In setting up agricultural value chains, three things are important to remember; farmers respond to incentives, most agricultural value chains are primitive at farmer level, and climate change is real – Pic by Shehan Gunasekara
What is the most important element in an agricultural value chain? An agricultural value chain is a collection of many stakeholders. Some of these stakeholders are rent seekers, such as the middle tradesman, transporters and buyers (including exporters). Some stakeholders are there to make sure the governance of the value chain. Those are government institutions, certification entities and quality checking officials (such a quarantine officers, custom officers and GAP officers).
All these stakeholders play an important role in making the agricultural value chain sustainable. However, I argue that farmer is the single most important element in ensuring the sustainability of the agricultural value chain. It is important that we understand the farmer to the best ability we can.
For the longest time, farmers, especially the small holder, was seen as a price taker with no or limited ability to decide on the price. Therefore, they were a source to be exploited by the other rent seeking stakeholders in the agricultural value chain. But it is important to see whether this conventional thinking can be challenged.
Transaction costs have pushed farmers to be price takers. Inability to deal with increasing transaction costs in terms of agricultural information and market information have cornered farmers to give in to the pressure from rent seekers and accept less. But increasing involvement of ICT initiatives, agricultural insurance and technology transfer into value addition have given farmers new tools to break away from just being a price taker. Therefore, slowly but surely, farmers are becoming the most important element in an agricultural value chain.
Imagine a situation where framers decide what to cultivate (based on the market, price, agro-ecological and crop cultivation information they have) and they trade what they produce at an online market place with no involvement of middlemen with 100% traceability. Isn’t this the goal we want to achieve with our agricultural value chain? Isn’t this one of the disruptive innovations we are looking for in agricultural value chains? However, in order to achieve this status fully, we need to carefully consider some important areas.
Farmers respond to incentives
There are two types of farmers. Farmers who produce for their own consumption and farmers who produce for commercial purposes. Commercial farmers can be at different levels. There are farmers where their main objective is commercial production and they spare some of that for their own consumption as well.
At the same time there are farmers who in general produce excess amounts, they either store that or sell at a convenient price (for the convenience let’s call them semi-commercial farmers). These types of farmers respond to different incentives. For example, price could be the single most important element for a farmer who puts up excess produce for trade. As price becomes attractive they will be producing more for commercial purposes. However, price might not be a convincing factor for a subsistence farmer since land might be the biggest constraint they have to expand. Therefore, anyone who is establishing an agricultural value chain first needs to understand their farmers and then the incentive structure around them.
For anyone who is trying to establish a local market oriented agricultural value chain, working with semi-commercial farmers would be alright. However, for someone who is looking to establish an export oriented agricultural value chain the best option is to look for a commercial farmer.
The main focus of this article is on establishing export-oriented value chains. Therefore, I would like to explore the incentive structures around farmers in export-oriented value chains. Export-oriented value chains are capable of yielding higher prices. However, there are well-defined quality parameters to adhere to.
For example, okra is a crop that is demanded by local as well as export-oriented value chains. While the local value chains do not require any specific quality parameters, export-oriented value chain is all about quality parameters. Export-oriented value chain accepts a certain size, a colour and a shape. In order to maintain these quality parameters, it is important that a certain variety are cultivated and crop management practices are followed, especially the harvesting intervals. Therefore, going in to the export-oriented value chain there are several and specific transaction costs to the farmer.
To be more specific with an example, short-term vegetable varieties that are recommended for export-oriented value chains require at least six seed packets (250g each) for an acre. One seed packet is close to Rs. 3,000, therefore seed cost for an acre is on average Rs. 18,000. Compared to this, the seed cost of a local-oriented value chain is far less. Therefore, farmers are interested in export-oriented value chains as long as all these costs are covered with enough incentives. While farmers who are in a local-oriented value chain get Rs. 35 per kg, farmers in the export-oriented value chain get Rs. 130 per kg. Therefore, price is a major incentive for farmers to operate in export-oriented value chains.
Is higher price the only incentive? Not really. One of the biggest transaction cost in a local-oriented value chain is finding a market place. On any given day there are plenty of lorries lined up at Dambulla Regional Economic Centre loaded with vegetables and fruits. Entrance is not necessarily on a first come first served basis.
There are many factors that decide which farmer/trader gets to enter into the market place first, however it is clear that connections are an important element. Therefore, there are farmers who comes early in the morning with a lorry load of fruits and vegetables but have to wait till the last hour of the day to have an offer from a buyer. This will limit the ability to bargain for a better price.
Most of the time farmers hire lorries to bring their produce to the market place, therefore they can’t take the produce back and come the next day. To make things more difficult, farmers don’t have cold storage facilities, so they need to sell on the same day. At the end, during the last hour, farmers will end up selling their produce for pennies.
An export-oriented value chain that works with a forward contract agreement will have a harvesting and a delivery schedule. Most of the time the exporter/collector will come and pick up produce from the farm gate, or farmers will have to bring produce to a collection centre. There will be a time specified to come to the collection centre as well, for example short-term vegetables are usually harvested with a couple of days’ interval and harvesting is done early morning and collection centres will accept produce from morning to evening.
