has been growth in the number of producer organizations and cooperatives and an increasing use of contract farming by commercial companies, the great majority of farmers in developing and emerging countries still follow traditional marketing practices. First they produce the crop and then they worry about selling it. Farmers make the decisions about what to grow rather than buyers who may be better able to understand the needs of consumers. Little or no advice is provided by the buyers to the farmers about how to improve quality and on-farm processing (e.g. paddy drying) is usually done badly. The practice of individual smallholders selling small quantities to traders or mills is inefficient. Their production should ideally be bulked into lots that can be readily and economically transported, sorted, processed, and stored. At the simplest level farmers can address this problem through informal group marketing arrangements that they can arrange themselves by coordinating with a trader to meet at a certain location at a certain time, or agreeing amongst themselves to hire a vehicle to take their vegetables to a market or paddy to a mill. Under such arrangements the individual farmers retain ownership of their produce until it is sold to the trader or miller. An alternative approach is the “lead farmer” model where farmers see the scale economy benefits of buying products from neighboring farmers and, perhaps, bulk purchasing inputs for sale to their fellow farmers. Transactions between smallholders and traditional traders and processors, using producer organization (POs) as intermediaries A more sophisticated arrangement involves a formal farmer marketing group, a producer association or a cooperative in purchasing produce from its farmers and then selling it in bulk to a large buyer. 2 Such arrangements involving POs permit the aggregation of larger quantities than would be possible through informal aggregation. With greater quantities it should be possible to access larger and more efficient buyers (e.g. rice mills with up-to-date equipment) and negotiate higher prices. Aggregation by POs seems to work particularly well in the dairy sector. They can operate milk cooling equipment (often donor or government supplied) that can aggregate sufficient quantities of milk to be of interest for a commercial dairy to send a vehicle to collect. Land consolidation and cooperative farming In addition to the aggregation of the products of individual farmers, aggregation can also be achieved by consolidating land into larger parcels. Several countries have been actively promoting consolidation through sale or lease. Although leasing can be done on an informal basis, formal sale and leasing requires that the title must be recognized and many countries struggle to provide appropriate registration systems. Three basic approaches are discussed: 1) consolidation to increase the average size of farms into viable commercial units, through sale or lease; 2) consolidation to reduce fragmentation of smallholder plots; and 3) cooperative farming where farmers keep their land but farm it jointly. The paper will discuss experiences with land consolidation in China and Vietnam as well as efforts at cooperative farming, such as the Small Farmers, Large Fields program in Vietnam. (b) Value chain coordination and aggregation Contract farming and similar arrangements between companies and smallholders The main form of formal vertical coordination involves the use of contracts. These can be simply an advance agreement to buy a particular product and variety from a farmer, but more normally involve the buyer specifying aspects of production and providing assistance with that production. The extent to which the buyer becomes involved in production can vary from a simple arrangement in which the company just specifies the variety, the production techniques, the inputs to be used and the delivery dates, to one in which the buyer supplies inputs on credit, provides advance payments, supports farmers with technical assistance, organizes certification, does land preparation and arranges collection of the products from the farm. However, most arrangements fall in the middle of the two extremes. Contracts usually specify the desired processes for crop production or livestock rearing, often in order to comply with domestic or international quality and safety standards. Indeed, the existence of such standards is one reason for the apparent rapid growth in contract farming worldwide. Exporters or processors cannot comply with international standards by buying products in the local wholesale market. Standards such as GLOBALGAP are also quickly becoming the basis of national standards (e.g. IndoGAP), particularly in light of the growth of supermarkets in fresh and processed food retailing. While some companies have found it preferable to work with smallholders directly, they usually have neither the skills nor inclination to do this. Thus POs can play an important role in coordinating production, input supply, product delivery and training. POs are likely to find this role easier than one that involves them in taking a financial risk by buying and selling crops. Virtually any commodity can be produced under contract. However, experience suggests that it is likely to be less relevant for undifferentiated staple crops and for crops that are widely consumed in the producing country. Thus there are relatively few examples of successful rice contract farming and where this has occurred it has invariably been for the production of specific aromatic varieties, for organic production, or for seeds, for which companies can offer a premium price and for which there are few if any competing buyers. 3 In recent years fruit and vegetable wholesalers have begun to work more closely with farmers, in response both to the growth of supermarkets and fast-food chains and demands from processors who are increasingly required to meet safety and quality standards. The wholesalers provide basic services to farmers, including arranging logistics, providing information and extension advice, and organizing sorting, grading, and packaging. In the commodity sector there is an increasing trend for consumer products to be related to the origin of the raw materials (e.g. cocoa beans), necessitating increased coordination between buyers and farmers. Transactions between smallholders and processors, exporters and wholesalers through POs This type of vertical coordination covers transactions involving producer organizations that enable smallholders to more effectively respond to market demand. Although it often shares some characteristics with contract farming, the crucial factor is that the linkages are initiated by the POs, with government and donor support, whereas in contract farming it is the company that actively seeks smallholder farmers to work with. The main example of this comes from Latin America where the development of productive alliances has benefitted from support from the World Bank. The assumption underlying the program is that smallholders and their organizations are finding it increasingly difficult to enter into modern agricultural value chains, as commercial buyers increasingly require large quantities of high-quality products that meet required standards. Productive alliances are formal Public-Private Partnership (PPP) agreements that bring POs together with at least one commercial buyer. POs are initially provided with support to develop business plans, followed by technical assistance, and some infrastructure and equipment. The agreement signed between the PO and buyer specifies product characteristics, quantities to be delivered, production modalities, post-harvest requirements, payment arrangements, price setting, and the contribution made by the buyer in terms of input provision and technical assistance. The World Bank has implemented a similar program in Vietnam. There are several examples of similar approaches to improving linkages between farmers and the private sector. One interesting example is the Competitive Business Grant program financed by IFAD in Vietnam. Cooperatives and small or medium enterprises (SMEs) can apply for grants to increase their capacity to purchase raw materials from smallholders and improve the quality of the support they can offer to them. For example, an existing processor may have identified smallholders capable of supplying the raw materials it requires but needs funding to construct a warehouse in the village to aggregate the produce until there is enough to collect. (c) Support for aggregation and coordination Warehouse receipt finance If the private sector, POs and even individual farmers are to increase the level of aggregation of non- perishable products they require storage facilities. They also need a way of monetizing stocks, as few have the resources to hold large stocks for any length of time. A processing company has to maximise its throughput by ensuring that it has sufficient stocks to keep the factory going year round, but having adequate finance is essential for this. Inventory credit, or collateral finance, provides a way of monetizing stocks and is a potentially important method of increasing the finance available to value chains to permit greater aggregation. However, attempts to introduce warehouse receipt finance in Indonesia have so far been relatively unsuccessful. 4 Use of information and communication technologies Modern information and communication technologies (ICTs) are playing an increasingly important role in agricultural marketing. Most farmers now have access to phones and can call buyers to check on the price before making a decision to harvest or to transport the produce to a buyer. Building on existing, often government-run, market information services (MIS), some companies have developed software to enable “market matching”, whereby farmers can indicate what they have to sell and buyers what they want to buy. However, such ventures have not yet succeeded in developing viable business models. ICTs can also facilitate the use of warehouse receipts and a whole range of activities in vertically coordinated chains, such as the use of traceability. They have also been used for direct marketing where farmer groups supply fresh fruits and vegetable (usually with particular characteristics, such as organics) directly to consumers, who order online. 2. Primary production aggregation and coordination This section examines experiences with the aggregation and coordination of agricultural product marketing when there is horizontal coordination but relatively little vertical coordination. It considers (1) arrangements where smallholders coordinate informally to aggregate products to sell to traders, and (2) the situation where this aggregation function is organized by formal producer organizations (POs). In addition to the aggregation of products once they have been harvested, there have been moves in some countries to promote ‘joint farming’, in which smallholders either farm larger parcels of land cooperatively or agree to all produce the same crops individually. Land consolidation through sale or lease can also result in improved aggregation by reducing fragmentation. These issues are discussed at the end of the section. (a) Direct transactions between smallholders and traditional traders, mills and processors The great bulk of smallholder sales are made to individual traders, who either work on their own account or act as agents for others, such as mills. In some Asian countries direct sales by farmers to small local mills are also still important. Sales to small-scale traders can be ad hoc but in many cases transactions result from longstanding trading relations. Small-scale traders have both advantages and disadvantages. The advantages are that they provide aggregation and access to markets for numerous smallholders. They are prepared to travel to remote areas, buy small quantities and, usually, pay in cash, which is an important consideration for poor smallholders. The role that traders play ensures that processors have access to raw materials, wholesalers have access to supplies to meet consumer demand and commodity exporters can meet overseas contracts. Traders have flexibility and can often handle a range of products, depending on the level of seasonal supply. Their dealings with smallholders may also involve provision of limited amounts of credit. On the other hand, traders individually handle small quantities and are thus relatively inefficient. As a consequence their costs can be high. Small traders generally contribute little to vertical coordination, such as by advising farmers on which varieties to grow, or on how to improve quality and post-harvest handling. Smallholders selling to traditional traders have no incentive to try to improve their quality as they are likely to receive the same price as other farmers producing lower qualities. Traders face significant constraints in aggregating, particularly in remoter areas. When they drive to a village to make purchases they cannot always be sure there will be anything for them to buy, even if 5 they have previously contacted the village by phone. Traders may have to drive from farm to farm in order to obtain sufficient quantities to justify the trip, rather than meeting farmers in one place. In some countries being a trader is a risky business: they are known to be carrying money to buy the products and theft is common. For all of these reasons many purchases of fresh produce from farmers are made at rural assembly markets rather than at the farm. While use of assembly markets in Indonesia is facilitated by the fact that vegetable-producing areas tend to be clustered, individual farmers are still faced with the difficulty of getting their products to the market. Their production needs aggregating into lots that can be readily and economically transported. In the fruit sector in Asia another form of aggregation is when traders agree in advance with farmers to “buy the field”, i.e. while the fruit is developing they negotiate a price with the farmer to buy the produce from an entire orchard and then return to harvest it when the fruit is ripe. One trader may have such arrangements with several farmers in the same area in order to maximize economies of scale. Less frequently, the same practice is applied to field crops. Although the majority of small-scale producers are not grouped in formal, market-oriented organizations, most belong to social networks that can also serve as a channel to organize aggregation. Farmers can address the problem of accessing traders through informal aggregation arrangements by agreeing with a trader to meet them at a certain location at a certain time, or agreeing amongst themselves to hire a vehicle to take their paddy to a mill or vegetables to a market. Group activities can also be used to purchase inputs by delegating one or two farmers to go to town to buy in bulk. Unfortunately, little is known about the extent of such group marketing practices. Researchers tend to study the operation of more formal aggregation arrangements, such as those discussed later. One exception is a study carried out in Uganda, as shown in Box 3. Box 3: Community coordination and aggregation in Uganda Smallholders who grow matoke (plantain) in the Kasenda area of Uganda have organized to increase their profits without a formal cooperative or farmers’ association. They coordinate their activities only in the harvest season. Farmers call relatives in the capital, Kampala, to check prevailing market prices. This information passes throughout the producing area via community informants, who also prepare everyone to deal with bulk buyers. Trusted community members are identified who will coordinate the marketing and negotiate on behalf of other farmers. These representatives survey households to assess the amount of matoke expected at harvest and then contact buyers to discuss volumes and prices. Once these are set, the farmers establish two collection centres and designate days for each to bulk their harvest. On these market days, the community representatives conduct the final negotiations and collect payments, distributing the money to farmers according to the pre-agreed prices. Source: Learning Network, Bihunirwa and Shariff quoted by Vorley et al. 2012 An alternative approach is the “lead farmer” model where farmers, either on their own initiative or in response to proposals for collaboration by buyers, see the benefits of buying products from neighboring farmers for resale. In some cases the lead farmers will act as traders, making a profit on the transactions: in others they obtain benefits as a result of their own reduced transport costs resulting from the economies of scale achieved by aggregation. Again, information about such arrangements is relatively limited but the practice does appear to be quite common, although most examples relate to linkages with larger companies rather than traditional marketing channels. Some lead-farmer marketing activities have attracted external support. For example, the case from Thailand described in Box 4, in which a lead farmer initiated activities, has received substantial financial assistance from the local sub-district, while an often-quoted example from Mindanao, Philippines, in which a lead farm coordinates deliveries of lettuce to a fast-food chain, has been supported by USAID. 