Agribusiness & Markets Key Concepts

1 Small farmers and markets ...................................................................................1 1.1 Self sufficiency vs commercial production .....................................................1 1.2 Factors limiting agro-enterprise development................................................2 The agro-industry system .....................................................................................2 2.1 The product chain ..........................................................................................2 2.2 Value addition ................................................................................................3 2.3 Agro-industry clusters ....................................................................................3 Competitiveness ...................................................................................................4 3.1 Competitiveness ............................................................................................4 3.2 Comparative advantage.................................................................................4 3.3 Competitive advantage ..................................................................................5 Marketing strategies..............................................................................................6 4.1 Marketing basics............................................................................................6 4.2 Market opportunities ......................................................................................6 Private and social benefits ....................................................................................7 5.1 Financial and economic returns.....................................................................7 5.2 Competitiveness and comparative advantage revisited ................................7 References and acknowledgements.....................................................................8

1 Small farmers and markets

1.1 Self sufficiency vs commercial production

Many small farmers have traditionally produced their basic food needs, and sold surpluses to provide for additional needs of the household. However, this livelihood strategy is increasingly seen as insufficient to raise rural incomes, provide the stimulus for rural development, and alleviate poverty. Some of the trends that are driving the need for change are summarised in a separate ICRA handout (Scenarios and Strategic Planning Key Concepts). Prime among these forces is the liberalization of international markets in agricultural produce, the increasing dominance and power of international corporations or supermarkets as market outlets for increasingly processed agricultural produce and demanding consumers, and the stagnating or decreasing world price of basic agricultural commodities such grain, coffee, cotton, sugar, etc. Even from a food security standpoint, it may be a better strategy to produce and sell higher value produce, and buy the more basic (and cheaper) foodstuffs needed. A common exhortation to farmers is therefore to produce what you can sell, not sell what you can produce. In todays world, in fact, many commercial farmers now produce what they have already sold under forward contract.

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1.2

Factors limiting agro-enterprise development

The need to diversify into new markets for higher value products, or add value to current products through improved quality, niche markets, etc. The need to build economies of scale to compete with large farms and increase bargaining power with buyers that require certain quantities, e.g. through collective action, farmer associations, etc.; The risks associated with change: e.g. the change to new production systems or to new relationships with other actors. The need to reorient research and extension from a supply-driven mode of generating information led by researchers to a demand-driven or client-oriented mode of service delivery. The need to improve information flows and develop synergy between the different actors in the production and marketing system.

Efforts to link small-scale farmers to markets face a number of constraints:

2 The agro-industry system

2.1 The product chain

The different economic activities that result in a marketed product can be represented as a system a system for producing and marketing fresh apples, for example. Another term to denote a similar concept is the product chain. The word chain denotes a linear sequence of mutually dependent and primary activities related to input delivery, production, processing, and marketing, etc. The product chain:

input supply chain

value or market chain

Other names that are sometimes used for (parts of) the chain include: input supply chain, for the downward or backward linkages from the farmer back to the input retailer, the transporter/importer and the producer of inputs such as fertilizers, seeds, etc. value chain or market chain for the forward linkages that link the farmer to the consumer, via the middle-man, processor, supermarket, etc. The word chain also emphasises that the different actors involved in the different links of the chain are mutually dependent. A weakness of one link will affect the price or attractiveness of the final product and hence all the actors will suffer. There is no point in spending scarce research and development resources on improving production on the farm, if the transportation of the product is expensive, or the processing and marketing are inefficient.

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2.2

Value addition

Each link in the value chain adds value to the basic product. Typically, the farmer only receives a fraction of the final value of the product (in terms of $ per kg of basic product) as sold to the consumer. The different prices reflect value added by the processes of transformation and commercialisation. Usually the added value is higher between the links of the chain closer to the consumer. The share of the farm gate price in the final consumer price in the supermarket is usually minor (e.g. about 35% in the case of milk in a British supermarket, or even less than 5% in the case of coffee or tea). A key strategy in improving rural incomes and livelihoods is therefore to add value to the product as sold on by the rural household i.e. to take a larger share of the final product price. Some of the ways in which value can be added to the products of small farmers include: Processing grading, washing, preparing for the table; Certified organic produce - which usually sells at a premium; Niche products - exotic fruits, herbs, biomedicines, etc.; Development of a premium and recognisable brand name.

