POLICY IMPLICATIONS OF TRENDS IN AGRIBUSINESS VALUE CHAINS

This is an Accepted Manuscript of an article published by Taylor & Francis in The European Journal of Development Research in December 2006, available online: http://www.tandfonline.com/10.1080/09578810601070704 POLICY IMPLICATIONS OF TRENDS IN AGRIBUSINESS VALUE CHAINS John Humphrey Institute of Development Studies University of Sussex Brighton, UK August 2006 Summary Production and export of non-traditional agricultural products offer potential for economic growth and poverty reduction in developing countries. However, market access for small farmers is being undermined by the increasing complexity of global value chains in agribusiness. Increasing vertical coordination in global agribusiness value chains changes the requirements placed on small farmers. Policies aimed at supporting such farmers need to be realistic about the prospects for small farmer upgrading by large firms in global value chains and about how to respond to the new challenges posed by public and private food safety standards. In the light of these challenges, consideration should to be given to policies that shift small farmers away from the most demanding global markets and global buyers. I. INTRODUCTION A large part of poverty reduction strategies developing countries, particularly in Africa, is predicated on expanding agricultural production and improving the output and capabilities of small farmers. In recent years, there have been numerous successes in the production and export of non-traditional agricultural exports. However, the value chains for these products typically display greater coordination between enterprises along the value chain, as discussed by the Dolan and Humphrey [2000; 2004]. 1 This is evident in the complexity and intensity of information flows between firms in value chains and the greater coordination of activities along value chains. This level of coordination has been attributed predominantly to the increasing importance of buyer service requirements such as product variety, just-in-time delivery, and improved quality. However, this is only one part of the transformation. Equally important is the proliferation of public and private standards in the food industry. 2 These respond to concerns about food safety, healthy eating, the origin of food products, animal welfare, environmental impacts and social impacts. These pressures provide opportunities for adding value and for product differentiation by producers in developing countries, but they also create reputational and regulatory risks for global buyers and drive the introduction of process controls at all stages in food value chains. 1

This paper argues that value chain governance and food standards interact in complex ways. Together they create new challenges for food systems in developing countries. In turn, this creates new challenges for agriculture development programmes. This paper examines underlying trends in the global food industry and their implications for policy interventions to promote agriculture development and poverty reduction in developing countries. It identifies four trends leading to increased vertical coordination in value chains and then considers three issues for policymakers: the extent to which greater value chain coordination creates possibilities for private sector actors to support small farmer upgrading; the response of donor agencies to the challenges posed by public and private standards in export markets; and, alternatives to promoting small farmer involvement in agribusiness export chains. II. FOUR TRENDS IN GLOBAL AGRIBUSINESS In recent years, global markets for food products have been changing rapidly. There has been a dramatic shift in a way that food is traded. Trade in food through spot markets, characterised by intermediaries and bulking of produce (combining the output of various small producers to create larger volumes, but thereby losing traceability) has declined in importance. In such markets, information flows are limited because product identity is not maintained, and there are break points in the chain, such as auctions. Goods and money flow up and down these chains, but little else. Greater coordination in global value chains, as exemplified by the 'field to fork' approach, eliminates these break points and increases the amount of information flowing along value chains. In addition to products and money, other things flow along value chains, including finance, scheduling information, technical knowledge and buyer requirements. In other words, the intensity and scope of value chain interactions increases (more information about more things, and more resource close) and the span over which these interactions take place also increases. There is no one, single driver of this change. Four elements of the transformation are highlighted in this section. Retail concentration and power The increasing prominence of large retailers in the global economy has been widely discussed in recent years. In Europe, the five largest food chains increased their share of total retail food turnover from 13% in 1990 to 26% in 2000 [Jacobsen, 2002: 7]. 3 In the United States, the top five food retailers increased their share of the United States market from 27% in 1992 to 43% in 2000 [Wrigley, 2002: 63]. Concentration in the retailing of fresh and processed food has led a substantial reorganisation of agribusiness value chains. One aspect of this has been a shift in the balance of power between retailers and processors/manufacturers of food products: "With the substantial consolidation of retail and procurement markets at both the national and aggregate EU level, the nature of the supply chain has changed considerably. Where manufacturers may traditionally have driven distribution by developing brands and then used a network of wholesalers and retailers to 2