This gives flexibility to farmers since they don’t have to go early in the morning and wait in a line. They are sure that their produce will be taken in since they have a forward contract. Therefore having a market place is a major incentive for a farmers to get into an export-oriented value chain.
Most agricultural value chains are still primitive at farmer level
This is a popular mantra among experts who advocate value chain development. This is partly true; we need accept that our value chains can be better. Therefore, we would hear most experts saying that farmers need to start value adding before selling to the next point in the value chain. However, this is always not true. You won’t be able to say exactly whether value addition at farm level would yield higher returns unless proper gross margin analysis and opportunity cost calculations are done.
Therefore, higher level of technology adoption might not be feasible for all value chains given the current conditions. Argument is that, there has to be enough and proper incentives for farmers to do so. This way a balance between opportunity cost of production and premium gained from value addition will be balanced.
Let’s take a popular example from a short-term fruit and vegetable value chain. One of the simplest technology adoptions we talk about in these value chains is the use of agricultural crates for transportation. This has a clear justification and a purpose.
Nearly 40% of harvest is lost during transportation. One of the ways to minimise this is to use agricultural crates with proper packing methods. For example, short-term vegetables need to be stored in layers when using agricultural crates. Layers can be separated using clean and clear white colour papers. However, this hardly happens.
There are popular hypothesises for not practicing this. Some argue that the prices of agricultural crates are not attractive for farmers. This could be true. An agricultural crate that can hold 25kg of harvest will cost around Rs. 1,000. A farmer who has one acre of short-term vegetable that produces 200kg every other day will have to have 16 crates at his disposal to do this operation effectively. This means that cost will be around Rs. 16,000 for crates only.
Another popular hypothesis is formed around management of crates at the market place. Farmers bring harvest in creates and they will be unloaded at the economic centres. Most of the times, these crates will not be given back to farmers, rather another set from another farmer will be given back. Therefore, if I am a farmer, I might bring my harvest in brand new crates but I will be given heavily used ones in return. This happens since there isn’t a proper crate identification system in place.
Another popular hypothesis is around logistics. A crate has a maximum limit. Most of the time, based on the crop you will not pack even the maximum amount. For example, brinjal might be okay to pack to the maximum limit but it is not advised for a crop like okra. Okra has a softer skin that can get damaged easily and discoloured with contact and pressure.
Farmers and collectors use lorries to transport their produce to regional economic centres. On average a lorry will charge at least Rs. 35 per km (most of the time this will be done on a trip based cost rather than per km rate). Farmers and collectors will want to transport as much as possible in a single trip. If crates are used, a usual lorry (this is the DIMO batta lorry) can pack up to 1,400kg, using 25kg capacity crates.
All that I explained above are disincentives for a farmer to use agricultural crates. A farmer’s best possible incentives for using these crates are less post-harvest losses in transportation, and may be better price because the harvest will be less damaged. While post-harvest losses will definitely go down by using crates, it does not guarantee a better price. Therefore a farmer will evaluate all these incentives and disincentives before making a decision whether to use crates or not.
At the moment disincentives easily outweigh the incentives and you can’t expect farmers to adopt creates. However, in order to get “primitive condition of using gunny bags for agricultural packing and transportation” out of agricultural value chains, it is essential we create enough incentives to adopt agricultural crates. The important question is, how?
Introducing agricultural crates are easy for export-oriented value chains. Penalties in post-harvest losses are high, therefore there are enough incentives for a farmer to make sure he packs things properly. Export-oriented value chains are built on traceability (we still have a long way to go in implementing this properly. Traceability does not mean that, you are directed to the company website once scanned. This should have more information such a farmer information, geography, field information, crop information, etc.).
Studies have shown and exporters will tell that traceability attracts higher prices from consumers. Therefore, agricultural crates with proper traceability system will be the future for export-oriented value chains and the incentive structure around is relatively developed. However, this is not clear in value chains that produces for local markets.
Supermarket chains are doing a good job promoting agricultural crates but only a very small fraction of farmers are working directly with supermarkets. Though supermarkets most of the time offer higher prices compared to other local markets, it does not compensate the opportunity cost of using crates. Therefore, what could be the incentive structure around a farmer that produces for a local market?
If a farmer is producing for an export-oriented value chain, that means he produces for a local market as well. For example, TJC mango value chain producers three grades. Grade 1 is for the export market. Grade 2 is for the local market where it might end up in supermarkets and grade 3 will go for processing (pulp and chutney making).
Grade 1 definitely has to be transported in crates and traceability is a feature that is slowly but surely being introduced to this value chain. Therefore, for a farmer in this value chain, there is little opportunity cost to continue to use crates in dealing with grade 2 and 3 as well. Now that happens if the value chain is only focused on producing for the local market (which majority of farmers do).