6 Box 4: Lead farmer aggregation in Thailand The In-Net-Vegetable Growers' (INVG) group, in Chiang Mai Province, Thailand, consists of 72 members from eight villages who produce kale, cabbage, beans and broccoli. Members of the group pay no membership fees, but each bought a share of 120 baht (USD 4), which was used as initial funding and operating capital, mainly to provide loans for inputs. The group has also invested in water pumps and tube irrigation. Source: Aree Wiboonpongse and Songsak Sriboonchitta, Chiang Mai University, Thailand. An example of a “lead farmer” activity initiated by the buyer comes from the Vietnam dairy sector. The multinational, Nestlé, was facing difficulties in organizing milk supplies under a contractual arrangement with smallholders. Changing its approach it organized farmers into clusters and in each cluster a leader, elected by the members and trained and paid by the company, had to ensure that farmers were supplying the contracted amount of milk. The cluster leader was also in charge for the company’s payments to all the farmers. Box 5, regarding horticulture in Central America, also provides promising evidence that the lead- farmer approach can be successful. Box 5: Lead farmers for supermarket supply in Central America Hortifruti is the specialized wholesaler for fresh fruits and vegetables for a leading supermarket chain in Central America. The company worked with vegetable farmers in Honduras and Nicaragua, often purchasing products from existing farmer cooperatives. However, it experienced significant difficulties with these POs because of lengthy decision-making processes. As a result, Hortifruti Honduras developed a ‘lead-farmer’ model through which it identified farmers who could meet its quality needs in a consistent fashion, and built up their capacity. After demonstrating such capacity, lead farmers received larger and larger orders and were invited to work with neighboring farmers to meet this demand. Lead farmers provided access to technology and technical assistance to their network of neighbors as part of a bundle of production and marketing services. Further expansion of this model depended on the identification of new lead farmers but early results indicated that the approach was low-cost, scalable and sustainable. Source: Vorley, Bill; Lundy; Mark and James MacGregor 2009. There has been a tendency by governments to ignore the traditional trading sector. Although small traders still account for the marketing of a high proportion of agricultural production (some estimates suggest as high as 80%), the support provided to them by governments, donors, etc. has been negligible. Because of the high costs in the system traders are often incorrectly portrayed as ‘unscrupulous middlemen’ who cream off profits from the chain, while contributing little. Thus development agencies have sometimes tried to develop market linkages that by-pass traders and connect farmers directly with the end buyers. Some have even tried to do the marketing themselves, usually with disastrous consequence. An example of what can be achieved by working with the private sector comes from Lao PDR and is presented in Box 6. The methodology used here would appear to offer a useful model for replication in Indonesia. Prior to the project intervention, farmers lacked access to quality rice seed and negotiated prices individually with mills or traders. 7 Box 6: Improved coordination between rice mills and paddy farmers in Lao PDR The Enhancing Milled Rice Production project (EMRIP) in Lao PDR succeeded in developing improved relations between 21,361 smallholders and 21 rice mills within two years of the project’s start-up. In return for supporting farmers with inputs, extension advice and better prices, millers received project support, funded by SNV (Netherlands), Helvetas (Switzerland) and an EU grant, to improve milling facilities and equipment. Central to the success of the project was a rigorous selection process, which chose the most promising millers to work with. In two years, farmer yields increased by 30%; income from rice increased by around 60% and millers saw improved profitability as a result of a 10% increase in throughput and a guaranteed supply of high-quality, single-variety paddy. The selection of committed millers was crucial. The project assisted the selected millers to develop a Business Plan, which described the steps to be taken to increase productivity and to support farmers to upgrade their paddy. In order to work with farmers the millers formed farmer groups, having first received training and advice on forming such groups, on input provision, and on business management skills. This enabled them to provide seed, fertilizer and extension services, based on production agreements with the farmer groups. They also improved extension services by collaborating with government extension officers, and paying officers a salary supplement. A co-investment fund helped millers to upgrade their equipment, which contributed to increased recovery of milled rice. Regular consultations between millers and farmers facilitated trust and the development of fair trading relations. A small, but significant, intervention was that millers helped to purchase communal weighing scales and facilitated their certification by government authorities. These minimized allegations of cheating by both mills and farmers. The rice mills participating in the project took the lead in forming miller associations in their respective districts. Participation was not just limited to the mills working with the project and within two years 14 local associations with 261 mill members were operating in five provinces. Formation of these groups has enabled miller participation in multi-stakeholder meetings designed to encourage a “bottom-up” approach to policy formulation and to address the problem that responsibility for rice development in Laos is presently split between several different bodies. Source: Ranjan Shrestha, SNV. (b) Transactions between smallholders and traditional traders and processors, using producer organizations (POs) as intermediaries Aggregation of smallholders into producer organizations has a number of potential benefits:  It permits the supply of larger quantities than would be otherwise possible. While processors and other buyers are looking for farmers who can reliably deliver sufficient quantities of produce at the right time and with the quality required, they do not want to have to deal with thousands of individual farmers. In this case, POs can offer a central point of contact, which reduces transaction costs for buyers and can also provide intermediate activities, such as transport, storage, quality control and primary processing (e.g. paddy drying);  It facilitates capacity building of farmers in groups rather than individually, to enable them to comply with the increasingly stringent demands of modern markets;  It can improve logistics and reduce transport costs. Harvests can be scheduled so that losses are not incurred while harvested produce waits for transport to arrive. Similar improvements can be made to arrangements for input supplies;  It reduces the costs of disseminating information; 8  It can enhance rural employment by offering opportunities for service providers to provide commercial services to organized farmers, such as land preparation or harvesting services. These service providers can either work individually or through agro-service centers developed by governments or donors. Evidence suggests that smaller marketing groups have higher internal cohesion because it is easier to monitor other members. However, while the organization of smallholders into small groups is widely followed and can be used to link farmers with traditional traders and SMEs, small groups cannot access larger buyers without some sort of federated arrangement, which can be complex to organize. In India farmers have been mobilized into groups of between 15-20 members at the village level (called Farmer Interest Groups or FIGs), which, in turn, have been built up into federations. The program is accompanied by the development of local business centres, which provide services to farmers of member FIGs. These agribusiness village resource centres (AVRCs) are managed by their associated federations and are equipped to provide a variety of services and also to support farmers to access targeted assistance and capacity building. Land preparation services are also available. In Indonesia, a cocoa exporter has worked with a PO, with assistance from the Belgian NGO, VECO, to improve aggregation and quality of smallholder cocoa beans, as described in Box 7. Box 7: Cocoa aggregation and coordination in West Sulawesi Armajaro is a leading cocoa bean exporter. It has a policy of getting closer to its suppliers in order to develop traceability, improve quality and facilitate certification. Since Armajaro cannot buy from thousands of individual farmers because of their low volumes, several ways of improving linkages have been developed. In the area of Polman, West Sulawesi, Armajaro has operated a program with support from the Belgian NGO, VECO. It started by paying AMANAH, a multi-purpose cooperative, to promote aggregation by the farmer groups that were members of the cooperative. AMANAH received a fee of IDR 50 per kg sold to Armajaro, which was used by AMANAH to expand operations to other villages. Subsequently, Armajaro raised the fee to IDR 100 per kg if the quality met expectations. In three years, AMANAH earned IDR 30 million and used this money to buy fertilizers and other inputs for its members. Armajaro experimented by giving farmer groups pre-financing, amounting to 70% of the expected value of projected sales. However, this was later stopped because the farmers also sold their cocoa to local traders when they received better prices or when they had also received loans from the traders. Although the company no longer offers pre-financing to individual farmers, it does offer guarantees to enable farmer groups to access bank credit. Difficulties were experienced because the cocoa purchased through the cooperative was shipped to Makassar, an eight-hour drive. Quality control was done in Makassar and when the company’s quality assessment was below that of the farmer it bred discontent. Thus Armajaro agreed to put a warehouse in Polman district and to organize quality evaluation there, in the presence of the farmers. As a consequence, transparency and trust increased between farmers and the company. In 2011, 67 of AMANAH’s farmer groups received UTZ5 certification. Source: VECO. 5 https://utz.org/ 9 Despite a few good examples such as the above, producer organization development in Indonesia has tended to involve a top-down approach designed to ensure rice self-sufficiency. Village Unit Cooperatives were established by the government and given the responsibility of implementing farm credit schemes; distributing agricultural inputs (e.g. fertilizer under the BIMAS program); organizing marketing logistics; and distributing subsidies. The government guaranteed both the market and the price (particularly of rice) for sales by cooperatives in order to encourage their growth. Measured in terms of the amount of fertilizer distributed and increases in rice production the cooperative development program was considered quite successful but it resulted in cooperatives becoming heavily indebted. However, observers have noted that any success was achieved primarily as a result of government coercion as it was obligatory for farmers, particularly paddy farmers, to join in order to have access to incentives distributed by the cooperatives. Thus the principle of farmers being able to freely decide whether or not to cooperate did not apply. Towards the end of the 20th Century the number of such cooperatives began to decline, in part due to the disconnect between the multiple responsibilities given to the cooperatives and the capacity of their management to carry them out. By carrying out aggregation and horizontal coordination, POs in Indonesia could have a potentially important impact on the rice sector. Although paddy is usually sold by smallholders to local traders or mills and there may not be the same incentives for farmers to aggregate, if there were greater quantities of higher quality paddy to sell it should be possible to access larger and more efficient buyers (e.g. rice mills with up-to-date equipment) and thereby negotiate higher prices. Producer organizations seem to work particularly well in the dairy sector, including in Indonesia where dairy cooperatives are supervised by the National Union of Dairy Cooperatives. This relative success is usually assumed to reflect the specific characteristics of milk, which is bulky, requires special containers and is very perishable. POs can operate milk-cooling equipment that can aggregate sufficient quantities of milk to be of interest for a commercial dairy to send a vehicle to collect. Management of the PO needs to be able to maintain the equipment and carry out basic quality assessments to ensure that the milk meets the required quality in terms of fat and protein content and cleanliness of the milk, and that it has not been adulterated with the addition of water. In time there is potential to develop further vertical coordination with the dairy company in terms of meeting specific quality requirements. There have also been examples of where companies have established demonstration farms and supported artificial insemination, while cooperatives themselves have ventured into areas such as fodder production. It is estimated that, worldwide, no more than 20% of farmers are members of a PO. How active these POs are in commercial activities remains unclear, however, as does the percentage of members actually using the services provided by the PO. In some cases farmers may benefit from collective action for one activity but not all. For example, they may wish to organize in groups to improve their input supply or their access to finance, but feel they have no problems with output marketing. Or they may use a cooperative to sell one product but sell all others on the local market. POs generally develop or expand as a result of external promotion by governments or donors, such as the cooperatives in Indonesia described above, and there are relatively few examples of such bodies growing to any size solely as a result of the initiative of farmers. Despite the considerable resources that have gone into their development many POs have run into difficulties and sustainability has been a significant issue. These difficulties apply whether the organization is carrying out simple aggregation activities or involved in vertically coordinated value chains. They are briefly discussed below. Excessive external support. This can undermine ownership, profitability and sustainability. Planning for sustainability is made difficult because POs usually have little idea of the true cost of external 10 technical support. The availability of government funds may cause smallholders to want to become members of a PO more with the intention of accessing the funds (e.g. through subsidies) than benefiting from improved production and marketing. Keen to produce successful results, agencies supporting POs may carry out marketing activities directly, but experience shows that projects ignoring traditional intermediaries have generally had poor results. Similarly, direct provision of credit or inputs on credit should be avoided in favor of developing farmer linkages with financial institutions. Contradictions between PO aims. The most sustainable POs involved in business are those that function more like the private sector, and have a closed membership consisting only of farmers with a viable farm size who are able to meet buyers’ quality requirements. It becomes difficult to run a business-oriented cooperative if all members of the cooperative have a say in its business activities even if they are not producing the products marketed. Further, many cooperatives carry out activities that, while worthy, are not commercially focused and which can absorb resources and management effort, distracting them from what needs to be a commercial focus. Legal and taxation arrangements. These are often complex. POs must have legal standing in order to be able to enter into contracts, open bank accounts, borrow money and receive grants. While POs can often justifiably be accused of competing unfairly with the private sector as a result of donor support received, they can also experience unfair competition as small-scale traders often do not pay tax whereas POs need to register for tax. Cooperatives are obliged to prepare formal accounts and submit annual tax declarations. This puts them at a disadvantage to informal traders both because of the possibility of paying tax and the costs involved in preparing accounts. Also, some of the cooperatives’ potential customers are in the informal sector but are unable to provide the necessary documentation for the tax authorities, such as invoices and receipts. Management skills. Like private businesses, POs may lack sufficient management and commercial skills to operate in complex agricultural markets, or may not be able to mobilize the level of resources required to supply their identified buyers. But POs face additional problems not normally experienced by the private sector, resulting from the complexity of their organizations and the fact that members usually have a significant say in decision-making. For example, farmers may put pressure on management to pay dividends rather than make investments. As POs become more commercial, they can reduce these risks by employing managers who are authorized to take business decisions without prior consultation. However, a sizeable turnover is required to justify employing an experienced manager. While studies often show that farmers selling produce through POs achieve higher returns than those marketing individually, it is not clear whether the PO model is inherently better or whether gains to farmers result primarily from the heavy subsidies and technical assistance that POs often receive. Nevertheless, the