sell and distribute goods to consumer, it is now retailers who mostly drive the supply chain" [Dobson et al., 2003: 121]. Large buyers have transformed themselves from resellers of products made by others into firms that go out to find suppliers for the products that they want for their customers. Increasingly, they play a role in product development, branding, supplier selection and distribution. 4 This is evidenced by the increasing importance of private label produce in supermarket sales in the 1980s and 1990s, particularly in northern Europe [see Dobson Consulting, 1999: 50]. In order to achieve these goals, retailers have transformed global value chains. The most direct consequences of this process have been seen in the sourcing of fresh produce, are nowhere more so than in parts of northern Europe, particularly the Netherlands and the United Kingdom. 5 In the United Kingdom, supermarkets acquired a dominant position in fresh food retailing by the mid-1990s, selling more than 75 percent of fresh produce [Gray and Kleih, 1997: 30]. Sales of fresh produce (fruit and vegetables) were seen as critical for attracting higher-spending customers. The supermarkets developed competitive strategies based on increasing the range, quality, year-round availability and pre-processing of fresh produce. Later, a combination of inter-firm competition (product differentiators are quickly copied by rivals) and consumer concerns about food safety, animal welfare and the environmental and social impacts of food production led to further innovations, including product differentiation, through the development of new product characteristics (for example, organic, Fairtrade, environmentally-friendly, etc.). The second element of the supermarket strategy was to maintain brand image, and to this end the supermarkets worked to devise systems that would reduce the risks of damage to brand image from their supply chains being associated with unsafe food, poor working conditions or negative environmental impacts. This meant responding to changing regulatory requirements such as reductions in pesticide residues in fruit and vegetables and accompanying consumer trends such as increased environmental concerns. These goals could not be achieved while continuing to use wholesale market distribution channels. The supermarkets replaced the arm's-length market relationships of the wholesale chain with more durable, information-intensive relationships. This allowed them to specify how products should be grown, harvested, transported, processed and stored, and to work with suppliers on product innovation. It also allowed them to have more directly control over food safety, labour and environmental standards in the value chain. Inevitably, this meant supply chain concentration. Supermarkets worked with preferred importers and their suppliers, monitoring activities along the chain and using their market power to exercise control along the chain. As gatekeepers to substantial parts of the total European food market, supermarkets have sufficient power to impose their strategies on their suppliers. 6 The impact of these changes on the horticulture sector in Kenya has been described by Dolan and Humphrey [2000; 2004]. It led to the emergence of a small number of large, technically competent fresh produce exporters, that added value through production management (on company farms, through working with large 3

contract farmers and through the management of outgrower schemes), post-harvest processing, logistics and product innovation. Increasing retailer power is not confined to developed countries. Supermarket penetration of food retailing is also increasing in developing countries, as documented by Reardon and others. In Latin America, supermarket shares of food retailing have reached European levels in cities such as São Paulo [Reardon et al., 2003: 1143], and it is argued that the same processes are occurring, albeit at a less advanced stage, in other continents. Reardon and others argue that this will create a shift to preferred suppliers and the use of supermarket's own grades and standards along the lines already seen in developed countries [Reardon et al., 2003]. As a result, suppliers for the domestic market will come to face the same pressures as those already experienced by suppliers selling into export markets. Increased concentration at multiple points in food value chains Retailing is not the only part of agribusiness showing increasing concentration. It is also evident in the upstream parts of value chains, such as seed supply, where concentration in the seed industry and in the ownership of plant variety rights have been documented by Srinivasan [2003]. At the opposite end of food value chains, the growth of large chains in the fast-food sector and a shift towards reduced numbers of suppliers has led to concentration back along the chain, as documented by Schlosser [2001: 136-37] for the impact of McDonald's sourcing policies on the structure of the beef industry in the United States, and by Mateos and Capezio [2001] for the consequences of the sourcing strategies of fast-food companies for potato production in Argentina. In both cases, the scale and market power of fast-food companies enabled them to drive local agricultural production systems towards larger producers using more technology-intensive methods and to larger, more centralised food processing plants. Of particular interest are trends in the food processing industry and their implications for value chain governance. These have been extensively researched in the United States. In the case of the pork industry, for example, there are clear indicators of increasing concentration and increased vertical coordination: The four-firm concentration ratio for pork packers increased from 37% in 1987 to 59% by 2001 [Hendrickson and Heffernan, 2002]. The size of production units has increased. Production operations with an inventory of more than 1000 hogs raised heir share of the total number operations from 37% in 1987 to 47% in 1992 and 71% in 1997 [Martinez, 1999: 9]. Production coordinated through production contracts or direct ownership of production units by processors increased from 11% in 1993 to 59% in 1999 [Lawrence et al., 1997: 24; Martinez, 1999: 10-11]. The extent of the integration between producer and buyer varies from agreements about timing, pricing and quantities to the buyer providing detailed specifications of production processes and being involved in "the management of farm production and the provision of important inputs" [Martinez, 1999: 13]. 4