2.3

Agro-industry clusters

The Harvard professor Michael Porter introduced the concept of industry clusters to denote the grouping of actors involved in one industry (different firms producing one or related products, their suppliers, buyers and supporting services, etc.) in a specific location. When these actors form a critical threshold, the synergy or mutually beneficial interaction between these can give the whole cluster a sustainable competitive advantage over other firms/locations. Examples of successful clusters are the information technology industry in Silicon Valley, California, and the flower industry in the Netherlands. In terms of agro-industry clusters relevant to small farmers, some of the main actors include: Farmers of one product, who may be grouped/associated formally or informally to jointly produce and/or market their output; Suppliers of seed, fertilizer, machinery and other production inputs; Buyers, transporters and processors; Technical services, including research, extension, NGOs etc; Commercial services with information on markets and marketing, and offering training on business management and administration; Financial services, including banks, credit associations, informal lending groups, and insurance companies, etc. Facilitators of development processes (development projects, NGOs, etc)
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Successful industries tend to have strong links between the different actors or firms in the cluster. These linkages can be vertical (i.e. those between actors involved in primary activities in the main product chain, such as input suppliers, producers, and buyers), or horizontal (i.e. those between competing firms involved in primary activities, or between these and actors involved in support activities such as technical, financial and business development services).

3 Competitiveness
3.1 Competitiveness

As with many concepts in ARD, there are many definitions of competitiveness and competitive advantage, reflecting different emphases. At a simple level, competitiveness refers to the ability to succeed commercially: Competitiveness is the ability to earn profits and maintain market share. Competitiveness is a measure of whether a technology or product will survive and flourish commercially. A firm has a competitive advantage over its rivals when it sustains profits that exceed the average for its industry.

Competitive advantage is something that gives a firm or industry an edge over its rivals. Taken in a broad sense, the concept of competitiveness can be applied to different entities and at different levels. At a micro level, it is more common to talk of profitability. Within a cropping system, for example, one crop variety might be more profitable than another, by reason of higher productivity or higher sale price for a more marketable quality. At the level of a farm system, growing vegetables might be more profitable to a farmer than grain crops. Competitiveness is more normally referred to between the firms or industry clusters across regions or countries, and often with reference to a particular market location. Potatoes from the central mountain region might be more competitive in the capital city than those of a drier region further away. Wine from South Africa might be more competitive in the United Kingdom than wine from Chile. Competitiveness has also been used to compare countries. Many organizations (e.g. the World Bank) calculate and publish country competitiveness indicators that are intended to indicate the ability of industries in one country to compete with those of other countries. However, many economists argue that such indicators are not very useful, as countries dont compete firms compete, and a country may have competitive firms in one industry, but not another. Taken in this (non industryspecific) way, country competitiveness refers to the ability of a nation to provide an environment generally favourable to commerce, due to high standards of infrastructure, human capital (education), low interest rates, regulations that enable easy entry and exit for businesses, etc.

3.2

Comparative advantage

Almost two hundred years ago, David Ricardo put forward the argument that nations could benefit by producing and selling those products for which they had a comparative advantage, as conferred by favourable factors such as cheap or available raw materials, suitable soils and climate or cheap labour, and buying those
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products for which other countries had a comparative advantage. Such free trade, he argued, would thus benefit all nations. Ricardos view has been influential since then. More recently however, the benefits to firms or industrial clusters conferred by such national factor endowments have been questioned: Factor advantages are easily imitated (there are many countries that have good conditions for growing coffee; and there is nearly always somewhere else where labour is still cheaper such as China today). Maintaining low labour rates does not help the overall development of a country; low incomes do not create demand for goods and services and hence promote positive onward linkages in the economy. An over-reliance on comparative advantage and favourable production factors can make firms lazy: discouraging them from innovation and from getting closer to their customers; encouraging them to look for government intervention to help maintain such advantage, through measures such as favourable exchange rates, subsidies, or trade measures such as import tariffs or quotas, etc.

