THE TWENTY-FIRST CENTURY AGRICULTURAL COOPERATIVE: INCREASING THE BUSINESS CREDIBILITY OF SMALLHOLDERS

This essay is part of a special edition being published in partnership with Foreign Affairs, titled “African Farmers in the Digital Age.” This anthology explores the future of African food systems and the role that digital solutions can play in overcoming the isolation of smallholder farmers and speeding up rural development. Look for it at https://www.foreignaffairs.com/anthologies on February 15.

Geographic distance and diseconomies of scale have historically made the cost of doing business with smallholder farmers prohibitively high. Where this problem has been overcome are instances in which public or private sector actors mediate. These firms serve to increase the financial credibility of participating smallholders with input dealers, technology providers, traders, financial services providers, processors, and exporters. I will refer to this role as “business credibility intermediation.”

With the dismantling of parastatals and a dearth of private companies operating in rural areas on a large scale, the future of smallholder agriculture will depend on finding workable alternative approaches to business credibility intermediation. The best candidates to fill the gap in the near future are the large number of smallholder producer organizations that have mushroomed across Africa. Most of these organizations, however, lack the organizational, commercial, and technical capacities to operate effectively.

Modern information and communications technologies (ICT) can enable producer organizations to provide business credibility intermediation both at a lower cost and more effectively for their members. ICT can help overcome the physical, infrastructural, and institutional obstacles facing smallholders, not just with the promise of innovation but first and foremost by reducing costs and ensuring scalability.

The Challenge of integrating African smallholders into agricultural value chains
Increasing globalization presents African smallholders with considerably greater challenges than those faced by Asian producers during the Green Revolution era. African smallholders today need not only to produce more efficiently, but also to contend with far more complex and competitive markets. Growing specialization, rapidly changing consumer preferences, and increasingly intricate technical specifications place significant demands on the average smallholder

With the exception of producers of major traditional and some high-value export commodities, the large majority of African smallholders are isolated from the rest of the agricultural value chain for a variety of reasons, most of which center on their small scale, their geographic isolation, and their lack of capital.

Due to the small scale of production that one household can effectively manage, independent smallholders are unable to realize economies of scale for input procurement and output commercialization. The firms that sell inputs to and buy output from smallholders tend to be significantly larger and better capitalized than the farmer, and do not experience the fragmentation or logistical difficulties associated with agricultural production. When it comes to selling their output, farmers find themselves in a poor negotiating position, and inter-farm competition lowers prices further, relegating many household farmers to subsistence production or migration out of farming.

Inconsistent quality and reliability of smallholders’ output, as well as the costs of assembly, storage, and transport, make financial intermediation complicated and expensive for both farmers and the financial sector. Low productivity and a limited ability to buy and sell reduce the expected rate of return and thus smallholders’ inclination to invest. Small transaction sizes and the dispersion of holdings raise the cost of providing financial services, which in turn raises the cost of capital to those who are inclined.

Compound all of this with a lack of information, unenforceable contracts, and poor physical infrastructure and, operating individually, smallholders are unlikely to generate the demand for financial services necessary to stimulate significant investment by the banking sector. In turn, the banking sector offers a limited range of services that do not meet most smallholders’ needs.

The role of producer organizations in agriculture in developing countries
In Africa, as elsewhere, a plethora of institutional arrangements govern agricultural production , but collective action—increasing scale and market power while retaining independent ownership—is increasingly being recognized as a way for rural smallholders to deal with missing markets or to empower themselves against monopolies or monopsonies. Cooperative producer organizations thus appear to be an essential institution for inclusive agricultural development in rural Africa. In fact, cooperative organizations have been showing consistent growth throughout Africa over the past decade. At the same time, numerous studies show that the role played by collective action organizations in emerging markets remains highly contested). For every success story there seem to be many failures.

A major challenge to the effectiveness of such organizations is their general lack of sufficient customer service and business orientation, which hinders their ability to deal with the commercial and technical issues facing their members. The transformation of producer organizations into market-driven actors that can efficiently provide technical and commercial services to their members and serve as credible business partners will result from the achievement of two objectives: one, organizational maturation and two, market intermediation and technological innovation.

Organizational evolution and maturation
Organizational maturation is reflected in the capacity of producer organizations to apply effective governance and management practices that ensure transparency and accountability. Historically, the organizational evolution of cooperative producer organizations has proven problematic. Practically all cooperatives start on a small scale, with a small number of founders—neighbors, colleagues, and relatives—most often all living in the same small geographical area. Establishing a jointly owned organization entails significant risk by creating mutual dependence; if one or a few members decide to free ride, the entire group suffers. Therefore, the establishment of a producer organization requires a high level of social capital. To run its operations and make the necessary investments for vertical integration, however, a cooperative must build up financial capital. The resource base of cooperatives is the social capital that makes the members willing to supply financial capital.

To stay competitive, cooperatives—like any business—tend to integrate vertically toward the more lucrative and less price-sensitive consumer goods markets, where there are greater possibilities for product differentiation and market segmentation. The strategy of vertical integration is especially resource demanding; the cooperatives need more capital, and the capital must ultimately originate from members. Likewise, cooperatives integrate horizontally, mainly through mergers, to lower costs through economies of scale and scope. However, the shift toward horizontal integration (large-scale operations) tends to create large, heterogeneous memberships. Management becomes increasingly autonomous, with members having less influence on the cooperative’s decision making.