The driving forces for these changes in value chain structure and governance are fivefold. First, large processors with large processing plants need assured, scheduled supplies to keep facilities fully utilised. Working with small numbers of large suppliers operating to specific production schedules meets this need. Second, close coordination with suppliers helps to improve quality. Improved quality or reduced risk of poor quality is the benefit of contracts most cited by processors, and working with larger suppliers with long-term contracts provides greater opportunities for rewarding and securing higher quality inputs [Lawrence et al., 1997]. Third, turning independent producers into contracted pig farmers allows processors (should they wish to do so) to profit from the supply of inputs into the production processes of their captive suppliers. Fourth, processors may seek to secure consistency and productivity improvements by playing a more direct role in the management of the contracted units. Finally, to the extent that the meat packers provide inputs and take a role in farm management, they are better placed to drive technological change through the value chain. Such trends are not confined to the will sector in the United States clearly echo earlier trends in other parts of agribusiness. Martinez observes that "Many of the current structural changes in the pork industry resemble past changes in the broiler industry" [1999: 8]. Such transformations are also taking place in developing countries. Landes [2004] has commented on the beginnings of such a transformation in the poultry sector in India: "While independent and relatively small-scale producers still account for most production, relatively large-scale integrated producers account for a growing share of output in some regions. Integrated operations include large regional firms that incorporate all aspects of production, including raising grandparent and parent flocks, rearing day-old-chicks (DOC), contracting production, compounding feed, providing veterinary services, and wholesaling" [Landes et al., 2004: 10]. Similarly, Reardon and Farina have documented concentration and the dairy industry in Brazil and its consequences for small farmers. In the 1990s, leading processors developed new quality and safety standards in order to improve the efficiency of processing and assure consumers that their products were safe. The consequence was concentration at the producer level, with fewer, larger farmers supplying the large processors [Reardon and Farina, 2001: 419-420]. Standards Value chain coordination is not only driven by the competitive strategies and lead firms. Standards in the food industry also play an increasingly large role. The range of public and private institutions that define standards in the food industry bears eloquent witness to the increasing importance of global standards. Alongside public standards, sponsored by governments, there is an increasing range of company standards promoted by individual companies and collective private standards [Fulponi, 2006 refers to them as private voluntary standards ] developed by coalitions of private sector companies. 5

The increasing scope and stringency of public standards reflects in large part public concern about food safety. Food safety has moved up the agenda in industrialised countries in recent years as a result of a series of food scandals: dioxins, BSE ("mad cow" disease), pesticide residues, cyclospora contamination in raspberries, salmonella in eggs, contamination of dairy products, etc. These have led to a crisis in consumer confidence that both governments and food companies have struggled to address. Governments have responded by introducing new and more stringent standards. In the case of the European Union, the standards have included more stringent maximum residue limits for pesticides and veterinary drugs, controls over heavy metal contamination and greater controls for processing plants, including the application of HACCP (Hazards Analysis and Critical Control Point) risk control procedures to suppliers of dairy, meat, and fish products. 7 Alongside these public, mandatory, process-based standards, there are an increasing range of collective private standards, developed by coalitions of private sector companies. These include EUREPGAP for the horticulture sector, the British Retail Consortium standards of food processing plants (and its European equivalent, the International Food Standard), Safe Quality Food, the Global Aquaculture Alliance's Best Aquaculture Practice standard, etc. The common trends in these public and private standards are three-fold: controls over processes rather than products, the maintenance of identity and traceability and a whole chain approach. One example of the transition from product controls to process controls is the adoption by many countries of HACCP in food processing. Overall, process controls have two main objectives. First, they provide a more efficient way of ensuring that products conform to their desired characteristics: "There is growing adoption in the food industry of management practices that focus on prevention and control of food safety hazards. Many hazards are expensive to test for and may enter food products at several points in the production process. Therefore, documented production practices, that are verified to prevent and control hazards, are becoming accepted as the most costeffective means of reducing food safety hazards. While testing and verification are essential for establishing good process controls, testing can never be practical as the only means of monitoring safety" [Unnevehr, 2000: 235]. Second, process controls allow regulation of characteristics of food and food systems that are not intrinsic to the outputs they produce. Process controls are the only way of regulating child labour, environmental impact, etc. In these cases, it is the characteristics of the process rather than the product that have value. Process controls have to be complemented by steps to maintain traceability. This is partly a goal in its own right, as it is a basic requirement for responding to food safety problems. 8 It is also essential for maintaining the integrity of process standards. Traceability establishes a link between a particular product and the processes further back along the chain that contributed to its creation. It is one way of ensuring that particular items of food have been sourced from certified farms and processing plants. 6