Under the current situation, regional markets such as Dambulla will not give you a higher price based on whether creates are adopted or not. Therefore, rather than trying to persuade farmers to use crates (the conventional supply driven approach), I argue that we should provide incentives to the buyers of the local markets to push excepting harvest in creates only (this is the demand driven approach).
Establishing these incentives will take time and might seems impossible. Whether it has to be market conditions or attitude changes, it will take lot of effort since for the moment price signals do not provide any incentives even for the buyers. We can move further in the value chain to look for an answer.
Consumer awareness in consuming better produce is increasing. I am sure every one of us has the experience of trying to sort vegetables into a bag or a basket at the market, trying to see what is not discoloured and damaged. How much extra will we pay not to do that anymore? If the consumer (demand side) is willing to pay a higher price, then that can be transferred along the value chain to farmer as a price signal to adopt crates.
My argument is, what goes along the value chain will be a price signal, but what generates that will be an attitude change starting from the point of demand: the consumer.
Climate change is real
Whether we like it or not, climate change is real and its impacts are clearly evident. Agriculture will be heavily affected by climate change. Shifting of seasonal rainfalls, changes in rainfall intensity, floods, droughts, changes in day and night temperature will affect agro-ecological systems. These systems will not be able to maintain a sustainable production anymore and there will be more food security related issues. Overall, uncertainty around agricultural production will increase.
Uncertainty is a part and parcel of agriculture. However, these uncertainties were more predictable. Farmers used to predict weather events using their indigenous knowledge. Looking at how animals, especially birds behave, observing the cloud patterns and changes in the ambient temperature and wind speed, our farmers were able to predict whether they would receive rainfall in the near future or whether there would be prolonged droughts.
Climate change has changed all these signals in the environment and these observations are no longer valid. Therefore, uncertainties around agricultural production has increased drastically. Whether these changes have affected the incentive structures around the sustainability of value chains and how farmers will approach a particular value chain is an important question to look at.
Agricultural insurance is something that is very important to address the issues of uncertainties in agricultural production. However, this was something hard to promote among smallholder farmers in developing countries and it is nothing new to Sri Lanka as well. However, before the era of climate change farmers were able to predict weather-based uncertainties to a greater accuracy. Therefore, there weren’t much incentives for farmers to buy insurance since they could easily forgo cultivating during the uncertain periods.
However, as explained earlier, this is not possible anymore. Usual weather pattern does not exist anymore and that has created a demand for climate-based insurance products. Indemnity-based insurance schemes are going out of fashion and now the demand is for index-based insurance schemes and weather index-based insurance schemes are essential. Therefore, climate change has created a secondary market for agricultural insurance and that is essential for the sustainability of the agricultural value chains.
Forward contracts are something not easy to implement in agricultural value chains, especially in the short-term fruit and vegetable value chains. Farmers had a fairly good idea about the seasonal production and they knew when the price would go up and down. Because of this, they were reluctant to get into forward price agreements especially during the times when they knew they would have a better price in the spot market.
However, climate change-induced uncertainties are changing the seasonal production patterns and historical production patterns do not hold anymore. Therefore, holding off for a better spot market price is becoming less and less attractive for farmers. Rather a forward price agreement will guarantee them an average price that can compensate the uncertainties of climate change around agricultural production. This is in fact a positive impact of climate change. Increase in farmer willingness to accept forward price agreement with uncertainties induced by climate change will help value chains to be more formalised and sustainable.
Agriculture in the open field is always risky. Agriculture practiced under a controlled environment will have less issues of pest and disease attacks and weather changes. However not all farmers can afford agriculture under a controlled environment. Though green houses and drip irrigation is more beneficial, it is costly.
Farmers are increasingly realising that open field agriculture is becoming riskier with climate change. This will create an issue of sustainability in agricultural value chains. Therefore, more and more farmers, especially the ones who are into export-oriented value chains, are adopting agriculture in controlled environments. With controlled environments, farmers are able to do year-round production and a lesser exposure to heavy rainfalls, droughts, and pest and diseases. Therefore, climate change impacts are creating a demand for adopting new and high-end technologies in agricultural value chains.
With climate change farmers will have enough incentives to move towards control environments more and more rather than working in open fields. Furthermore, with controlled environments agriculture producers are looking at incorporating the next generation of technologies such as IOTs (Internet of Things), machine learning technologies and Artificial Intelligence (AI) into agricultural production.
In setting up agricultural value chains, three things are important to remember; farmers respond to incentives, most agricultural value chains are primitive at farmer level, and climate change is real. Careful evaluation of these conditions will give us a clear idea why stakeholders in an agricultural value chain behave in such a way. Incentive structures will explain why a particular stakeholder behaves in such a way.
Understanding why most agricultural value chains are primitive at farmer level will help design alternative incentives for modernisation. Finally, accepting the realities of climate change might open up incentives for innovations in agricultural value chains such as crop insurance, forward price agreements and agriculture in controlled environments.
(The writer is an agriculture economist. He can be reached at email@example.com, +94 76 35 99 243).