theoretical reasons for POs hold true: i.e. the potential for exploiting production and managerial economies of scale, overcoming market-entry barriers, and reducing transaction costs. POs are playing an increasing role in vertically coordinated chains and seem essential if contract farming and other forms of vertical coordination are to expand. Reviews of the role of POs in aggregation activities have come up with a number of lessons as to ways of avoiding some of the problems discussed above:  Unless the justification for PO involvement goes significantly beyond just allowing farmers to benefit from subsidies, collective action by farmers is unlikely to be successful. Just starting from the perspective that POs are a ‘good thing’ should be avoided; 11  Simple and easily understandable rules increase compliance within organizations and reduce governance costs. There is also a need to develop accountability and enforcement mechanisms. Rules developed by the PO members themselves, as opposed to rules imposed from the outside, have a higher likelihood of being understood and followed;  There is not one model of a PO that guarantees success. POs should develop depending on the context. For example, informal groups set up to aggregate and coordinate sales may already work well and do not need to be taken to the stage of becoming formal groups;  Simplifying the registration processes for POs would facilitate the smooth formation and operation of marketing groups, farmer associations and cooperatives;  From an early stage it is necessary for POs to clearly understand what costs they will eventually need to bear when operating independently, to avoid government support giving a false impression of an activity’s profitability. (c) Land consolidation and cooperative farming Land consolidation and joint farming are other ways of promoting greater aggregation in agricultural production and of achieving economies of scale. While governments cannot create new arable land, they can pursue policies to support, consolidate, and intensify farming operations on the land that is still available. Three basic approaches are discussed here: 1) consolidation to increase the average size of farms into viable commercial units, through sale or lease; 2) consolidation to reduce fragmentation of smallholder plots; and 3) cooperative farming where farmers retain ownership of their land but farm it jointly. Several countries have been actively promoting consolidation through sale or lease. Although leasing can be done on an informal basis, formal sale and leasing requires that the title must be recognized. Many countries struggle to provide appropriate registration systems. Despite continued emphasis on smallholders by governments and international agencies, there is a growing view that farmers should be assisted to “move up or move out” of farming. China has been particularly active in promoting consolidation and evidence suggests that this has both led to increased investment for agricultural production and facilitated temporary or permanent migration to urban areas of people who no longer wish to remain on the land. Prior to reforms resulting in the issuance of land certificates that confirmed a person’s entitlement to land, farmers were reluctant to migrate for fear of losing their land access to expropriation. The new system permits sale and lease of land rights. Around 25% of rural households have rented out their cultivated land. Compared with past practices of only renting to friends and relatives, recent transfers have included leases to farmers’ professional cooperatives, as well as private companies. To facilitate land transfer and consolidation in China, land transfer service centers have been set up by local governments. Most of these service centers or platforms have been established at township level and, in some cases, a larger networking platform to pool rental information across townships has also been set up. The main responsibilities of these centers are to: 1) collect information on who is looking to lease out; 2) providing potential clients with information on location, area, major land characteristics, and suggested price of land to be leased out; 3) prepare a formal land contract; and 4) be responsible for contract dispute mediation. In Vietnam, a model called “big tenant, small landlord (BTSL)” has been developed to consolidate small pieces of land into large fields. This involves farmers with small amounts of land leasing out their land use rights to other farmers, cooperatives or commercial enterprises, who then manage larger land areas. Lease arrangements can be anywhere from one to 20 years and the consolidated fields typically range in size from five to 20 hectares. Advantages of the BTSL model include the fact that many 12 younger members of farm families have migrated to urban areas. By leasing out their land elderly farmers can earn a reliable rental income. If younger people do stay they often receive priority for employment on the consolidated farm. Inevitably there are some problems still to be resolved. First, there is often a lack of trust between farmers and commercial enterprises leasing the land and there is no clear arrangement for arbitration of disputes. Short-term lease durations resulting from this lack of trust mean that the party leasing the land will be reluctant to make improvements. Second, land that has been leased and improvements that have been made, such as the construction of a farm building, cannot be used as collateral for bank loans. Third, there are official limits on the amount of land that can be accumulated in this way. Finally, the land is often fragmented into many small plots, increasing the costs of consolidation. Investors have to negotiate with a large number of households to accumulate a significant area of land. If a few farmers don’t wish to collaborate the whole venture is jeopardized as tractors and combines have to work round individual holdings in the middle of a larger farm. In many countries smallholders’ land is distributed among many small fragments, often at large distances from each other. This increases production costs by requiring more time to move between fragments and makes use of machinery almost impossible. A response to this is to restructure land holdings while ensuring that farmers retain the same amount of land. In Uttar Pradesh in India a government program led to field boundaries being straightened and land areas as much as possible being reshaped in rectangular form. This improved ease of cultivation, particularly plowing, and lessened disputes due to unclear border demarcations and encroachments. Unnecessary field boundaries were eliminated, increasing the total area available for farming and saving farmers’ time in moving from one farm to another. In the Dinh Hoa commune of Vietnam, land consolidation has similarly been carried out in order to reduce the number of plots owned by individual farm households, thereby increasing the average size of a plot without changing the total farmland area of each household. This is done with the involvement of the local government and the smallholders. The move has resulted in reduced labor costs and increased mechanization, and has also permitted some restructuring of the irrigation systems. Indonesia appears to have had only limited experience of such land consolidation. The National Land Agency (BPN) carried out a project on 79 ha of urban fringe land in Medan, North Sumatra from 1986 to 1990 but matters were not taken further as necessary infrastructure was not constructed. There is also evidence of collaboration between farmers to carry out farming activities on a cooperative basis. Rice seems to be particularly suitable for cooperative collaboration between farmers. It normally grows in standing water and farmers in a village traditionally share the same water reserves, which leads to a need to cooperate in the management of the common resource and the maintenance of the irrigation system. In addition, paddy farming requires a large amount of labor. To address the shortage of labor supply during planting and harvesting seasons, farmers in rice villages in Indonesia sometimes form cooperative labor exchanges, working on one farm one day and another the next. Joint farming can be done informally, by POs, or through government initiative. An example of informal coordination by smallholders comes from southern Cambodia. A decade ago there was a rapid increase in the use of combine harvesters for paddy. However, this ran into problems in some areas as the combines had trouble accessing fields because farmers were planting different varieties at different times. In order to harvest one farmer’s field a combine would have had to drive over the growing crop of another. To overcome this problem, farmers agreed to plant the same variety at the same time. Not only did this facilitate harvesting but it also led to greater aggregation and the 13 possibility to make bulk sales to buyers. This approach may have been inspired by the Small Farmers, Large Field program in neighboring Vietnam, which buys a lot of Cambodia’s paddy. Under this Small Farmers, Large Field (SFLF) program farmers integrate their small rice areas into one large field. Benefits are said to include greater bargaining power with buyers and input suppliers, an increased use of on-farm and post-harvest mechanization, an aggregated supply of just one rice variety, and improved storage. In some areas being a member of the program is now essential for farmers wishing to become involved in contract farming. Under the SFLF, participating farmers organize themselves into groups, often with assistance from the local authorities. They synchronize their operations by adopting a single rice variety to plant. Instead of operating their own nurseries they establish a group nursery, transplanting and harvesting around the same time, thereby converting their small plots into a large field. This creates favorable conditions for the application of improved technologies such as combine harvesters, and for improvements to irrigation. The SFLF schemes range from formal arrangements, in which farmers set up a company structure and become shareholders, to informal coordination of activities. They invariably involve aggregation of the paddy, with sale to one buyer, with or without contractual arrangements, as well as group purchase of fertilizer and pesticides. Occasionally the enterprise purchasing the paddy also supplies seeds. Studies indicate SFLF farmers have been more efficient than individual small farms and that farmers have higher levels of productivity. The Nepal Agricultural Cooperative Central Federation (NACCFL), which groups over 800 agricultural cooperatives, has launched several joint-farming initiatives, whereby farmers pool their resources, including land, under a central management unit. Neighboring farmers lease their land to NACCFL for 15 years and keep working on the joint plot (about 70 hectares). They are paid according to their work, and also receive income from leasing the land. In the Philippines, the country’s program of Land Reform resulted in the allocation to smallholders of land areas that were too small to farm efficiently. In the sugar sector in 2011 a program called Sugar Cane Block Farming (SBF) was introduced to encourage farmers with contiguous areas to join together as cooperatives or POs so that their land preparation, planting, fertilizer and chemical application, weeding and harvesting could be consolidated to attain economies of scale. A related development is the “one village, one product movement”, which began in Ōita Prefecture in Japan in 1980. Under this, communities agree to produce goods with high added value. The program has been copied by Thailand, India, Nepal and others but seems mainly to have been limited to products that, although of high value, have limited demand. 3. Value chain coordination and aggregation Coordination and aggregation in the value chain requires much greater involvement from all parties than simply organizing the bulking up of products into economically viable quantities, as discussed in section 3. While horizontal coordination is still required, the most important feature of value chain coordination is that it is both horizontal and vertical. Vertical coordination implies that all stages of the chain are coordinating in one way or another. The following situations are examples of coordination.  Exporters coordinate with overseas buyers to ensure that the variety, size and grade of the products they are exporting meets consumer demand and that the products arrive when needed and in the quantities required. In some cases they will also coordinate in order to meet certification standards. With such coordination it is possible for an exporter to supply 14 an overseas company directly, as opposed to the previous common practice of selling through an auction or commodity exchange.  Exporters, in turn, coordinate with producers to ensure that the quantities and qualities they supply meet the overseas buyers’ requirements. This may involve specifying varieties and inputs to be used and, in the case of contract farming, can often involve supplying those inputs as well as providing technical assistance and other support.  Processors coordinate with producers in similar ways to exporters. They often have strict quality standards that are relayed to farmers, and can also be involved with contract farming. Coordination with farmers also involves logistics, as companies need to ensure a regular and manageable flow of raw materials into their factories.  Supermarkets and caterers (e.g. fast food outlets) coordinate with farmers in similar ways, either directly or, more likely, through specialized intermediaries.  Many companies link with smallholders through producer organizations (POs) who function as intermediaries in the vertical coordination between company and farmer. This section differentiates between (1) vertical coordination that involves contract farming (with or without the involvement of a producer organization) and (2) vertical coordination between POs and companies that does not involve contract farming. (a) Contract farming arrangements between companies and smallholders The term “contract farming” is occasionally used to refer to cases where the buyer simply specifies the quality required and the price offered, and the farmer commits to deliver at a future date. Such contracts have little impact on agricultural practices, yields, product quality and income, although in some cases varieties to be grown and other inputs to be used are recommended, without the inputs being provided. Commonly, however, contract farming implies more than this. The important feature of most contracts is that the buyer has an influence on how, when and where a product is produced and harvested, i.e. the buyer is vertically coordinating the chain. Thus contract farming is best defined as “agricultural production carried out according to an agreement between farmers and a buyer, which places conditions on the production and marketing of the commodity.” Although contract farming is not a new concept, its recent expansion can be attributed to, on the one hand, an increasing consumer demand for products of high quality that meet safety and other standards and, on the other, the problems which farms face to supply such products reliably, consistently and on a timely basis. However, in Indonesia, while there is some contract farming for seed rice, as well as for seed corn, poultry, tobacco, oil palm, and aquaculture, expansion of this mode of production seems to have been relatively limited. An exception is the companies supplying fruits and vegetables to the supermarket sector, which places greater importance on food safety and quality than traditional marketing channels. For example, Bimandiri is a specialized intermediary that has developed from being a traditional wholesaler to a supplier of vegetables and fruits mainly to two leading supermarket chains. It encourages farmers to join together in producer organizations and works with those groups to purchase agreed quantities. In the past it supplied technical assistance and credit, in order to assure quality standards and consistent volumes. Now, while continuing to work with the same suppliers it has moved away from playing a close extension role but continues to implement transparent negotiated producer prices and also supports the distribution of planting material to ensure that farmers are planting the right varieties. 