Finally, food safety systems are moving to a 'whole chain approach' as exemplified by the regulation that established the European Food Safety Authority. This states that food safety requires consideration of "all aspects of the food production chain as a continuum from and including primary production and production of animal feed up to and including sale or supply of food to the consumer because each element may have a potential impact on food safety" [CEC, 2002: paragraph 12]. This approach to food safety creates real challenges for developing countries. The whole chain approach, with its emphasis on process controls and traceability, was developed to control national (or EU) food systems, but this occurred just when the challenges to exercising food chain control increased as a result of global sourcing. Global sourcing means that food value chains are elongated and fragmented across both different enterprises and across space. This creates new sources of risk as food is transported and processed to a greater degree and greater challenges for coordination and control. The global food trade also brings together quite diverse food production systems that are heterogeneous in terms of producer characteristics, regulatory frameworks, environmental conditions, technical expertise and consumer preferences. Part of the strategy for meeting this challenge is the search for equivalence (that food produced in different countries can be guaranteed to reach the same level of safety as that in the EU because national food safety systems are equivalent to those in the EU). However, the EU also places considerable responsibility on the private sector. The General Food Law states that food business operators should have "primary legal responsibility for ensuring food safety" [CEC, 2002: paragraph 30]. This, and similar legislation which preceded it, such as the UK Food Safety Act 1990, 9 places a legal burden on private companies in the food industry. The guidance notes issued by the EU for the General Food Law states that food business operators should actively participate in implementing food law requirements by verifying that such requirements are met [CEC, 2004: 6]. These legal obligations have been reinforced an extended by NGO and consumer activism, which increasingly holds leading brand-name companies responsible for what happens in their supply chains. These responsibilities, combined with the need to simplify the management of global food sourcing, have generated an the explosion collective private standards developed by "private firm global coalitions of leading firms for setting standards for food" [Fulponi, 2006: 3].. These private standards incorporate the same principles of process controls, traceability and a whole chain approach. Such standards are a direct response to the increased stringency of public standards and the obligations they place on food companies. According to Fulponi, Third party certification and traceability required of suppliers is one of the responses to the risk of civil or criminal responsibility as well as setting standards above minimum levels to ensure a margin of defence [Fulponi, 2006: 9]. Product differentiation and credence claims In a globalised world, one response to competition has to differentiate products and add value. The overall trend to product differentiation and increasingly complex value chain linkages has been driven in large part by trends in retailing, which has been called branding from above. Such branding is seen in private company standards 7

such as Tesco's Nature's Choice, which is also based on third-party inspection and certification of suppliers, creating new forms of control along the value chain, while at the same time establish credible bases for claims about environmental impact, food quality, etc. Nevertheless, retailers are not the only actors in this field. Product differentiation is also a strategy of producers and intermediaries (producer associations, traders, NGOs, certification companies, etc.). "Branding from below" has been used by these actors in response to declining prices for agricultural commodities and increasing competition from new entrants to global food markets. Products can be differentiated on the basis of quality, environmental impact, origin, community development, animal welfare, etc. In the words of a World Bank report on coffee, they are part of a strategy to move "outside of the commodity box" [Lewin et al., 2004]. Product differentiation based upon such claims is part of a broader trend towards the increasing importance of credence characteristics in the food industry. Reardon et al. [2001: 424-5] defined in the following terms: "A credence good is a complex, new product with quality and/or safety aspects that cannot be known to consumers through sensory inspection or observationin consumption. The quality and safety characteristics that constitute credence attributes include the following: (1) food safety; (2) healthier, more nutritional foods (low-fat, low-salt, etc.); (3) authenticity; (4) production processes that promote a safe environment and sustainable agriculture; (5) 'fair trade' attributes (e.g., working conditions)." These claims differentiate the credence goods from standard products by identifying particular characteristics that give them increased value. They act as a form of product branding, identifying particular labels with particular characteristics that may be valued by consumers. Such branding from below has been developed by a range of organisation. These include private companies, such as Thandi in South Africa, which uses black empowerment as its differentiating characteristic, producer associations (for example, the Kenya Flower Council scheme), and labelling schemes developed to identify particular characteristics of product or production processes originating from designated producers Fairtrade is one example, organic production another. The full potential of such product differentiation is hard to establish. In the case of the coffee sector, the overall penetration of what has been labelled "sustainable coffees", which includes certified organic, Fairtrade, and ecofriendly coffees, is not large in absolute terms. The market share of sustainable coffees in Europe in 2001 averaged 1.6% [Lewin et al., 2004: 118-120]. Nevertheless, the returns can be high: "Today s flooded commodity market is but one instance where many producers earn minimal prices and barely recover their costs while many sustainable or differentiated coffees sell at considerable premiums. Furthermore, a number of other benefits accrue to growers and their communities that follow sustainable growing practices that are somewhat independent of the success or failure of sustainable coffees in the marketplace" [Lewin et al., 2004: 126]. 8

