The Crowdy Three in agro food supply chains

Value chain upgrading processes in agri-food supply chains such as coffee and horticulture are increasingly being promoted as an intervention framework for rural development in developing countries. However, evidence suggests that value chain upgrading is often strongly associated with elite capture, fail to provide any value for participants, or are unable to scale. In this article we describe this outcome as the Crowdy Three and discuss how the Crowdy Three has its roots in asymmetric information and transaction costs in value chains.

At Heuris we are passionate in providing inclusive and sustainable rural development, and have developed highly inclusive, scalable and high value supply chains with our partners in Uganda and Australia.

Value chain upgrading in agri-food supply chains – the new solution for rural development?

Extreme poverty, measured by the number of individuals living below $1.90 US dollars a day, remains high at 689 million people (World Bank, 2020). There is an increasing consensus that economic growth is insufficient in alleviating poverty where inequalities often prevent the poorest and most marginalised accessing the benefits of economic growth.

It is recognised that improving the welfare of rural communities who depend on agriculture is the most important goal in global poverty alleviation. However, modern agricultural supply chains have evolved over the last 20 years due to worldwide income growth, technological change, urbanisation, economic liberalisation, and globalisation. Evidence suggests that this evolution has made smallholders and poorer rural communities more vulnerable to volatile prices and has favoured power imbalances in supply chains where rents are extracted to downstream retailers and processors.

Given these concerns with modern agricultural supply chains, Value chain upgrading processes are increasingly being promoted as an intervention framework for rural development.

Value chain upgrading is the process of improving the competitiveness of the value chain by improving product quality and production efficiency, or changing value chain functions, governance or end markets (Humphrey and Schmitz, 2002).

alue chain upgrading can be complementary to broader development where processes seek to organise and support the livelihoods of smallholders and other value chain participants (Kelly et al., 2015), whilst providing mutual benefits for downstream value chain participants.

The emergence of value chain upgrading has occurred in parallel with the evolution of agricultural supply chains. Firstly, rural communities are increasingly exposed to public and private standards or food quality and safety to access new domestic and export markets. Investments are also being made by modern retailers and processors in transitioning economics to meet new demand segments - known as the “Supermarket revolution” (Barrett et al 2020). These retailers and processors have increasingly sought greater vertical coordination in the supply chains by more closely engaging with smallholders through contract farming or outgrowing schemes. Finally, increasing incomes and preferences in high value markets are seeking assurance over social and environmental traits in the products they consume, increasing the incentives of private businesses to engage in accreditation schemes such as Fair Trade and Rainforest Alliance.

Increasingly value chain upgrading is being considered as a more direct vehicle for rural development outcomes. Value chain upgrading has been adopted by organisations such as the FAO (Kelly et al., 2015) and UNDP (2015), and represents a key focus area for large NGOs (Oxfam-International, 2019) and ACIAR (2020). Smallholder dominated, export orientated value chains, such as coffee, cocoa, vanilla, and other tree crops have received particular attention in value chain upgrading processes given production is closely linked to a large number of poorer communities (Vicol et al., 2018, Ros-Tonen et al., 2019).

Value chain upgrading in smallholder dominated value chains is often achieved through differentiation along product attributes based on quality, ethical or sustainable “content”, which has increasing global demand in more developed countries (Ponte, 2002, Reardon et al., 2009). Value chain upgrading processes can seek to provide market access and new economic opportunities for smallholders and poorer rural communities in these niche markets, thereby contributing to development outcomes through potentially higher incomes and reduced risk.

For value chain upgrading to be an effective vehicle for development outcomes in rural communities, value chain upgrading must meet three necessary factors:

• Value: Value chain upgrading activities must generate meaningful income increases for participants accounting for the additional effort/cost that may be required for participation. Value may also consider other benefits from participation beyond incomes that are valued by participants, such as assurance over price, and other support services such as financial management and agricultural extension.
• Inclusivity: The inclusive factor relates to the distribution of value across the rural community. An inclusive value chain has limited barriers to entry for anyone seeking to engage with the value chain. Inclusive value chains will have broader engagement with smallholders, women, youth, and those without land, rather than focusing on larger farmers.
• Scalability: A scalable value chain upgrading activity is one that can grow and support more people over time in a way that is sustainable. This requires the value chain to remain financially self-sufficient, have effective governance structures and remain competitive for end markets.