15 Types of contract farming There are multiple types of arrangements under which contract farming can be structured. At the simplest level, the company supplies extension and inputs (resource provision) to the farmers including, sometimes, land preparation services, and then deducts the cost of those inputs and services from the final price paid after harvest and delivery. In more complex arrangements the company contracts third parties to supply inputs, etc. Arrangements may also involve banks. For example, a company might have an arrangement where the bank pays the input supplier or service provider on delivery of the service, with the company repaying the loan when the crop has been sold. In a few cases farmers may be expected to obtain loans, which the company repays after the crop has been delivered. Furthermore, companies will usually not want to work directly with thousands of farmers and thus they develop an arrangement with a PO or similar. Such arrangements can vary from one in which the PO is only responsible for logistics and, perhaps, extension, to one in which it purchases the product from farmers and then sells it to the company. The product has an important impact on the nature of the contractual arrangement and the support provided by the company. Seasonal production of vegetables incurs limited risks for farmers and thus often involves a verbal contract and, perhaps, just the provision of seeds. Poultry rearing, on the other hand, requires the farmer to make sizeable investments in housing for the birds, investments that cannot be used for other purposes, and thus written guarantees from the company are essential. In the case of poultry contracts, the company usually supplies all inputs, from day-old-chicks to feed and medicines. There is strict monitoring of the use of the inputs supplied and of the weight gains of the birds. Oil palm is another risky investment for farmers in that if the processor goes bankrupt, the farmer may not have access to another buyer. There is also concern that once farmers have established their palms they are vulnerable to price reductions enforced by the buyer. For this reason, Indonesian Plasma programs have prices set by committees consisting of company, farmer and government representatives. Independent oil palm smallholders do not, however, benefit from the same arrangements. In some cases the company may also carry out farming itself. The importance of this can vary from being the dominant source of production, where smallholders are just an afterthought, to being responsible for only a small share of total production, with the company farm being primarily responsible for research. This nucleus estate or Plasma approach is usually found in oil palm production, for example. Contract farming where companies also have their own farm arguably has a better chance of success as the companies are able to appreciate the production difficulties facing smallholders and are also not totally dependent on smallholders for their supply. Having its own farm also suggests that the company is making a long-term commitment and is not just a “fly-by-night” operation. However, in many countries land for estate production is not available. In most cases contract farming involves the establishment of an entirely new operation and new product for a locality. A company seeking supply of a particular product will work with government officials and local communities to identify interested farmers with the potential to be involved in a contract to produce it. However, in some cases contract farming involves existing producers of a product being asked to make changes to their production systems, while still growing essentially the same product. For example, paddy farmers may be invited to become producers of rice seed or of aromatic varieties for which there is a specialized market (see below). Contract farming is also used to achieve conversion to organic production. Less common examples of contracts being introduced for existing production include Laos where wild tea gatherers, who used to sell in open markets, were 16 offered contracts for both forest-gathered tea and planted tea under a scheme where the company provided resources and training. In the country of Georgia, hazelnut farmers were offered contracts by a leading producer of chocolates, in which the company provided orchard management advice so that price premiums could be obtained for farmers’ crops. Benefits of contract farming For companies, the main advantage of contract farming is that smallholders have land. Moreover, in the case of crops or livestock that depend on intensive care during the growing season or rearing cycle, farms relying on family labor are often more efficient performers than larger farms that depend on casual labor. Indeed, in some cases companies have leased land to smallholders, providing that they use it for agreed purposes. Contract farming can also reduce companies’ operating capital requirements as they only have to pay farmers when the crop is delivered, whereas laborers on estates have to be paid all the time. Although yields are, of course, variable and there is sometimes a danger that farmers may sell outside the contract, contracts with smallholders mean that companies can be more confident about their supply than if they were dependent on independent farmers. This may give them the confidence to make the necessary investments in processing equipment. Reliable supply is essential when companies have sales contracts to fulfil or processing facilities need a high capacity utilization to be profitable. Contract farming is growing in importance where companies have to comply with international standards and traceability, as this cannot be done without close monitoring of production to ensure smallholders comply with all requirements for certification. Provision of extension services also enables companies to monitor how farmers are performing. For smallholders, contracting reduces the risk of being unable to sell their products at harvest time or having to sell at a low price. It can help overcome the problems of lack of finance and shortage of input supplies, as inputs are usually supplied under the contract. It can also provide access to extension advice from the company. Problems and solutions Inevitably there are problems with contract farming, as well as advantages. First, the company may lose its market or the price of its products may go down. The former is more likely with competitive export markets, where, for example, a company suddenly finds it is unable to compete with a new market entrant from another country. The latter is more common with products traded as commodities, such as palm oil, where world prices can fluctuate considerably. Such problems cannot always be foreseen but they do illustrate the need for good market research before setting up a contract, both by the company and by farmer representatives. Additional problems and possible solutions include the following. Smallholders may be tempted to sell outside the contract (side selling), particularly when open market prices are higher than the contracted price or when competing buyers pay more rapidly than the contracting company. Depending on the crop there are multiple ways for companies to minimize the side-selling problem, including by accepting that it is going to happen and permitting farmers to sell some of the production to other buyers. Companies can resolve the payment problem by ensuring that payment takes place on delivery, or soon after. Although quality specifications must be included in the contract, these can still cause problems when they are not sufficiently specific. It is important that farmers or their representatives are present when produce is graded. For example, there are numerous grades for tobacco. In a tobacco contract farming 17 operation on Lombok, the farmer is present when the tobacco is graded and the extension worker who works with that farmer is also there. Where there are disagreements these are usually resolved amicably after discussions between the grader, farmer and extension worker. Farming systems will change as a result of contracts, particularly when new crops are introduced. Smallholder families may face problems in carrying out harvests and other farm activities. They may have no surplus cash to recruit laborers and laborers may, anyway, be in short supply. Alternatively, smallholders may pay laborers less than the legal minimum. Food production may suffer as a result of a concentration on the contracted crop. Decisions on contracts may be made by the men in a community, while women may end up doing much of the work, and at the same time losing access to their food gardens. It is therefore vital that these issues are addressed from the outset by the contracting parties, possibly with government support. Monoculture should be avoided and companies should encourage diversified farming. Not all farmers are suitable for contracting, whether working directly with companies or through POs. In choosing farmers, companies are first likely to consider factors such as agronomic suitability of the land; climate, pests and diseases; the location of the farm; and suitability of infrastructure such as roads, electricity and communications. Having selected the locations where they want to work they will then carry out a further selection of suitable smallholders, using criteria such as farmers’ assets and access to finance (e.g. to pay laborers); their capacity to meet market requirements (e.g. their ability to follow cultivation instructions), and the amount of land they have available. However, as the best land is usually densely populated, companies will inevitably end up working with farmers with small land areas, even if that is not their preference. There appears to be much fluidity in smallholder involvement in contracts, at least for seasonal crops, with farmers working for one company in one year and another the next. Companies should also meet certain criteria and smallholder representatives or governments should carry out “due diligence” to minimize risks of signing contracts with unsuitable buyers. While it is unrealistic to require all companies to have had previous contract farming experience, it is desirable that some of their employees have had such experience, as poor managers can jeopardize success. Research suggests that the main factors leading to successful operations were the prior strength and capabilities of lead firms. Where these were well-managed, had ample finance and had a competitive position within domestic or international markets, it was possible to have reasonable success with upgrading smallholder production. Company managers have to be able to ensure on-time delivery of good-quality inputs and also need to be able to develop harmonious working relations with farmers. Efforts to establish contract farming may fail if the buyers make little effort to understand both the agricultural practices and skills of the farmers and their socio-cultural environment. A common difficulty is that companies often have unrealistic expectations of the yields that can be achieved by smallholders and thus promise farmers a much higher return than will prove possible. Contract farming is much more likely to succeed where the so-called “enabling environment” is suitable. This means that political, legal, and financial factors must be supportive of both the private sector and of the contract farming concept. There must be a strong political understanding of contract farming but, unfortunately, there have been international examples of both national and local politicians seeking political advantage by encouraging farmers to break their contracts; Evidence suggests that farmers can easily handle small-scale changes to their farming practices but that more rapid changes to the technology adopted can cause complications. The conclusion is that changes need to be introduced on a step-by-step basis over a number of years. 18 Contract farming works better for some crops than others, generally being more common for crops that are of high value, difficult to grow, perishable, requiring prompt processing (e.g. oil palm, tea, sugar cane) or subject to strict standards. It also seems to work better when there are few alternative markets for the smallholders, thus limiting the chances of side selling. In the case of vegetables, contract farming is usually less risky for a company when it is working with farmers on crops for which there is little local demand (e.g. Kenya exports to Europe large quantities of green beans and flowers grown under contract; neither of these have a big market in the country) or on specialized products such as organic crops, for which the company is able to pay a premium. Poultry contracts have also generally been successful, given the high level of interdependence between the parties. Many crops that require processing in specialized facilities have lower side- selling risks. For example, oil palm yields only about 24% palm oil and palm kernel oil and for this reason processing facilities are situated close to the farms. Transport costs would usually make it unviable for a competitor to drive long distances to buy oil palm from farmers contracted to another company. Governments can take a proactive approach to contract farming by assisting companies to identify suitable farmers. Inadequate land tenure laws provide smallholders with no incentive to make long- term investments and land tenure laws may need to be reviewed. If producer organizations are to be involved with contract farming then rules governing them are necessary and their legal status must enable them to trade. A strong banking environment is essential if companies, service providers and farmers are to be able to finance their activities. Contract farming for rice Experience to date suggests that rice and other staples are not really suitable for contract farming. Because they can obtain supply from multiple sources, companies have limited incentives to try to introduce contracts for standard varieties for which there are no quality specifications and multiple buyers. The main examples of where contract farming has been used for rice relate to varieties that can command a premium on national or international markets, such as aromatic varieties and organic rice.6 There are several examples of contract farming for rice in Cambodia. It was first introduced by a company that exported an aromatic variety. The company worked with farmers in four provinces, which were selected on the basis of their suitability for the cultivation of the variety. At one time there were 87,000 participating farmers. After identifying suitable areas the company established farmer associations and used these to recruit farmers. Resource provision was limited to the provision of seed, with farmers paying for the seed at harvest time by supplying the mill free of charge with the same quantity of paddy. The associations were responsible for monitoring production progress by their members and reporting back to the company. Each association also provided basic technical advice. A review concluded that the associations were a good model for community-based agricultural development but also noted that there was a tendency for farmers to move out of the contract as they became more experienced in applying the lessons learnt, suggesting that the contract provided them with relatively few benefits. Another company in Cambodia has worked with 2000 farmers to produce organic rice. Support has been provided by the French Development Agency (AFD) to implement contracts through agricultural cooperatives, which are responsible for organizing the farmers. A well-structured process is used to set up the contracts, involving a business-matching workshop to bring the company and cooperatives together, followed by contract development and negotiation, agreement and endorsement by the 6 Although one academic paper reports on a successful program for standard rice in Benin, West Africa 19 ministry of agriculture, implementation of the contract and monitoring and evaluation. The contracts do not involve financial support or input supply but the company provides technical support and training, transport for the paddy, and bags that are marked to ensure identification of the individual farmer. The price paid is based on a formula involving the maximum price paid at three local rice mills in the previous week, together with a premium to reflect the fact that the rice is organic. A third Cambodian company has been planning a similar arrangement, illustrated in Figure 3. However, in this case the European buyer for aromatic rice has already been identified and certification of the farmers, the cooperatives and the mill by the Sustainable Rice Platform7 is required. Another feature of the plan is that a Bank would lend to farmers through the cooperative, with the existence of the contract serving as collateral for the loan. Figure 3: Rice contract farming system proposed for Cambodia Due to rapidly growing costs the Vietnamese rice sector is now less able to depend on cost competitiveness to compete on world markets. As a result some of the leading milling companies have been looking to increase production of high-value rice, and contract farming is being introduced as a way of guaranteeing supplies of such rice. A particular problem in the Vietnamese rice sector is the lack of varietal purity, which seems possible to address only through the vertical coordination that can be achieved with contractual arrangements. Many larger rice-sector companies are joint-stock companies in which the government still has a share. All of these are now carrying out some form of contract farming, following government instructions. A common practice in Vietnam seems to be for companies to start by using a simple marketing contract as the basis for establishing good working relationships with farmers. Under these contracts no inputs are supplied but farmers are advised which inputs (including seeds) should be used if they want to sell to the company. A marketing contract is a less costly business model for rice buyers since they do not pre-finance the farmers by providing inputs. However, a marketing-only contract does not allow companies to govern the production process as efficiently as would be required to market certified rice or to provide quality guarantees. Thus companies are increasingly moving towards input 7 http://www.sustainablerice.org/ 20 provision, although the extent of the inputs provided varies from just the seeds to seeds, chemicals and fertilizer. Companies have found that where all inputs are supplied it becomes easier to request farmers to change the variety grown, in response to market demand. AGPPS is a joint-stock company in the Mekong River Delta. The Government of Vietnam holds a 26% share. The company initially started as an agricultural services supplier, subsequently expanding to incorporate milling and wholesaling into its business