As with the other trends highlighted so far, these credence claims have implications for value chain organisation. Credence claim are difficult or impossible to verify through inspection of the product. A credence claim such as Fairtrade for example, requires some form of inspection to establish the claim in a credible manner at the point of origin. It then follows those products subject to credence claims need to be traceable and to have their identity secured as they move along the value chain. They have to be kept separate from products that do not possess the credence characteristics. This requires collaboration between different agents along the value chain, stretching from the point of production (or even inputs into production) to the marketers responsible for branding products in the destination markets. III. NEW CHALLENGES FOR TECHNICAL ASSISTANCE PROGRAMMES The changes in agribusiness value chains outlined above have moved the markets for more dynamic agricultural products away from spot markets characterised by standardised products, small intermediaries and bulking of produce. The danger is that the new requirements of global value chains customisation of products, greater control of risk and a high degree of coordination along the chain will undermine the cost advantages enjoyed by small farmers and require capabilities that they cannot offer. If they can meet the requirements, there are frequently benefits such as higher prices, more stable demand and flows of technical assistance from within the chain. Therefore, there is a lot at stake. Donor programs aimed at supporting small farmers in particular and agricultural development and poverty reduction more generally need to recognise the new challenges and opportunities. Here, three issues for donor programs are addressed: If farmers are expected to meet new requirements in terms of what they produce and how they produce it, to what extent can private sector companies in the value chain be mobilised to support upgrading? In other words, can donors expect agribusiness buyers to collaborate with efforts to help small farmers meet new market demands? To what extent do changing standards and increased use of process controls alter the way in which donor should approach the challenges involved in maintaining or enhancing the participation of small farmers in agribusiness export markets? This issue will be addressed with specific reference to the challenges posed by the EUREPGAP standard for horticulture. If the requirements of high-value export markets are becoming more complex, are there alternative markets and strategies for agricultural development that might be more effective in ensuring that agricultural development contributes to poverty reduction? Under what circumstances do lead firms enhance knowledge flows and upgrading in value chains? The increasing importance of vertical coordination in agricultural value chains has led to an appreciation of the potential role of value chain linkages in knowledge flows along chains and supporting supplier upgrading. Clearly, the rapidly evolving nature of global markets means that knowledge requirements are continually changing with 9

respect to both products and processes (how to produce the right products both efficiently and in accordance with food safety standards). Increased vertical coordination in global value chains brings buyers and suppliers closer together and offers the prospect of private sector knowledge transfers that should provide up-to-date and relevant information for producers, processors and exporters in developing countries. One of the criticisms of state-financed extension services in the past has been their failure to keep up with the latest knowledge and provide clients with the knowledge relevant to their needs. The increasing pace of technological development and reduced investment in public sector extension services only exacerbate this problem. Such transfers of knowledge are by no means automatic. In fact, the extent to which the knowledge flows within value chains are a basis for farmer development varies considerably, as was highlighted by a recent study of agricultural markets in Zambia. This study found that for local tomato producers, "All the supermarkets interviewed did not provide any technical assistance to their suppliers except information on crops the supermarkets wanted to buy and the grades and standards the farmers have to achieve" [Emongor et al., 2004: 34]. Assistance, when provided, came from NGOs. Nevertheless, the same study did find considerable technical support for local dairy farmers from international companies involved in milk processing: "Dairy farmers are receiving technical assistance from processor such as Parmalat and Finta. These processors collect milk in bulk from collection centres. They have also provided equipment to the milk cooperatives to test for the quality of milk at the point of purchase" [Emongor et al., 2004: 35]. This support was complemented by USAID-funded technical assistance project run by the large American producer and consumer cooperative, Land O' Lakes. Value chain analysis provides two analytical elements for explaining these differences. The first is the recognition that large buyers differ in capabilities and in requirements. Generally speaking, retailers are less likely to provide technical assistance. The typical large-scale retailer is responsible for sourcing hundreds, often thousands, of different product lines, and it does not have specialist knowledge of products. Rather than provide "solutions" (instructions and information on what needs to be done and how to do it), it provides "problems" (specifications about the types of products and services it wants), as in the tomato example cited above. Even when large retailers are involved in innovation, they are focused on the final product, not the production process. This puts the onus very much on firms further back along the value chain, notably importers and exporters, to provide suppliers with the support they need. 10 These firms are specialists, and to the extent that consistently meeting the demands of their major customers for specific volumes at specific times is central to their continuing success, they have a strong interest in promoting supply chain capabilities. For example, two UK fruit importers described how they worked closely with Brazilian exporters to diversify their ranges of mangoes and melons so that their established suppliers could match changing consumer preferences (sponsored largely by the supermarkets themselves). Similarly, if a UK supermarket wants Fairtrade flowers or EUREPGAP-certified passion fruit, the importers and exporters are under great pressure to provide them. One implication of this is that meeting the changing 10