Why has value chain upgrading failed to deliver broader development outcomes? The “Crowdy Three”

A significant number of studies have considered whether value chain upgrading processes provide broader development outcomes for rural communities (see Oya, 2012, Ton et al., 2018, Bellemare and Bloem, 2018, Oya et al., 2018 and German et al 2020 for a review of this literature).

However, evidence suggests that value chain upgrading is often strongly associated with ‘elite capture’ wherein wealthier and/or more socially powerful households are able to capture opportunities more effectively than poorer households (Vicol et al., 2018, German et al., 2020). Whilst these households are often able to derive value from participation through higher incomes or new market opportunities, this value is concentrated only within a few households who are relatively well off.

In some cases value chain upgrading avoids this elite capture issue, but the value of participation in terms of average income have been shown to be lower (Ton et al., 2018). In the literature, this has been defined as adverse inclusion, where the participation of smallholders in a value chain leads to low or diminishing returns due to unfavourable terms of engagement (Herrmann and Grote, 2015, Ros-Tonen et al., 2019). In other cases adverse inclusion in value chains can be related to other aspects of welfare such reducing women’s empowerment, exposing smallholders to additional risk, or trapping households in cycles of indebtedness (German et al., 2020).

The issues around elite capture and adverse inclusion directly relate to underlying factors that are required for value chain upgrading to be an effective vehicle for development outcomes. We have summarised these factors as the ‘Crowdy Three’ because two of these factors can be solved using traditional value chain upgrading models but not all three at once – i.e. ‘three is a crowd’. The linkages between these three objectives, and how they relate to existing supply chain models is shown in the figure below.

Figure 1: The ‘crowdy three’ – how traditional value chain upgrading fails to achieve either inclusivity, scalability, or high-value objectives

The trade-off between transaction costs and asymmetric information and how it relates to the Crowdy Three

Transaction costs between producers and downstream firms, and asymmetric information about product traits such as quality, are core to why value chain upgrading efforts suffer from the Crowdy Three.

Asymmetric information is prevalent over hard-to-observe traits in production outputs. These can include product quality in quality-focused value chain upgrading (e.g. the quality of coffee cannot be observed at time of purchase), or other important credence attributes such as social and environmental factors in production. Producers face costs to produce higher quality outputs, and quality monitoring typically occurs on an aggregated basis by downstream firms. This creates free-rider incentives, where individual producers face incentives to lower the quality of their own produce and pass it off as higher quality in order to take advantage of low levels of quality monitoring at an individual level. These incentives lead to a lowering of quality incentives over time and an associated reduction in aggregate quality. This is the typical race to the bottom outlined in the classic Akerlof (1978) “market for lemons” summarised below, and means that participants in these value chains face low value from participation even if barriers to entry are low.

Figure 2: Akerlof’s (1978) “Market for Lemons”

alue chain upgrading typically seeks to resolve these unobservable quality attributes to access new markets, albeit by trading off inclusivity objectives to maintain the financial viability of incentivising quality. To observe traits such as quality or credence attributes, procuring firms face substantial quality monitoring costs under standard approaches to quality measurement. These transaction costs include monitoring programs over production and outputs to provide assurance over hard-to-observe traits, and monetary incentives to the producers for repeated contracting over time. To minimise transaction costs, monitoring programs in high-quality value chains ubiquitously involve contracting with a smaller number of larger primary producers and lead firms.

This ‘relationship’ approach to overcome information asymmetries has been widely leveraged across commodities, such as contract farming in horticulture (Ton et al 2018, Bellemare and Bloem 2018) to relationship-based coffee value chains (Vicol 2018). It is often claimed as an ethical approach to contracting, but the evidence and theory indicate create elite capture concerns because the incentives for lead firms are to engage with a smaller number of larger and better-connected farmers (Ton et al 2018, Vicol 2018).Farmers may also face upfront transaction costs to participate in these value chains (e.g. invest in higher quality production processes) or face non-monetary barriers to entry such as exclusion from farmer cooperatives, which reinforces the elite capture problems with relationship approaches.