model. Through partnerships with leading agrochemical and fertilizer companies it is able to offer attractive input packages to farmers, who also benefit from input price discounts. Farmers also have access to credit and to transportation services and receive free technical support. Being part of the Small Farmer, Large Fields (SFLF) program, described earlier, is a pre-condition for working with the company. AGPPS buys fresh paddy after harvest and threshing, providing bags for the paddy. The experience of PepsiCo in India, described in Box 8 suggests that management flexibility and adaptability to the enabling environment can be conducive to successful contracting for rice. Box 8: Basmati Rice Contract Farming in India Having carried out contract farming for other crops in India, PepsiCo saw an opportunity to expand into Basmati rice in the late 1990s by contracting smallholder farmers in the state of Punjab. This was accomplished by focusing on areas not yet well-developed for Basmati rice production. The firm provides farmers with improved seed varieties, technical expertise and training, and then commits to buy back the crop at pre-announced basic prices. As a consequence of outdated laws that require all produce to be sold through regulated markets, farmers sell their products not to the company but to market commission agents with whom PepsiCo has an agreement. Purchases are also made from independent farmers but contracted farmers benefit from guarantees by the firm to buy their products through the agent and from rapid payment, which is not available to the independents. The example well illustrates the importance of location in choices made by companies of where to work, as few farmers in the areas chosen by PepsiCo had the opportunity to market Basmati independently of the contract. Source: Da Silva and Rankin 2013. Contract farming for rice in Indonesia seems to be limited. P.T. Pertani, a seed producer, provides smallholders with free foundation seed and with extension advice. The farmers must deliver at least 75% of their paddy production to the company for use as seeds but can sell the remainder for seeds or consumption. Drying is done by the company. Company employees carry out visual inspections of the fields prior to harvest and reject about 15% as being unsuitable for seed production. The paddy from those areas can be sold by farmers for consumption purposes. The price paid by the company is reportedly only around 50% of the market price for paddy but this is accepted by farmers in view of the benefits of working with P.T. Pertani. One milling company also experimented with contract farming for an aromatic variety, but could not achieve the necessary commitment from farmers. Implementing contract farming Parties involved in contract farming should generally be free to draft their contracts as they see fit, based on the principle of freedom of contract. However, this has to be within the context of national laws that apply to all contracts, whether used for agriculture or for other purposes. Smallholders should be able to form an opinion about a contract on the basis of having received all information necessary to do so. However, they will usually lack the skills to carry out a full market assessment or a 21 due-diligence review of the company. There may be thus a need for an independent body to assist farmers with this in order to reduce their risks. Recent work by UNIDROIT8, FAO and IFAD provides excellent recommendations on the legal aspects of contract farming. As with any other type of contract, the role of government is to ensure that the necessary regulations are in place for the contract to work properly. Governments should, however, avoid trying to dictate to companies the terms of a contract, such as the price to be paid. In order to offer some protection to farmers, long-term contracts are essential when longer investments are made but informal agreements may be adequate for seasonal crops. Some government involvement may be necessary in monitoring long-term arrangements, such as for oil palm, but it is generally considered that government supervision is not required for seasonal crops. There is no doubt that governments and donors can be of considerable assistance in facilitating linkages between companies and farmers. They usually assume active facilitation roles in areas such as coordinating farmers and matchmaking between buyers and producers when a contract farming operation is in the planning stages. They can also play a conflict resolution role. However, several considerations are relevant here. External support may provide the chosen companies with an unfair competitive advantage over others. Thus the support provided should be relatively limited and should concentrate on aspects such as group organization and trust development, avoiding direct subsidies to operations of the companies. This recommendation also has implications for sustainability of interventions: the model followed by such external assistance often cannot be maintained once the assistance is no longer available. Collaboration with government and development agencies makes sense for the private sector when it has few costs to bear, but subsequently taking on those costs itself may not represent a sustainable business model. Governments often lack a commercial focus and may see their intervention as being mainly targeted at the poorest rather than those most able to benefit from contract farming. This can cause conflicts with the company. It is generally agreed that not all farmers can be involved in contract farming, for reasons such as their location, farm size and natural resources; their capacity to meet strict product standards; their cash reserves; and their level of risk aversion. Although efforts have been made to promote poor farmer “inclusion”, that approach does have its limitations. Companies need to recognise that developing contract farming cannot be done overnight. It takes time to develop the trust between farmers and buyers that is essential if contract farming is to be successful. The existence of trust depends on a variety of factors. It is easier to achieve in some cultures than others; and it is more likely when there have been pre-existing trust relations (e.g. a processor who has had good trading relations with farmers for a long time will find it easier to develop contract farming than a total outsider). However, the main factor seems to be the level of communication that takes place between the parties. The role of outsiders in supporting this communication can be particularly important. In the case of contract farming, regular meetings between buyers’ representatives and farmers are essential. Wider coordination within a sector can be developed through multi-stakeholder approaches (see section 5). (b) Vertical coordination between farmers and companies through POs, without contract farming This type of vertical coordination describes transactions involving producer organizations, through which smallholders are enabled to more effectively respond to market demand. Although it often 8 International Institute for the Unification of Private Law https://www.unidroit.org/ 22 shares some characteristics with contract farming, the support provided by companies is largely limited to advice on varieties and qualities required rather than the physical provision of inputs and other assistance. Also, in many cases the initiative for the linkage comes from the PO, rather than from the company. Many of these linkages have been developed through donor programs which, while ensuring full involvement of the private sector, tend to place the greatest focus on POs. Productive alliances The productive alliances that have been promoted for POs by the World Bank in Latin America involve three core actors: a group of smallholder producers, one or more buyers, and the public sector. The approach aims to promote horizontal alliances among the producers as well as a vertical alliance between the producers and the buyer(s). These alliances are usually initially supported through grants from the World Bank. Although implementation varies according to the country, grants primarily fund technical assistance aimed at reducing risks for the buyer and facilitating activities to develop trust between the parties. Grants also co-finance infrastructure and equipment, such as warehouses and irrigation. A business agreement is signed between the agency in charge of project implementation (e.g. a ministry), the commercial partner, a service provider, and the PO. Over 3,500 such agreements have been reached since the inception of the program, which now covers ten countries. The philosophy underlying the program is that smallholders have been limited to selling in less- rewarding markets owing to the small scale of their production, high transaction costs, and inability to provide goods of consistent quality. Productive alliances aim to address these weaknesses by promoting linkages between organized producers and at least one buyer. The agreement developed specifies product characteristics, such as varieties to be grown; the quantity to be purchased; production methods; and logistical arrangements such as how and when the product will be delivered; as well as ways in which the price is set and payment made. It also indicates any contributions of the buyer, such as input provision and technical assistance. As a first step, an information campaign is conducted to raise awareness among POs. This is followed by the issuance of a call for proposals, which is often made by the agriculture ministry. POs start the process by preparing basic business plans, which are evaluated against strict predefined eligibility criteria, thereby minimizing the risk of political interference. If chosen to be taken further, a proposal is developed into a more detailed plan, usually with the help of a Business Development Service (BDS). From the beginning the plan should indicate the commercial partner. Following final funding agreement, World Bank funds are transferred to the PO in instalments, which are paid on receipt of evidence that the previous instalment was used as intended. The World Bank grant is expected to be matched by contributions from the PO and the buyer (in the form of technical assistance and inputs) and, possibly, funding from public institutions and bank loans. The average size of farmer group POs has been around 50. About one-third of the alliances have broken down after World Bank support ended but the intervention was nevertheless considered beneficial in that members of the groups developed their technical and managerial skills and in some cases had been able to access financial institutions for loans not previously available to them. Benefits have been noted in terms of increased production and sales and higher quality products purchased by the buyers, leading to increased income for farmers as well as the generation of on-farm and non- farm employment. In addition to receiving improved supplies, companies have benefitted from an enhanced reputation as a result of working with local communities. 23 In some cases farmers have been unable to maintain the stringent quality requirements of the buyers. Other problems experienced are rather similar to those discussed in relation to the role of POs in aggregation and contract farming. There have been weaknesses among the POs, including failure to communicate with members, poor management, inability to manage conflicts, and a lack of social cohesion within the organization. Lack of management skills is perhaps inevitable when the groups are relatively small. Only much larger POs can afford to employ full-time managers. As with contract farming, the productive alliance approach is not really suitable for the poorest smallholders. Projects generally have targeted “transitional smallholder producers” who lack well- established linkages to buyers and markets but have the willingness and capacity to engage in modern markets. To be considered, smallholders must already be engaged in market-oriented production and have the potential to generate income and jobs. Lessons learned from early operations include the need to involve financial institutions from the beginning. However, while projects have aimed to enhance smallholders’ access to commercial finance these efforts have rarely been successful. The reasons for this include low coverage of financial institutions in rural areas, lack of collateral available to smallholders, and regulatory issues that prevent financial institutions from making loans to groups. A further lesson has been that more emphasis should be placed on achieving project sustainability when project funding comes to an end. The levels of grant support and co-financing have varied considerably. Experience suggests that sustainable outcomes are more likely when a minimum of 30% co-financing is required from beneficiary producers. Normally, producers are required to only make in-kind contributions but there is evidence that cash contributions encourage greater commitment on their part. A similar World Bank project in Vietnam aimed to catalyze smallholder - agribusinesses linkages. The main instrument used for this was to support farmer group investments through matching grants that initially covered 40% of the eligible investment. POs were required to finance the remaining 60%, in part to emphasize the project’s focus on competitive smallholders. However, smallholders proved unable or unwilling to do this, which caused delays to project implementation. An evaluation of the productive alliance program concluded that the individual projects should not end once the funds have been disbursed: long-term advisory support is also required. In the case of productive alliances one problem seems to have been the small size of many business partners, who lacked both the resources and business acumen to continue the arrangements. Measures to ensure continuity of business relationships include improved assessment of buyers and their market competitiveness; provision of brokerage services for POs that outgrow their existing arrangements with buyers to enable them to find new partners; and an increased attention to linking with larger buyers outside the local area. Experience has thus shown a need to conduct a more detailed assessment of the capacity of the parties involved, both POs and companies. Targeting financially and commercially strong buyers and ensuring their commitment to an alliance is critical. To date, very few projects have established strong eligibility criteria for buyers. A further area of concern is the use of so-called Business Development Services (BDS) to support development of business plans and the ongoing implementation of activities. BDS are often established by donors and also experience problems with sustainability. Most such companies rely on donor projects for the bulk of their work and few have been able to attract sufficient business from the private sector. Moreover, organizations making use of business plans developed by BDS often find that the work done is inadequate. 24 Public-private-producer-partnerships (4Ps) The 4P program has been developed by the International Fund for Agricultural Development (IFAD) and aims to forge linkages between smallholders and small-and-medium enterprises (SMEs). Like the productive alliances program, it is based on the idea that there are new market opportunities that local agribusiness companies are keen to exploit but face difficulties in doing because of poor linkages with farmers. Thus IFAD defines 4Ps as involving “cooperation between a government, business agents and small-scale producers, who agree to work together to reach a common goal or carry out a specific task while jointly assuming risks and responsibilities, and sharing benefits, resources and competencies”. Its main characteristics are: Involvement of the private sector in IFAD’s project design;  Selection of the private-sector partner through a rigorous process that ensures transparency and objectivity, while meeting the project’s social, economic and environmental objectives;  An active role for producers in negotiating partnership arrangements;  Sharing of benefits and risks. Private-sector partners are expected to allocate matching financial resources;  The 4P should be an entry point to scaling up project results through additional private-sector investment. IFAD stresses that partnership opportunities vary considerably across countries and commodities, and thus significant variations can be expected in the approach adopted. For instance, partnerships where there are multiple private-sector buyers are likely to be different from those in remote areas where there is only one buyer. The competitive process to identify viable 4Ps entails a call for proposals for interested private-sector companies or POs to prepare business plans. Funding from IFAD is primarily targeted at financing part of the public-sector investment but may also provide (through governments) seed funding such as matching grants for business plan implementation. IFAD in Vietnam has operated a similar program, Co-investment with Enterprises and Farmers, in several projects. This includes the provision of Competitive Business Grants to SMEs and cooperatives that are awarded based on a competitive and transparent process, and must be matched by a significant contribution from grant recipients. Activities supported have to be consistent with the objectives of the particular IFAD project. In addition to the grant the project supports improved SME or cooperative management, business planning and business linkages, as well as activities to improve the quantity and quality of the primary produce procured from the farmers. Thus the grants are made within the context of a vertically coordinated chain and could be used, for example, to construct village-level storage to facilitate aggregation of raw materials to be delivered to a processing facility. (c) Some additional observations There are a number of common threads running through academic research on agricultural value chain coordination, much of which has looked at interventions involving producer organizations. The first is that the approach adopted by governments, donors, etc. should not be based on “one size fits all” but must be adapted to the context. Further, there is a need to recognize that smallholders cannot change their practices overnight and need time to adapt to more demanding requirements, such as those involved in meeting certification standards. Thus developments should be conservative and ensure that realistic changes in farmer production systems are being proposed. Where possible, changes should align with existing farmer practices and should be the minimum required to achieve yield quantity and quality improvements. Evidence suggests that projects that promote many changes in production practices or try to encourage production of a new crop achieve far slower adoption rates. 