demands of global markets does depend to some considerable extent on the capabilities of local agricultural systems to support to the technological capabilities of local supply chains. If these chains cannot meet new demands, global buyers will look elsewhere. Like specialist exporters and importers, processors are usually technical specialists. They focus on well-defined areas, such as livestock (or more specifically beef, pork, poultry, etc.) or dairy or particular types of fruit. They are particularly aware of the factors that lead to differences in yields or quality during the processing stage. Their understanding of the technical and economic impacts of differences in the products they process provides them with a knowledge base that can be used for improving productivity, particularly with captive suppliers. Processors can be drivers of technical change in agriculture. The challenge for development interventions is to mobilise this knowledge in the service of small farmer improvement, given that the search for improved quality and reliability of supply often leads to value chain concentration. In addition, there are other sources of knowledge that come from different parts of the value chain. This is particularly true for niche products, where major global buyers are struggling to catch up with the success with consumers enjoyed by organic produce, Fairtrade produce, etc. For example, it is a small German company, Naturland that has pioneered the production of organic shrimp. It was responsible for the certification scheme and label, defined the different processes and procedures required to produce organic shrimp, and worked together with multiple stakeholders (public, private and NGO) to create the necessary capabilities. The fact that knowledge is available does not mean that it is transferred. The second insight of value chain analysis is that firms try to minimise their transactions costs, and for buyers to invest in producer capabilities, and in particular in the capabilities of small farmers, they need to be able to appropriate benefits that arise from such investments. Provision of technical support for small farmers offers direct benefits to those providing it in the following circumstances: There is scarcity of supply, and technical assistance helps to lock in suppliers to a particular buyer. Scarcity can arise when new consumption trends develop. An example of such a situation would be the recent investments by European cocoa producers in outgrower schemes in the Caribbean and Latin America. These are partly driven by a scarcity of organic cocoa in the European market. It follows that when supply and demand become more balanced the use of outgrowers will have to be justified by factors such as cost competitiveness. Similar shortfalls of supply arise when regulatory requirements change. When the EU tightened up regulations on pesticide residues, exporters and importers had to drive innovation (for example, integrated pest management) along the chain so that the farming systems and controls over pesticides and pesticide use were in place at the farm level. Alternative sources of supply are restricted by land scarcity. It has been suggested that one of the reasons for continued sourcing from family farms in Eastern Europe is the lack of land freely available for large-scale farming [Swinnen, 2004]. In other words, given the lack of alternatives, processors may be willing to invest in the capabilities of family farms. The biggest 11