The strategies of vertical and horizontal integration are a way to adapt to the developing market situation, but such market orientation is at odds with the member orientation necessary for cooperatives to succeed. Social networks based on reciprocity and trust appear to be the most essential asset of cooperatives, in comparison to investor-owned firms. Failing cooperatives often characterized by an imbalanced relationship between financial and social capital. From this perspective, social relations within a firm should not just be assessed as a random configuration of human beings but as a concrete resource, the productivity of which depends on the organizational form.

The challenge for producer organizations going forward is to identify the size and level of heterogeneity at which they can maintain a stable base of social capital while generating sufficient financial capital and establishing credibility with business partners.

Market intermediation, financial services, and technology innovation
The transformation process also requires the acquisition of the technical, commercial, and financial resources necessary to meet the needs of the producer organization’s membership and develop into business entities that can serve as credible business partners. Historically, smallholder cooperatives have acquired technical and commercial skills through services provided by public or private organizations. However, even in the first couple of decades after independence, when extension services had their widest coverage and strongest capacities, skill development of smallholder cooperatives had very limited reach either in terms of subsectors involved, topics covered, or both. Hence, very few cooperatives have been able to successfully integrate vertically and enable smallholders to participate in emerging value chains.

Cases of successful integration of smallholders into value chains, however, do exist. In West Africa, for example, smallholders have been able to aggregate and sell groundnut and cotton competitively to global export markets. Common to all cases where smallholders have successfully integrated into value chains is the important role played by third party, public or private sector firms in providing services.

The third party helps negotiate business contracts, facilitate payments, and source technology, as well as access training and other advisory services. Through the partnership between the producer organization and this service provider, smallholders are able to access to improved seeds, fertilizers, pesticides, herbicides, machinery, transport, storage facilities, packaging, and other quality management equipment and infrastructure. In value chains where public or private sector firms have not been operational, such as millet and sorghum or to a lesser extent cassava or maize, yield gaps and dispersion tend to be larger and input use lower, as are the volumes of sales.

It is important to note that the costs for all the services and support provided by public or private third parties are usually paid by the farmers themselves. The role of the public and private entities is largely to signal to other value chain members, through their presence and link to producer organizations, that the associated smallholder farmers are credible partners. Over the last three decades, however, the number of public sector companies providing such services has dwindled to near zero after the dismantling of costly parastatals in the 1980s, and the private sector remains hesitant to expand its presence substantially. The only option to integrate smallholders at scale is to work directly with a critical mass of producer organizations and help them acquire the technical, commercial, and organizational skills and capital they need in order to effectively fulfill the same credibility signaling function, and to enter into their own agreements with technology providers, market operators, processors, and financial services providers. They need to build their own credibility and capacity to serve their membership.

Technical skills will enable producer organizations to:

• source and apply technologies by working with technology providers; and
• claim a greater share of the added value through processing by meeting the technical requirements of third party processing firms or mastering the technical operations of their own plants.

Commercial skills will enable producer organizations to:

• work with financial services providers to meet the capital and insurance needs of their members;
• strengthen their bargaining positions with traders and exporters; and
• where possible, competitively expand their participation in trading and export activities.

Organizational skill will enable them to

• avoid erosion of social capital;
• achieve the level of governance and coordination required to participate in value chains; and
• improve the effectiveness and efficiency of service delivery to their members.

The role of ICT in increasing social capital, efficiency, and effectiveness of producer organizations
At the heart of the cost of doing business is the making, monitoring, and enforcing of contracts, processes influenced by the extent of imperfect information involved in any transaction. Central to the economics of a producers’ organization is therefore the cost of acquiring information.

The cost and risk associated with doing business includes coordination cost (the cost incurred in coordinating with units actually or potentially producing an input or purchasing the output), operations risk (stemming from conflicting goals among the parties and supported by information asymmetries or difficulties in enforcing agreements due to differences in bargaining power or incomplete or unenforceable contracts), and opportunism risk (the risk that other parties in the transaction willfully misrepresent or withhold information, shirk their agreed-upon responsibilities, or take advantage of a lack of bargaining power or the loss of bargaining power directly resulting from  the execution of a relationship, that is, a difference between ex ante and ex post bargaining power).

Strategic deployment of ICT could help producer organizations minimize risks by reducing the cost of communicating and reacting to information and of explicit coordination. Increased information availability and information processing capacity reduces operations risk by making monitoring easier and by enabling more efficient incentive structures. ICT investments could lead to more outsourcing and other strategic business partnerships, thus enabling producer organizations to reap the benefits of greater coordination, specialization, and economies of scale.

In the context of a producer organization, efforts to reduce the cost of acquiring information using ICT sometimes take place through the development of a portal. In such cases, mobile-to-web technology can then be used to collect essential data on the business operations of producer organizations (i.e., virtual bookkeeping). Such a portal can increase the transparency of the operations of producer organizations and, if made accessible to banks, for instance, can increase the transparency and credibility of an organization. In addition to the portal, ICT can be applied in a more targeted fashion such as grading and certifying products, delivering technical content, or improving organizational management skills.

A multitude of applications are currently being deployed in many parts of Africa targeting smallholder farmers. A key weakness is that many are targeting an isolated problem for a single segment of a given value chain, often in a specific geography. They offer solutions that are either not replicable or not scalable. Effectively linking farmers, in numbers large enough to make a difference, into modern value chains will require integrated solutions that deal with all major interfaces between smallholders and other value chain actors.

The twenty-first century producer organization can be more than an advocate or marketing body. With modern information and communication technologies at their fingertips, such organizations can upgrade their skills as well as their operations, to offer a comprehensive set of services to their members. With such an intermediary working in their interest, the potential of African smallholders can be harnessed to feed the continent and fuel economic development.

Originally blogged on IFPRI BLOG