25 A further concern is that donor countries look at projects from their own cultural perspectives and from the technical interest of the specialists who formulate programs. A consequence of this is a preference to work with smallholders to develop their export capacity, particularly to supply niche markets, rather than to support domestic market development. However, export market access is complex and often expensive, particularly for the horticultural sector. While export markets can superficially seem profitable, projects often do not adequately analyze in advance their profitability for smallholder farmers. Compliance with standards is increasingly complex and expensive and in many cases is only viable with government or donor assistance, with donors effectively subsidizing overseas consumers rather than the farmers. Governments should therefore consider redirecting donor assistance away from promotion of export production and towards strengthening domestic market access, as pushing smallholders and small companies in the direction of exports may be diverting them away from more remunerative and sustainable commercial opportunities. 4. Other developments contributing to successful aggregation and coordination The success of aggregation and coordination activities can be enhanced by the availability of various other services that contribute to a positive environment that encourages aggregation to be carried out. This section discusses the use of warehouse receipt finance and other value chain finance, as well as the increasing importance of Information and Communication Technologies (ICTs). Finally, the section considers the role of Multi-stakeholder Platforms (MSPs). (a) Warehouse receipt finance (WRF) If the private sector, POs and even individual large farmers are to increase the level of aggregation of non-perishable products they need to have storage facilities. They also require a way of monetizing stocks, as few have the resources to hold large stocks for any length of time without access to finance. It is a desirable business practice for a processing company, such as a rice miller, to maximize its throughput by ensuring that it has adequate stocks to keep its factory going year round, but finance is essential for this. Warehouse Receipt Finance (WRF) involves the storage of products in good quality warehouses, such that banks will be prepared to make loans using the warehouse receipts for the stored goods as collateral. Normally banks will not lend the entire value of the stored products as they need to cover themselves against price declines, in-storage weight loss and quality losses. Crops can be stored in two ways; either by retaining the identity of the depositor or by mixing up all deposits, a practice known as “commingling”. Commingling results in a more efficient use of storage space for products in bags and, where appropriate, enables the use of silos, such as for maize (corn). Warehouse companies must clean and grade products before putting them into store, ensuring they meet minimum standards. Such standards are essential if the warehouse receipts are to be negotiable. Commingling is easier for maize than for paddy given that the former is a more standardized product, while paddy rice has multiple varieties. While storage is normally carried out in certified warehouses that are qualified to issue warehouse receipts, it can sometimes be done through arrangements where the lender or its agent ensures that the grain is kept in good condition under lock and key at the borrower’s premises. This was the practice in the Philippines under the Quedan program, where the Quedan Corporation would guarantee loans by banks to rice millers against paddy held in separate warehouses on the miller’s premises. The warehouse locks had two keys: one held by the miller and the other by the bank. The finance obtained 26 by millers in this way enabled them to buy an increased share of the paddy crop at harvest time, which had several benefits: (1) increased purchases at harvest reduced seasonal price fluctuations; (2) mills were able to guarantee their throughput; (3) the loans could also be used to provide finance for farmers, so locking in supplies of their crops for the following season; and (4) the standard of storage at mills was generally better than that otherwise available to farmers, thereby reducing post-harvest losses. In order to lend to depositors against the collateral of a warehouse receipt banks need to have the staff with the required knowledge of agriculture to enable them to do this. In developing countries there has been some reluctance of banks to become involved, but the concept has been enthusiastically embraced in other countries, such as those of the Former Soviet Union. Additional components of such a system may include an indemnity fund, made up of contributions from the warehouses, to cover them against losses resulting from malpractice and other factors. This provides additional protection for both banks and depositors. Governments can play an important role in promoting WRF through passing legislation to govern the issuance of warehouse receipts, permit warehouses to take deposits, make provision for warehouses to be registered, ensure that the receipt holder has title to the deposit, and permit the operations of a certification agency. Governments also need to ensure that their actions do not jeopardize the potential success of WRF. A classic example of what can go wrong comes from Thailand’s former Paddy Pledging Program, as described in Box 9. Box 9: The dangers of political interference Thailand’s Paddy Pledging Program was originally set up as a form of warehouse receipt finance for smallholders, although it did not actually require them to obtain a bank loan. Farmers could deposit their paddy in state warehousing corporation stores and receive a loan payment representing the full value of the grain deposited. If, after three months, the market price had gone up, they could redeem the stocks by paying back the sale price and then sell the paddy on the open market. If prices had gone down farmers could just decide to leave the grain with the corporation. This was, for a time, fairly successful. Difficulties were experienced with matters such as the quality of the deposits, but these were considered manageable. Until around 2000, total pledges rarely exceeded 10% of the crop. However, from that time the scheme began to be subject to significant political interference in the price paid and the role it played in Thailand’s rice market grew rapidly, particularly in 2008 and 2009 during the period of rapid world rice price increases, when the pledging price was significantly in excess of the market price. Although the price paid to farmers was reduced in 2009, there was significant farmer opposition to any further reductions. Following the 2011 Thai elections further increases were announced as a way of subsidizing farmers who had, in the main, voted for the victorious party. The consequence was that the government found itself with large stocks worth far less than the price it had paid for them, while exporters were unable to meet contracted orders because they could not obtain any rice. Moreover, the government’s reluctance to sell the rice at a loss meant that it was kept in storage too long, with consequent losses in quality and quantity. The significant financial losses caused by the political use of the scheme are the subject of ongoing criminal procedures against the Prime Minister of 2011. Attempts have been made to introduce warehouse receipt finance in Indonesia. The country started implementing a regulated warehouse receipt system in 2008, with technical assistance from the IFC, but although there has been some progress the level of adoption has been below expectations. A regulatory system and warehouse receipts registry have been established, and potential users of the 27 system have been familiarized with its potential, including three banks that started to lend against stored collateral. A small number of warehouses have achieved substantial levels of operation. However, the system as currently designed is subsidy-dependent, lacks sustainability, and experienced a major decline in usage in 2015. This has been attributed to factors such as a failure to fully research the markets for the commodities being stored; a widespread misunderstanding of the purpose of warehouse receipt finance; insufficient consultation with the private sector; an over-complex support structure; and insufficient action to minimize the risk and impact of warehouse fraud. WRF in Indonesia has been targeted primarily at smallholders, with the aim of having them avoid selling their crop immediately after harvest and instead depositing their products in licensed warehouses, many of which have been constructed as part of the program and are now owned by regional governments. Interest rates for smallholders are heavily subsidized but these subsidies are not available to the private sector. Ten commodities are eligible for storage: paddy dominates, followed by rice and maize. Most of the warehouses, which each have a capacity of around 1500 tons, are operated by state-owned enterprises (SOEs) and financing is provided by state-owned banks. So far, warehouse receipts have been used only for collateral and they are not negotiable. The program presently seems to be primarily used as a smaller version of Thailand’s now-discredited Paddy Pledging Programme (see previous Box), with the main benefit to smallholders being the ability to access low-cost loans. However, in a few locations (e.g. Cianjur) the system is being well used by millers to access loans for operating capital in order to increase their milling throughput through greater aggregation. This should be encouraged as a potentially useful contribution to the essential upgrading of the milling sector. (b) Other approaches to value chain finance Much of the finance within value chains originates with those participating in those chains. In traditional marketing systems, rice mills in Asia provide loans to farmers, which is more of a way of guaranteeing supply of paddy for the following year than of making money from interest charged. Similar arrangements also exist in the fruit and vegetable sector, with traders who lend to farmers often being funded by wholesalers in urban markets. Contract farming is a further way in which farmers can be financed by the chain. However, in order to lend money to smallholders in this way, companies, wholesalers and millers themselves require finance. Banks are reluctant to lend to the agricultural sector. In some ways this is understandable as agriculture is a risky business, subject to the vagaries of climate, price fluctuations and, occasionally, political interference. A leading banker in Africa was quoted as saying “10% of our loans are to agriculture but 90% of bad debts come from that sector,” and he was probably not exaggerating by much. Banks should develop loan products that fit in with agricultural seasonality and the time taken for crops to become mature. Most loans for other sectors involve repayment beginning almost immediately, but farmers often cannot repay short-term loans until harvest and investing in tree crops involves a wait of several years before revenue is generated. (c) Information and communication technologies (ICTs) Modern information and communication technologies (ICTs) are playing an increasingly important role in value chains. At the simplest level the fact that most farmers now have access to phones means that they can call buyers to check on the price before making a decision to harvest or to transport the produce to a buyer. This should lead to their being able to obtain the best available prices and avoid harvesting perishable produce for which there is no buyer. It also reduces the transaction costs involved in finding out the price, such as by making a trip to the local rice mill. Research in Bangladesh, 28 China, India and Vietnam found the 80% of farmers had mobile phones and one half of those had used those phones to reach deals with buyers. Governments and some companies have for decades been providing agricultural market information services (MIS) that utilize ICTs. That offered by Departemen Pertanian has been one of the best. Some years ago it introduced an arrangement whereby farmers could buy inexpensive smartphones with the MIS App. already installed. Some organizations have gone a step further than just providing price information. In West Africa a French NGO has set up N’kalô, which offers both farmers and traders a “prospective analysis”: an impartial analysis and forecast of supply, orders and demand. Sharing this with both sides means they can both make decisions based on the best available information. Some companies, such as MasterCard (see Box 10), have developed software to enable “market matching”; through which farmers can indicate what they have to sell and buyers what they want to buy. However, it should be noted that ventures of this type have yet to develop viable business models. ICTs reduce the costs of coordination and transport and increase transparency, so reducing the potential for mistrust between partners. For instance, oil palm smallholders may accuse companies of exploiting them when the Fresh Fruit Bunch price is reduced. Their anger may be reduced when they can check world market prices on their phones to confirm that the world palm oil price has also declined. In Indonesia, the cocoa exporter, Armajaro, sends daily mobile phone text messages containing cocoa market price information to its farmer group leaders. Box 10: Matching smallholders to buyers by cell phone MasterCard has introduced a mobile application, 2Kuze, which directly connects smallholders with buyers. Providing farmers with greater market access should increase their returns, and the sales record contained within the database will help them apply for loans by allowing them to demonstrate a sustainable revenue stream. 2Kuze, Swahili for “let’s grow together”, was introduced in Kenya in January 2017, with an initial 2,000 farmers, 27 medium- to large-scale buyers and 100 small-scale buyers. Developed at the Mastercard Labs for Financial Inclusion in Nairobi and funded by a grant from the Bill & Melinda Gates Foundation, the platform is designed to reach the 80 percent of farmers in Africa that are currently classed as smallholders. The 2Kuze platform makes it possible for farmers to conduct the entire transaction of selling produce and receiving payments via their mobile phones. This builds on Kenya’s pioneering success with using mobile phones for payments and money transfers under M-Pesa. The concept aims to mirror as closely as possible existing trading practices and to cover the full process of buying and selling produce. Producers and buyers are first registered on the system by appointed agents. Prospective buyers then log purchase requests via text message, indicating quantities required and the price offered. Farmers are able to respond directly to the potential buyer. Both parties then negotiate the sale price. If a deal is reached, an agent is deployed to the farmers to collect the produce and transport it directly to the purchaser. Money is transferred to the farmers through their preferred method: mobile money, bank transfer or cash paid by the 2Kuze agents. Although 2Kuze has been developed with Africa in mind, MasterCard hope to eventually introduce the platform in other parts of the world. As it was introduced less than two years ago there has, to date, been no formal evaluation of how it works in practice. Source: MasterCard. 