challenge the processors face is to devise mechanisms that tie farmers to them. If one assumes that the investments required are lower for larger and more capitalised farms, and for more educated farmers, then these are the ones that are likely to benefit most. Alternative sources of supply are restricted by transport costs. This is one of the reasons for processor investment in milk suppliers in Zambian: imported milk is expensive. Once again, if processors can appropriate the benefits from their investment, it pays them to develop a local supply capability. Over time, the supply of capable local farmers should rise, eliminating the need for technical assistance. The competitive advantages of particular localities are so great that they are indispensable to buyers. Product availability at particular times of year and advantages in relation to transport costs can make some locations indispensable to importers seeking a competitive, year-round supply, and therefore they will invest in capabilities in these areas if this is necessary. However, global buyers also try hard to eliminate such 'monopolies' by developing alternative sources of supply. Firms are trading on their image as socially responsible, or supporters of small-scale farming. In this case, there is a direct return to the buyer from the investment in the suppliers. These cases show that there are situations in which both producers and exporters in developing countries might receive technical assistance from buyers. Donors could build on this to promote public-private partnerships, but only if the private sector has an interest in obtaining the improved outputs from upgraded farms and cannot easily obtain them from other sources. The direct business case for investments by major retailers in supply chain capabilities in developing countries is limited. The involvement of large retailers in supplier upgrading in developing countries is more likely to be the result of policies related to corporate social responsibility, such as the UK government's Ethical Trade Initiative than because of supply chain considerations. Meeting developed country food safety standards The increasing importance of process standards, both public and private, presents big challenges for developing country food systems in general, and small farmers in particular. Donor agencies have invested in the capabilities of the public standards infrastructures of developing countries. They have also responded to the challenges facing small farmers, but it is not clear whether their interventions adequately address the implications of greater value chain coordination for the competitiveness of small farmers. This issue is examined through a consideration of the response of donors to the challenges posed in Kenya by the EUREPGAP standard for small farmer horticulture. Developed by the Eurep consortium of fresh produce importers and retailers, it primarily addresses food safety in horticulture (with some additional requirements relating to social and environmental standards). It introduces farm-level third-party audits and a paper-based system of record-keeping and control. Export horticulture has been regarded as a success story in an otherwise rather dismal economic landscape in Kenya. Small farmers have been able to participate in this success. 11 However, the market requirements for Kenya's most important market, 12

the United Kingdom, became notably more stringent in January 2005, after which point UK supermarkets required produce to be sourced from farms certified to the EUREPGAP standard developed by Eurep, a consortium of European food importers and retailers. In order to meet the EUREPGAP standard, farms or groups of small farmers, are audited by a third party. Farms have to conform with requirements relating to relating to food safety (particularly the control and use of pesticides), environmental impact and labour conditions. Demonstrating this conformance requires good agricultural practices (for example, management of chemicals, controls over pesticide spraying, worker hygiene) that are verified through equipment and procedures designed to ensure that requirements can be met and are followed in practice. This is backed up by extensive record-keeping designed to provide an audit trail demonstrating both compliance and the capacity of the system to control what happens on the ground. A variety of foreign donors responded the challenge by developing programs in the period 2004-06. Some initiatives were aimed at strengthening the national standards infrastructure and the capacity of local institutions to support initiatives around compliance with new standards, and a promoting both public and private sector support services. These include certification services, training services, pest control, etc. Here, however, the focus is on the donors' initiatives with respect to certification of small farmers. The donors correctly perceived that EUREPGAP was a threat to small farmer participation in export horticulture. 12 The issue is whether they perceived the problem correctly. In particular, did they understand the implications of vertical coordination for the success of their initiatives? The responses of donors appear to have been based on the following assumptions: 13 1. EUREPGAP would involve investments by small farmers in the chemical stores, etc. Financial support would be required. 2. EUREPGAP represented a significant change in farming practices. Farmers would need to be trained in order to become familiar with the requirements and how to meet them. 3. The cost of certification would be prohibitive to small farmers. One means of reducing these costs would be through group certification (usually referred to as Option 2, although there is some conflict in opinions within the industry about how groups of farmers can be organised and certified). Somewhat perversely, the January 2005 deadline for compliance seemed to provoke an increase in activities aimed at promoting small farmer involvement in export horticulture, just at a time when it was becoming much more challenging. It was as if EUREPGAP was seen as a guarantee of accessing the export market. This was a misunderstanding of the value chain. EUREPGAP is only required by EUREP members supermarkets and large importers, who have tended to work exclusively through a limited number of large exporters. 14 These large exporters sourced produce from small farmers almost exclusively through tightly-managed outgrower schemes. Initiatives to train large numbers of farmers about EUREPGAP irrespective of whether or not they were, or might be, incorporated into exporter outgrower schemes 13