One component of the Crowdy Three not yes discussed is scalability. Indeed, value chains may both be inclusive and provide value for participants. But because increasing cost of maintaining relationships across member bases to provide assurance over product quality, these value chains tend to be uncompetitive as they scale without external funding from development programs or Governments. The governance of these value chains also tends to be unstable, meaning that as these value chains scale, they either tend to fail in terms of inclusion (i.e. trend towards elite capture) or value (adverse inclusion). This is driven both by local elite capturing the benefits from value chain upgrading (e.g. Vicol 2018), and where ownership and governance of value chains becomes increasingly concentrated to larger firms who increasingly seek to reduce contracting costs (German et al 2020).

For value chain upgrading to be an effective vehicle for development outcomes in rural communities, the trade-off between information asymmetry and transaction costs needs to be resolved.

Other concerns with value chain upgrading

The ‘Crowdy three’ may be a critical factor in establishing high value, inclusive value chains for rural communities. However, value chain upgrading faces several other concerns can limit the effectiveness of these value chains in providing development outcomes in a way that is scalable.

Firstly, the power imbalances in export orientated value chains are another source of adverse inclusion where little benefits flow onto primary producers even where information asymmetries can be resolved. Large, lead firms have incentives to extract rents from the value chain if the negotiation position of farmers and other upstream firms is limited. The dominance of retailers and processers in western countries also means limited value-add opportunities for downstream value chain activities are conducted in developing countries.

Secondly, the concept of inclusion is multi-faceted and goes beyond farming households participating as primary producers in the value chain. An inclusive value chains must also consider the barriers to entry for landless poor either as on-farm labour or as employees in downstream activities, and whether value can be derived for their participation. The inclusion of women, youth, Indigenous people, and other marginalised groups may appear obvious, but is often difficult because these groups tend to be less involved in existing farmer groups and cooperatives. As these farmer groups and cooperatives are typically leveraged when establishing value chains upgrading programs, engagement of marginalised groups requires additional effort and costs, but the benefits in terms of development objectives can be significant.

Finally, participation must not prevent households pursuing better, alternative opportunities by trapping them in unfavourable contracts or debt. Often the most effective development pathway for rural households is to pursue diverse income generating opportunities such as off-farm income. Contracts in value chains may prevent households from pursuing off farm income due to higher labour expectations or prevent the households exiting the value chain entirely due to debt obligations. Even if the value chain can provide marginal value from participation from price premiums, the long-term development implications may be worse from participation.

How is Heuris seeking to overcome the “Crowdy Three” in value chain upgrading?

To create inclusive, high value, and scalable value chains, the trade-off between information asymmetry and transaction costs needs to be eliminated. This requires efficient quality assurance and monitoring for the lead firm and for the farmers, with little to no barriers to entry from participation such as upfront investments for farmers. Methods include digitalisation of procurement and payment systems to reduce transaction costs associated with cash payments, and efficient quality assessment at the time of buying.

Other factors that need to be successful for the value chain to provide scalable development outcomes includes:

• Effective and transparent governance structures that prevents elite capture and can scale to new participants and regions at little cost.
• Incentives for value retention in producing countries, including value-add activities such as processing.
• Efficient methods in engaging with smaller and more marginalised groups, and incentives for procuring firms to engage with these groups.
• Methods to ensure value flows to landless poor through employment opportunities and wage premiums.
• Reduced tie-in through contracting to reduce transaction costs and maintain flexibility for households to exit and re-enter the value chain.

Solving all these factors simultaneously is complex, but at Heuris we embrace this complexity and are considering all these factors in the design of inclusive and high value agri-food value chains. This includes our role in developing the ‘Smallholder Inclusive Value Chains’ (SIVC) project. SIVC is a trial program that has been operating since 2018 that seeks to generate substantial value from accessing, at scale, high-value coffee markets for Ugandan coffee farmers. The program involves a novel digitisation, governance, and procurement regime that has been proven to generate substantial value improvements for export coffee and that achieves very high levels of inclusivity of smallholder farmers, women, and youth.