29 ICTs are also used for product traceability, which is essential in modern value chains in order to identify the source of any food safety or quality problems. Smartphone Apps are increasingly being used to supply information to smallholders on weather, pests and diseases, and farming practices. The use of videos that farmers can watch on their phones is a growing practice. For instance, in India Digital Green makes available 6000 videos for download. Thus smartphones are beginning to replace traditional extension services. However, the commercial profitability of such services remains unclear and they may not be available to poorer farmers who cannot afford phones. Contract farming companies use phones to remind farmers (or farmer leaders) of actions to be taken in the field and to schedule harvest and collection. They have also been used for direct marketing where farmer groups supply fresh fruits and vegetables (usually with particular characteristics, such as organics) directly to consumers, who order online. (d) Multi-stakeholder platforms Also known as innovation platforms, multi-stakeholder platforms (MSPs) are increasingly seen as promising vehicles to promote agricultural development. MSPs bring together stakeholders working in different stages of a value chain, as well as government and civil society representatives. Depending on the issues at stake, meetings can include farmer, trader, processor, exporter, retailer, civil society (e.g. NGOs), bank, government, research, and extension representatives. Through their interaction and participation, participants become aware of their different interests, needs and objectives, but also of their interdependence. They are more likely to support the implementation of innovations (e.g. improved methods of coordination) when they have been part of the development process. Multi-stakeholder meetings can be organized in order to identify innovations needed to improve a chain or to get broad agreement on whether to proceed with a proposal put forward by one actor in the chain. In the case of the former, meetings could be called to discuss infrastructural constraints, such as irrigation problems, poor roads, or the need for a new market. In the latter, such meetings could address the proposal by a company to start a contract farming operation or to discuss whether to apply for grants being offered by a donor to upgrade a chain. Either way, it is important to build on initial meetings by ensuring they become regular events, even after the initial question has been resolved. This requires one organization (e.g. the ministry of agriculture) to take responsibility for calling meetings and taking minutes. Over the past decade, there has been increasing enthusiasm regarding the potential role of MSPs in developing countries. However, bringing together diverse groups of stakeholders in a platform will not automatically lead to innovation or scaling and MSPs have also been reported to fail in delivering their objectives. A contributory factor may be that not all stakeholders are organized to be able to send representatives to such meetings. Traders tend not to have associations and MSPs without POs to represent farmers would be unwieldy. Box 11 describes a successful platform in Tanzania, noting the actions that need to be taken to ensure success with the approach and the importance of involving local government. Box 11: A Dairy MSP in Tanzania The Tanga Dairy Platform was set up on the initiative of Research into Use (RIU), a program funded by the UK government. RIU organized and facilitated the first meetings of the platform in 2008 and then organized training of the platform members so that they would be able to facilitate their own meetings in 2009. With help from RIU the platform also conducted a baseline survey of the dairy industry in 2009 to understand its structure and challenges. Discussions of the baseline survey led to the platform identifying three major issues for dairy development in the Tanga Region; milk production fluctuation in the dry season; the lack of a negotiation process between dairy chain actors to address milk price issues; and the lack of unity of stakeholders in the dairy industry. 30 Platform members therefore decided to work on three major areas: organizing milk producers and processors for effective lobbying and advocacy; strengthening the milk and milk products market; and developing a sustainable, year-round and profitable milk production system with smallholder farmers. This decision was reflected in the composition of the platform’s ‘board’, with the nomination of a coordinator for each of the three areas. The platform has experienced strong involvement of the regional administration in its activities. This started in 2011 as a result of a campaign run by the platform against an urban limit to dairy farming, which was being proposed by the Tanga City Council. Acknowledging the strong contribution of peri- and intra-urban dairy farming to the livelihoods of urban households the authorities dropped the proposal. Since then, a leading local government administrator has been attending and chairing in person all meetings of the platform. This high-level involvement from the regional government has increased the legitimacy of the platform as an important forum to discuss and take action to improve the region’s dairy value chains. Source: Cadilhon, Jean-Joseph, Ngoc Diep Pham and Brigitte L. Maass 2016. 5. The way forward for Indonesia Indonesian government support to agriculture remains heavily orientated towards the rice sector. While there has been some shift towards high-value agriculture, the extent of diversification has remained limited to a few regions. This compares negatively with most East Asian countries where rice as a proportion of total agricultural output has declined significantly as consumers switch to higher value and more nutritious foods. Based on the foregoing discussion, government policy relating to smallholder agriculture value chains should adopt a five-pronged approach: 1. Encourage the development of a more modern rice sector through facilitating improved aggregation and coordination that can lead to the development of larger and more modern mills; 2. Take steps to support the operations of the traditional trading sector, while, at the same time, being aware that some consolidation in this sector could also facilitate improved economies of scale; 3. Support partnerships between producers (including through producer organizations) and the private sector to develop better-coordinated value chains that can improve the quality and quantity of commodity exports, and of processed and fresh foods available on the domestic market; 4. Encourage the development of contract farming, recognizing that such contracts should always be dictated by commercial principles; 5. Ensure that the general enabling environment is supportive of efforts to improve aggregation and value chain coordination. (a) Modernizing the rice sector The way in which support is presently offered to the rice sector does not assure either farmer incomes or food security. While there is clearly a need for ongoing support to the sector, this should emphasize the development of a more efficient sector, rather than the subsidization of farmers. In Indonesia there are over 100,000 rice mills: in Thailand there are one thousand. Indonesia’s small mills use outdated equipment, achieve poor paddy-rice conversion factors and, because of their size, have poor 31 economies of scale. This inefficiency limits the returns that farmers can receive from paddy production and provides little incentive for them to make improvements to production and post-harvest practices. Improved aggregation and coordination in the rice sector can be achieved in the following ways.  Increasing the scale of smallholder production through land consolidation and joint farming. Particularly in West Java, there are many absentee land owners who work in the city. Developing leasing arrangements with smallholders who farm neighboring plots would improve economies of scale. The government needs to ensure that farmers have title to their land so that it can be leased or, if farmers wish to cease farming and move to urban areas, so that it can be sold. The possibility to carry out informal or formal land consolidation, so that farmers with several small plots are able to swap land amongst themselves, also needs to be explored.  Making existing cooperatives and other POs aware of the possibilities to play a role in paddy aggregation. This can be done by (1) coordinating with larger mills to buy from cooperative members at a particular time and location; (2) buying from members and then selling to larger mills; or (3) organizing farmers to grow particular varieties at the request of a mill. Of course, the traditional cooperative role of supplying inputs should not be neglected.  Working to replicate the work done in Lao PDR under the EMRIP project, under which mills were provided with grants to upgrade their equipment in exchange for improving linkages with farmers and providing extension support and seeds and higher prices for better quality;  Re-examining the work carried out to develop a system of Warehouse Receipts Finance, with the particular aim of focusing on the financial needs of mills rather than farmers.  Promoting consultations with the Rice Millers and Entrepreneurs Association (PERPADI) and banks to explore ways of improving the access of mills to finance to upgrade their facilities.  Encouraging the development of multi-stakeholder meetings in all rice-growing areas in order to promote improved consultation and understanding in the sector. (b) Supporting the traditional trading sector While the traditional trading sector in Indonesia has much inefficiency it remains responsible for the marketing of the great bulk of agricultural produce produced by smallholders. However, efforts to facilitate the work of this sector have been limited, both in Indonesia and the rest of the developing world. Government efforts to encourage more efficient trading by small-scale traders could include:  Recognizing the important role played by traders and addressing the negativity towards the trading sector that is often prevalent in government;  Encouraging traders to form associations to provide them with a voice in policy discussions and multi-stakeholder platforms and to provide a focus for technical assistance;  Developing national and local multi-stakeholder organizations and “innovation platforms” that can facilitate communication between farmers, traders, larger companies and policymakers and can assist in identifying infrastructure requirements (e.g. new markets);  Conducting value chain assessments, including detailed cost analyses, to identify areas where efficiency improvements can be promoted, and as an input into multi-stakeholder discussions;  Funding infrastructure such as roads and markets;  Encouraging government departments, donors, development assistance organizations and the large-scale private sector to view the small-scale private sector supplying the domestic market as potential partners;  Carrying out training for traders on post-harvest handling, particularly for fruits and vegetables; 32  Encouraging and training traders to provide technical advice to farmers;  Exploring with banks the ways in which loan products suitable for traders could be developed. (c) Promoting partnerships between producer organizations and the private sector There is considerable scope for developing the Indonesian agricultural sector but this is only likely to be achieved if value chain coordination can be enhanced through the development of partnerships, particularly for higher value products. Areas for possible government support include:  Coordinating government and donor support so that it stresses the need to develop value chain coordination;  Not trying to pick “winners” by identifying priority sectors but by facilitating farmer-buyer linkages on the basis of what is most profitable for both parties. This also includes the need to recognize that the poorest farmers may not always make good partners for commercial ventures;  Examining ways in which the lessons learned from experiences in other countries and regions can be applied to Indonesia, and inviting donors to support such programs, in association with financial and other input from the government;  Conducting or commissioning feasibility studies;  Developing effective legal, regulatory and institutional frameworks necessary for business transactions to be carried out and ensuring the regulatory compliance of partnership agreements (and supporting contracts) with national laws and policies;  Ensuring that legislation governing producer organizations enables these bodies to conduct business transactions and does not disadvantage their competitive position;  Providing awareness-raising to mobilize farmers to form farmer groups, grow new crops or adopt improved technologies;  Providing research and extension support for business partnerships and working with producer organizations and the private sector to conduct trials for new varieties;  Avoiding using the cooperative structure as a tool of rural development policy and for the distribution of subsidized inputs. The government should concentrate on developing POs that are best able to collaborate on commercial principles with the private sector, by strengthening their management and negotiating skills. (d) Encouraging the development of contract farming Indonesia has many attractions for private companies wishing to invest in agriculture in the country. With the growing attention to product safety and quality on world markets, companies increasingly see contract farming as a way of ensuring control over the products that are purchased and of ensuring traceability. With only limited land available for estate production, it is inevitable that much new production in the future will have to be achieved through contracts with smallholders or their organizations. Governments can assist such developments by:  Setting up a unit in the ministry of agriculture (or other appropriate location) to work with companies interested in investing in the country, in order to identify suitable locations and smallholders;  Protecting the interests of smallholders by carrying out “due diligence” on companies wishing to invest, to ensure that they have adequate management skills and necessary financial resources. Provide advice to smallholders so that they understand the contents of contracts;  Ensuring that the necessary regulations are in place for contracts to work properly. This also implies that the government should recognize that contract farming is a commercial decision and avoid trying to dictate to companies the terms of a contract, such as the price to be paid; 33  Developing arrangements for dispute resolution or arbitration in the case of disagreements over contracts;  Encouraging POs to work with contract farming companies, where required, and invite NGOs and others with experience of such operations to conduct training for POs;  Ensuring that national and local officials are fully familiar with what contract farming involves and ensure that extension officers are able to advise farmers and also set up meetings to establish initial contacts between farmers and a company. (e) Creating an enabling environment An appropriate enabling environment is necessary for value chain development, whether it be a traditional marketing chain or a complex contract farming operation. Components of an enabling environment for agriculture include policies, rules and regulations; the ease of doing business; the provision of infrastructure; availability of finance; and support institutions related to food safety, agricultural research and extension. Overriding all of this is that there must be recognition of the role of the private sector and an understanding of the way it functions. Too often, traders and millers are an easy target when the government wants to be seen to be doing something about food shortages and price rises. Specific areas of the enabling environment requiring attention are as follows.  Enacting national and local government regulations and laws to safeguard private-sector investment by ensuring that property, land and intellectual property rights are secured and contracts can be enforced. While enforcement of company contracts with individual farmers is in most cases not realistic, contractual obligations between companies and producer organizations need to be enforceable, as do contracts further along the chain, such as those that processors have with exporters or retailers. It is difficult for businesses to function in any sector without the security of knowing that contracts will be honored.  Establishing grades and standards, addressing food safety requirements, and ensuring bio- safety. While these are all legitimate activities for the government, care needs to be taken to ensure that government activities facilitate rather than hinder value chain development. For instance, grades for paddy and for fresh vegetables for the traditional domestic market would be largely unenforceable and could lead to corruption by officials. Standards are best established in association with the private sector. Food safety cannot be addressed solely by having laboratories to carry out testing as it would normally be difficult to trace the unsafe food back to the source. While laboratories are certainly needed, a “whole chain” approach is required to identify potential causes of problems and address them before they occur.  Investing in local level infrastructure that links rural populations to markets. Village-to-market access roads are critical for the rural poor, and for supporting the upgrading of value chains.  Limiting market interference by avoiding trade-distorting policies. Governments often implement policies without a detailed consideration of the consequences. For example, an export ban can cause major difficulties for companies that have export contracts to fulfill, and can damage a country’s reputation among importers. Particular care should be taken to avoid possible trade distortions resulting from the implementation of BULOG’s functions.  Working with value chain actors and financial institutions to develop new loan products or adapt existing products to effectively link sources of finance with the clearly expressed demand from agricultural value chains for finance, and enhance the opportunity for finance to be provided through the value chain, such as with warehouse receipt financing or input advances.  