were, consequently, futile. Fortunately, such initiatives were the exception, and most donors recognised the importance of working with exporters and outgrower schemes. The donor response, therefore, was to prioritise interventions that would reduce what were primarily seen as 'one-off', or start-up costs: initial training, group formation, preparation for the first certification and capital investment. On the assumption that there are considerable economies of scale in certification, subsidising these costs would offset the disadvantage faced by small farmers and reduce a possible tendency for exporters to shift their sourcing away from small farmers. The donor initiatives were certainly taken up by export companies. A majority of the largest fresh produce export companies were involved, directly or indirectly, with donor-funded schemes for farmer certification. However, these schemes rarely addressed the major cost disadvantage for small farmers, which is the increased cost of control. With a process-based system of food safety, the major costs lie not in setting up the system, but in running it. As well as complying with all the reporting requirements of the system (record-keeping, etc) and ensuring that farmers have the equipment and knowledge to operate it, exporters are also responsible for maintaining the integrity of the system. This involves three main challenges:(i) day-to-day management of the system, including detailed record-keeping at the farm or farmergroup level, (ii) supervision of outgrower schemes to ensure that rules are being followed correctly, (iii) reinforcement of knowledge about and commitment to the system's requirements through on-going training, and (iv) maintenance of the integrity of the system by ensuring traceability and preventing leakage of products into and out of the supply chain. 15 It is hardly surprising that exporters tend to view EUREPGAP as just one more imposition from their buyers and just one more thing that is liable to go wrong if close supervision is not maintained. While there are some advantages derived from introducing EUREPGAP, such as improved farmer practices, more efficient use of agrochemicals and clear reductions in alerts over excessive pesticides, the costs are also very substantial. This implies that one-off donor initiatives are unlikely to be decisive in securing the continued participation of small farmers. Therefore, donor interventions based on reducing start-up costs face two problems. On the one hand, they may be insufficient to offset increased small farmer disadvantage, with the result that small farmer involvement in EUREPGAP production will be unsustainable. On the other hand, exporters may have good reasons to continue outgrower schemes (for example, because of continuing small farmer cost advantages, or because of the social and political benefits of doing so), which means that donor interventions would be unnecessary. There is no simple answer to these challenges. What is clear, however, is that as the requirements of export markets become more complex, processors and exporters will play a pivotal role. Donors will have to work with large private sector companies and try to determine when their support provides genuine additionality. Alternative markets Given these challenges, it is worth considering whether a focus on small farmer exports to large buyers in the most challenging of global markets the EU, Japan 14

and the United States should be complemented by, or replaced by alternative strategies. At least four options merit investigation. The first option is to focus efforts on the potential of domestic and regional markets. Consumer demand and market structures are changing rapidly in developing countries as a result of factors such as urbanisation, increasing female participation rates and rising incomes (where they occur). Marketing outlets are also changing rapidly, as emphasised by the work of Reardon and others on the spread of supermarkets in developing countries [see, for example, Reardon et al., 2003]. However, there are still three important areas where better knowledge is required. First, the penetration of supermarkets in the fresh produce area is open to question. Even in São Paulo, the largest city in Brazil, the supermarket share of sales of fresh vegetables was much lower than for food retailing as a whole. Supermarkets accounted for 75% of total food sales, but only 25% of fresh food sales [Reardon et al., 2003: 1143]. 16 For fresh produce, traditional marketing channels remain an important outlet. Second, the extent to which supermarkets in developing countries will want to, or be able to, displace or transform small farm production along the lines suggested by the Reardon and others is open to question. Third, given the continued importance of traditional marketing channels, improving the efficiency of these channels could easily outweigh any potential benefits from the expansion of small farmer production either for export or for domestic supermarkets. A strong case for focusing on the potential of the domestic market is made for the case of Kenya by Muendo et al. [2004]. Unfortunately, some agricultural development programmes are focused exclusively on the export market. For example, the Zambian government, in cooperation with NORAD, provides support for outgrower schemes, but only those aimed at the export market [Emongor et al., 2004: 37]. A second option for small farmer promotion would be to examine the potential for niche products, and in particular those which are not sold through the major retailing outlets in developed countries. What needs to be clearly understood, however, is that marketing linkages are particularly important for niche products. The whole point of focusing a development strategy on niche products for consumers in export markets is that some special characteristics of the product are presented to the final consumer. This requires the identity and distinctiveness of the product to be maintained as it passes along the value chain, and for this distinctiveness to be 'sold' to the customer. In other words, it needs the whole chain approach, involving collaboration between producers and marketers. Regrettably, it is easy to find schemes aimed at promoting production of products such as Artemisia or essential oils by poor farmer communities that do not have a clear link to a buyer or market. Such coordination is not at risk-free. It tends to create an asymmetrical dependence. Producers rely on the marketer, but the marketers have multiple sources of supply. Dankers [2003: 47-8] cites the case of a Brazilian and Swedish NGO project to develop organic, shade-grown coffee production which brokered an arrangement with a Swedish coffee roaster, thereby securing a market outlet. While this project was initially successful, it took place at the time of continued growth in the global supply of organic coffee. With increased product availability, the Swedish roaster decided to discontinue purchasing from this particular cooperative. This is an example of the conditions under which buyers will commit to certain suppliers, as discussed earlier. 15