The trial program has been running for 4 years, doubling in scale (or more) each year and has generated a range of business and social value targets including:

Value to farmers: an increase in value to farmers of, on average, 20%-40% compared to normal market prices. This is equivalent to an increase in income worth over 1.5 months of normal labour and enough to send a child to school for an entire year.

Value retention in Uganda: An increase in the value of coffee sold of 148% compared to the average Arabica coffee sold in Uganda and of 49% compared to the highest-grade Mt Elgon Arabica coffee sold in 2021.

Smallholder focus: An average accepted lot size of approximately 50kg (an amount that can be harvested by one individual within ~3 hours) and a very high number of contributing farmers per tonne of equivalent green coffee (~30 farmers per tonne) compared to any high-value program currently in operation.

Inclusivity: Over half of the volume of accepted coffee provided by youth and 40% by volume by women.

Scalability: Operating a distributed network of buying agents that require no capital and for which governance issues are essentially non-existent (safety, financial accountability).

Financial sustainability: A proven business model that is financially sustainable.

If you’d like to know more about smallholder inclusive value chains or would like us to help you with your value chains problems, get in touch with us at Heuris. Our website has more details of SIVC and our associated quality assurance and procurement solution ADaPT.

Figure 3 – Training of farmers and pickers in the Smallholder Inclusive Value Chain

References

ACIAR 2020. ACIAR Annual Review 2019-2020. Canberra, Australia: ACIAR.

Akerlof, G. A. 1978. The market for “lemons”: Quality uncertainty and the market mechanism. Uncertainty in economics. Elsevier.

Barrett, C. B., Reardon, T., Swinnen, J. & Zilberman, D. 2020. Agri-food value chain revolutions in low-and middle-income countries. Journal of Economic Literature.

Bellemare, M. F. & Bloem, J. R. 2018. Does contract farming improve welfare? A review. World Development, 112, 259-271.

German, L. A., Bonanno, A. M., Foster, L. C. & Cotula, L. 2020. “Inclusive business” in agriculture: Evidence from the evolution of agricultural value chains. World Development, 134, 105018.

Herrmann, R. & Grote, U. 2015. Large-scale agro-industrial investments and rural poverty: evidence from sugarcane in Malawi. Journal of African Economies, 24, 645-676.

Humphrey, J. & Schmitz, H. 2002. How does insertion in global value chains affect upgrading in industrial clusters? Regional studies, 36, 1017-1027.

Kelly, S., Vergara, N. & Bammann, H. 2015. Inclusive business models. Rome: Food and Agriculture Organization of the United Nations.

Oxfam-International 2019. Fighting inequality to beat poverty: Oxfam International annual report 2018-19. Nairobi, Kemya.

Oya, C. 2012. Contract farming in sub‐Saharan Africa: A survey of approaches, debates and issues. Journal of Agrarian Change, 12, 1-33.

Oya, C., Schaefer, F. & Skalidou, D. 2018. The effectiveness of agricultural certification in developing countries: A systematic review. World Development, 112, 282-312.

Ponte, S. 2002. The latte revolution'? Regulation, markets and consumption in the global coffee chain. World Development, 30, 1099-1122.

Reardon, T., Barrett, C. B., Berdegué, J. A. & Swinnen, J. F. M. 2009. Agrifood Industry Transformation and Small Farmers in Developing Countries. World Development, 37, 1717-1727.

Ros-Tonen, M. A., Bitzer, V., Laven, A., de Leth, D. O., Van Leynseele, Y. & Vos, A. 2019. Conceptualizing inclusiveness of smallholder value chain integration. Current Opinion in Environmental Sustainability, 41, 10-17.

Ton, G., Vellema, W., Desiere, S., Weituschat, S. & D'haese, M. 2018. Contract farming for improving smallholder incomes: What can we learn from effectiveness studies? World Development, 104, 46-64.

UNDP 2015. Realizing Africa's wealth: Building Inclusive Businesses for Shared Prosperity.

Vicol, M., Neilson, J., Hartatri, D. F. S. & Cooper, P. 2018. Upgrading for whom? Relationship coffee, value chain interventions and rural development in Indonesia. World Development, 110, 26-37.

World Bank 2020. Poverty and Shared Prosperity 2020: Reversals of Fortune. Washington, DC: World Bank