Facilitating land consolidation to increase average size of farmed plots, such as by resolving existing problems with land rights in the country, ensuring that smallholders have the opportunity to sell or lease land for agriculture, and by establishing support services to enable this to happen. 34  Upgrading the skills of government staff to support improved production by farmers and value chain coordination activities such as multi-stakeholder platforms. 6. Summary of the main issues Table 2 on the following pages summarizes the main approaches to aggregation and coordination discussed above. It considers the benefits and limitations of each approach as well as the potential role for governments. As indicated in section 1, there are numerous different types of linkages between buyers and farmers. We have presented here broad categories of such linkages but it is necessary to reiterate that linkages form a continuum from the very simple farmer- trader arrangement to a complex contract farming one. Within each category of linkage identified there can be considered to be many sub-categories. For example, looking at the two ends of the continuum presented in section 1, there could be a variety of arrangements with different degrees of coordination and aggregation: Simple farmer-trader linkages  Trader makes speculative visit to village  Trader makes regular visits to same village  Trader make phone contact before visiting village  Trader advances funds to farmers prior to harvest  Trader agrees to “buy the field” and advances funds  Trader buys from farmers at assembly market  Trader indicates preferred varieties to farmers and offers premium for those varieties Contract farming  Company supplies planting material to farmers  Company supplies planting materials and other inputs (fertilizers, pesticides) to farmers  Company supplies inputs plus training and technical assistance  Company also assists with land preparation  Company advances consumption credit to farmers  Company supplies packaging materials  Company also organizes transport of products  Company assists with conversion to organic production or helps farmers to meet Fairtrade or other certification requirements  Company works with farmers through POs  Company also operates its own farm  Company works with farmers through input dealers and banks rather than directly  Company leases land to farmers on condition that they produce crops required by company Thus the following table makes general recommendations regarding the use of aggregation and coordination tools, but the exact type of relationship will depend on the particular circumstances, which, in turn, will depend on the nature of the product, the skills of the farmers, the location, the use to which the product will eventually be put, the perishability of the product, the existence of certification and food safety requirements, and a whole range of other factors. 35 Table 2: Summary of aggregation and coordination issues Primary production aggregation and coordination Type of aggregation and coordination Benefits Limitations Roles for government Informal land aggregation and  Development of larger farm areas  Only relatively small areas can be  Development awareness by restructuring (e.g. through leasing for more efficient operations and consolidated on an informal basis extension services of land arrangements or redrawing boundaries) for marketing aggregation  Usually only of short-term duration consolidation possibilities  Can be done without formal land  Not suitable for long-term fixed  Support trust development registration investments between participating farmers  Allows people to migrate while still obtaining income from leasing land Formal land aggregation (e.g. through  Development of larger farms for  Complicated to organize for large  Support land consolidation and government-supported land more efficient operations, including numbers of farmers provide practical assistance to consolidation programs) mechanization  Usually requires formal land bring this about registration arrangements  Develop a land registry Cooperative farming (joint farming of  Larger land area facilitates use of  Not all farmers may be willing to  Develop skills of local government individually owned land) mechanization, irrigation, etc. collaborate officials and extension staff to  Facilitates bulk input purchase and  Time consuming to organize and support cooperative farming planting material preparation requires support from government development  Facilitates product aggregation for officials  Encourage private sector to sale and development of linkages develop linkages with cooperative with buyers farmers Informal farmer marketing aggregation  Reduction in transport and other  Limited access to high-value  Awareness creation of group (e.g. through group marketing or marketing costs markets marketing possibilities farmer leaders)  Ability to negotiate a higher price  Limited access to technical support  Support trust development  Can also be used for input purchase between participating farmers and between farmers and traders Marketing aggregation by private  Aggregation increases efficiency,  Private sector usually has  Consistent policy environment to sector (e.g. increasing storage by resulting in higher returns for all inadequate operational capital for minimize storage risks traders and processors) involved long-term storage  Policy environment that sees  Traders and processors often have  Price risks may make private sector private sector in a positive light business skills necessary to reluctant to aggregate large aggregate quantities Warehouse receipts and  Leads to upgrading of quality of  Can be jeopardized by poor quality  Establish laws to ensure receipts collateralization (e.g. using warehouse stored products warehouse management are recognized as proof of receipts as loan collateral) ownership 36 Primary production aggregation and coordination Type of aggregation and coordination Benefits Limitations Roles for government  Facilitates trading without visual  Costs may exceed perceived  Avoid using collateralization as way inspection of product benefits of providing subsidies  Increases availability of finance in  Encourage use by mills and other value chains processors Aggregation using ICTs (e.g. to assist  Market information enables  ICT-based services often  Maximize competition between farmers to sell products and improve farmers to plan when and where to experience difficulties in phone service providers logistics and traceability) sell developing profitable and  Promote utilization by small  Market-matching services help sustainable business models farmers sellers identify buyers and  Market matching requires grades  Encourage support to ICT start-ups contribute to better aggregation and standards and trust between  Provide training in the use of ICTs  ICTs can enhance value chains, those buying and selling for aggregation such as through improved traceability and logistics Vertical value chain coordination by  Responds to needs of  Capacity of farmers to take  Coordination has developed largely the private sector (e.g. specialized supermarkets, processors and advantage of such possibilities independently of external wholesalers developing linkages exporters for high-quality products depends on location, land, assistance, although successful between farmers and supermarkets; that meet commercial standards education and financial situation programs attract government and exporters developing markets based on  Reduces farmer risk as production  Relatively small share of donor interest “origin” of cocoa or coffee) in response to clear demand agricultural production presently  Improved rural infrastructure a  Increases farmer income through benefits from such vertical major requirement if location higher quality coordination constraints are to be addressed to  Improves value chain logistics,  Mainly used for fruits and allow additional farmers to become reducing costs and permitting vegetables. Limited coordination at involved higher returns for all in chain present for commodities such as  Organize multi-stakeholder coffee and cocoa meetings to explore potential for value chain improvements Contract farming (where buyers  Can address rural finance  Not all farmers are suitable to  Create a policy environment at in provide production and logistics constraints by providing farmers undertake contract production. which contract farming ventures support to farmers) with inputs, land preparation, etc.  In many cases a need for POs to are supported Extension advice also supplied coordinate smallholder production  Conduct basic “due diligence” on  Reduces smallholder marketing and under contract but limited PO companies on behalf of farmers price risks with better market managerial skills  Organize multi-stakeholder guarantees  Potential for staple crop production meetings to explore potential for seems limited contract farming 37 Primary production aggregation and coordination Type of aggregation and coordination Benefits Limitations Roles for government  Companies are guaranteed supply,  Sometimes a reluctance on part of  Ensure appropriate legal which enables them to sign smallholders (and companies) to environment with emphasis on contracts with their buyers and to honor contracts when prices facilitation rather than control aggregate supply to maximize change significantly  Avoid controls on input imports throughput of processing facilities  Tendency of national and local (e.g. seed varieties) that could governments to want to intervene jeopardize farming operations in what should be a fully  Provide extension service support commercial activity to contracted farmers Productive alliances (linking producer  Provide access to modern supply  Danger of default on agreement by  Develop co-financing from financial organizations with buyers) chains for smallholders either PO or company institutions in addition to matching  Increase technical and managerial  Difficulty experienced by farmers in grants from government or donors skills of farmers and their meeting stringent quality  Pay greater attention to PO and organizations requirements private sector capacity at the  Respond to needs of supermarkets,  Lack of social cohesion within POs feasibility study stage to reduce risk processors and exporters for high- and contradictions between of failure quality products commercial and social objectives  Increase private sector awareness  In Latin America have generated  Lack of managerial skills of POs and of both benefits and difficulties of significant positive impact on weaknesses of some private sector working with smallholders to production, sales, income, and partners facilitate aggregation employment  Considerable work involved in organizing linkages and preparing business plans Other PPP vertical coordination  Addresses capital constraints faced  Difficulties experienced in  Ensure financial institutions are programs (e.g. provision of grants to by SMEs and cooperatives in developing and evaluating always involved at an early stage SMEs to help improve links with increasing number of farmers acceptable business plans that can and that matching grants are only farmers) serviced lead to sustainable investments given when banks are also  Provides farmers with access to  Full collaboration between farmers prepared to invest modern supply chains and SMEs not always easy to  Improve quality of value chain  Facilitates investment in value achieve assessments in order to identify chains assessed as high priority most promising sectors 38 References Ba, Hélène; Matty Demont; Pieter Rutsaert; & Sylvie Thoron. 2015. The rapid rise of contract farming in the Vietnamese rice industry. Paper presented at the International Conference of Agricultural Economists. 2015. Cadilhon, Jean-Joseph et al. 2005. Collaborative commerce or just common sense? Insights from vegetable supply chains in Ho Chi Minh City. Supply Chain Management Vol 10 No.3 Cadilhon, Jean-Joseph; Ngoc Diep Pham; and Brigitte L. Maass. 2016. The Tanga Dairy Platform: Fostering Innovations for more Efficient Dairy Chain Coordination in Tanzania. Int. J. Food System Dynamics 7 (2), 2016, 81-91 Collier, Paul and Stefan Dercon. (Undated). African agriculture in 50 years: Smallholders in a rapidly changing world? Paper presented at expert meeting on how to feed the world in 2050. FAO, Rome. Collion, Marie-Hélène and Michelle Friedman. 2012. Rural Productive Alliances: A Model for Overcoming Market Barriers. Module 1: Innovative activity profile 6. In Agricultural Innovation Systems: An Investment Sourcebook. World Bank. Washington D.C. CTA and EAGC. 2013. Structured grain trading systems in Africa. Technical Centre for Agricultural and Rural Cooperation, Wageningen and Eastern Africa Grain Council, Nairobi Dang, Khoi. (Undated). Large-field production zones – a sustainable rice production and water management model in Mekong River Delta of Vietnam Da Silva, Carlos and Marlo Rankin. 2013. Contract farming for inclusive market access. FAO, Rome. Da Silva, Carlos; Joseph Mpagalile; Johan Van Rooyen; and Costanza Rizzo (eds). 2016. Enabling more inclusive and efficient food and agricultural systems in Africa. FAO, Rome and Stellenbosch University Deininger, Klaus; Songqing Jin; & Fang Xia. 2012. Moving off the Farm: Land Institutions to Facilitate Structural Transformation and Agricultural Productivity Growth in China. Policy Research Working Paper 5949. World Bank, Washington D.C. Demont, Matty and Pieter Rutsaert. 2017. Restructuring the Vietnamese Rice Sector: Towards Increasing Sustainability. Sustainability, Vol. 9 Issue 2 Eaton, Charles and Andrew Shepherd. 2001. Contract farming: Partnerships for growth. FAO, Rome. FAO. 2013. ICT uses for inclusive agricultural value chains. Rome FAO, IFAD and UNIDROIT. 2017. Legal aspects of contract farming agreements. Synthesis of the UNIDROIT/FAO/IFAD Legal Guide on Contract Farming. Rome. GrowAfrica and IDH. (Undated). How do off-takers and smallholder farmers use aggregation models to grow their businesses? Hamill, Shane. 2017. Strengthening agricultural market access with ICT. In ICT in Agriculture: Connecting smallholders to knowledge, networks and institutions (Module 9). World Bank. Washington D.C. Hellin, Jon; Mark Lundy; and Madelon Meijer. 2007. Farmer Organization, Collective Action and Market Access in Meso-America. CAPRI Working Paper No. 67. IFPRI. Washington D.C. Huang, Jikun & Jiping Ding. 2016. Institutional Innovation and Policy Support to Facilitate Small-Scale Farming Transformation in China. Center for Chinese Agricultural Policy. IFAD, Vietnam Country Office. (Undated). Co-investment with enterprises and farmers: Guidance note for investment preparation. Hanoi IFAD. 2016. Public-Private-Producer Partnerships (4Ps) in Agricultural Value Chains. Rome IFC. 2011. Dairy Industry Development in Indonesia. Jakarta Jaffee, Steven; Spencer Henson; and Luz Diaz Rios. 2011. Making The Grade: Smallholder Farmers, Emerging Standards, and Development Assistance Programs in Africa. World Bank Report Report No. 62324-AFR. Washington D.C. Maertens, Miet and Katrine Vande Velde. 2017. Contract-farming in Staple Food Chains: The Case of Rice in Benin. World Development, Vol. 95. Markelova, Helen and Ruth Meinzen-Dick. 2009. Collective action for smallholder market access. CAPRI Policy Brief 6. IFPRI. Washington D.C. Oxfam. 2013. Land consolidation for poor people in Vietnam Pantoja, Blanquita et al. 2017. Assessment of Agribusiness Venture Arrangements and Sugarcane Block Farming for the Modernization of Agriculture. Philippine Institute for Development Studies Discussion Paper, 2017-35 Rankin, Marlo; Eva Gálvez Nogales; Pilar Santacoloma; Nomathemba Mhlanga; and Constanza Rizzo. 2016. Public–private partnerships for agribusiness development – A review of international experiences . FAO, Rome. Reardon, Thomas; Randy Stringer; C. Peter Timmer; Nicholas Minot; and Arief Daryanto. 2015. Transformation of the Indonesian Agrifood System and the Futurebeyond rice: Bulletin of Indonesian Economic Studies, 51:3 Shepherd, Andrew. 2007. Approaches to linking producers to markets. FAO, Rome. Shepherd, Andrew. 2016. Including small-scale farmers in profitable value chains. CTA, Wageningen Shepherd, Andrew. 2016. Lessons for Sustainability: Failing to scale ICT4Ag-enabled services. CTA Wageningen 1 Suradisastra, Kedi. 2006. Agricultural Cooperative in Indonesia. Paper presented at 2006 FFTC-NACF International Seminar on Agricultural Cooperatives in Asia: Innovations and Opportunities in the 21 st Century, Seoul, Korea, 11-15 September 2006 Swinnen, Johan and Miet Maertens. 2006. Globalization, Privatization, and Vertical Coordination in Food Value Chains in Developing and Transition Countries. University of Leuven. Syngenta Foundation. 2017. The Future of Small Farms: Report on an international conference. Syngenta Foundation, Basle, Switzerland Ton, Giel; Desiere, Sam; Vellema, Wytse; Weituschat, Sophia; D’Haese, Marijke. 2016. The effectiveness of contract farming for raising income of smallholder farmers in low- and middle-income countries: a systematic review. Campbell Systematic Reviews 2017:13 USAID. 2013. Indonesia’s Poultry Value Chain Verhofstadt, Ellen; Miet Maertens; and Johan Swinnen. 2014. Review of Smallholder Participation in Transforming Agri-Food Supply Chains in East Asia. Working Paper. World Bank. Washington D.C. Vorley, Bill; Mark Lundy; and James MacGregor. 2009. Business Models That Are Inclusive of Small Farmers. In Carlos da Silva et al, Agroindustries for Development. CABI, UK Wiggins, Steve and Julia Compton. 2016. Factors leading to Agricultural Production Aggregation and Facilitation of the Linkage of Farmers to Remunerative Markets. Overseas Development Institute for Evidence on Demand, London World Bank. 2016. Linking Farmers to Markets through Productive Alliances. Washington D.C. 2