3.3

Competitive advantage

In his influential book The Comparative Advantage of Nations Michael Porter put forward his diamond model to emphasize 4 areas that determine innovation and hence competitive advantage: Strategy

Factor Conditions

Demand Conditions

Related Industry Factor conditions: more than the easily imitated endowed general factors of cheap unskilled labour, raw materials and agro-climatic conditions, it is the created specialized factors of skilled labour, capital and infrastructure that are important. Demand conditions: the more demanding are customers, the more innovation is promoted. Strategy, structure and rivalry of firms: it is the competition between firms that promotes innovation and improvement. Related supporting industries: good linkages through closer physical location or through good communication - between firms, their upstream suppliers, downstream marketing channels and service suppliers encourages innovation. Although a comparative advantage based on favourable factor endowments may be the initial stimulus for developing a particular industry or industry cluster therefore, it
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may therefore not be sufficient in the longer term to sustain the competitiveness of that industry. Innovation to develop products with added value, targeted at specific and differentiated market segments, understanding (and even developing) customer wishes, to improve productivity and improve quality are seen as increasingly important for farmers to maintain a competitive advantage. The Netherlands is the third biggest agricultural exporter of agricultural products in the world (behind the US and France) in spite of its relative lack of land and expensive labour.

4 Marketing strategies
4.1 Marketing basics
Product quantity, quality, packaging, design Price including price guarantees under contract Place geographical location, type of market outlet, market segment, Promotion advertising, customer relations Markets are never static. Farmers who do not have a well-defined market strategy, and who are not constantly adapting, changing and improving this strategy, risk loosing any competitive advantage and therefore income.

Marketing is often said to be driven by the 4 Ps:

4.2

Market opportunities

For small farmers, 4 basic marketing strategies can be summarized in Anshoffs matrix: Existing products Existing markets New markets 1. Market penetration 2. Market development New products 3. Product development 4. Diversification

1. A strategy of market penetration implies increasing sales of current products to current markets, without changing the product offered. This can be achieved by either lowering the sale price (e.g. by increasing productivity and reducing production costs), or by improving distribution and/or promotion (e.g. through vertical integration or improving links within the market chain). 2. A strategy of market development means identifying and developing new markets for current products. These new markets can be represented by new outlets (e.g. supermarkets), or new geographical areas including export markets, or buyers using the product in new ways. 3. A strategy of product development implies adding value to the current product through one of the ways described above (e.g. better quality, improved packaging, washing, grading, processing, etc). 4. A strategy of diversification implies the developing new products (and hence new markets).
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All of these market strategies involve risk, which increases according to the degree of change involved. In general therefore, the risk increases from strategy 1 - 4.

5 Private and social benefits

5.1 Financial and economic returns

Individual farmers or firms respond to prices paid or received. Their profitability is based on financial return, which is based on the difference between the income received and the costs paid by a producer at prevailing market prices. The calculation of financial return is therefore an indicator of the profitability of the enterprise, and competitiveness from a private viewpoint. Financial return of the different options is an indication of where private or farm level resources should be concentrated. Prevailing market prices are often distorted however, through subsidies, import/ export controls, exchange rate policies, etc. Governments have often sought to protect or improve the competitiveness of certain industries or sectors through these measures. But these measures are not without costs, either to the individual country or its trading partners. Societies bear these costs through taxation, or through paying higher prices for the goods. The current global trend is to therefore to dismantle such protective measures and promote free trade, through regional agreements such as the EU, MERCOSUR, NAFTA etc, or through global agreements negotiated through the World Trade Organization. Currently the agricultural sector is very much in the forefront of such negotiations. From the point of view of the national society therefore, a better measure of benefit or competitiveness is the economic return, which is based on the difference between income and costs calculated at economic prices (that is, after adjusting for the distortions caused by policies, etc). Comparison of economic returns for the same agro-enterprise in different countries gives a measure of how competitive these enterprises would be if price distortions were removed.

5.2

Competitiveness and comparative advantage revisited

A modern view of comparative advantage is this ability in undistorted markets - to produce a good at lower cost, relative to other goods, compared to another country (compared to the Ricardian view described in section 2.1 above, where emphasis was on natural resources and labour factors rather than more recent emphasis on technology and institutional factors). With perfect competition and undistorted markets, countries would tend to export goods in which they have comparative advantage. In an era of trade liberalization and reduction of trade barriers etc., the analysis of comparative advantage allows for more informed decision-making concerning the efficient use of the country's scarce land, labour, capital, and foreign exchange resources. In summary therefore, it has been said that competitiveness is determined by the commercial performance of individual firms whereas comparative advantage is about efficient allocation of resources at the national level, especially among the sectors of the economy producing traded goods and services. Competitiveness is about businesses, comparative advantage about countries.

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6 References and acknowledgements

This learning resource was prepared for ICRA (www.icra-edu.org) by Richard Hawkins. It forms part of the ICRA learning resources, written for use in capacity building in Agricultural Research for Development. Sources of information used in this handout and additional links to information on competitiveness, small farmers and markets are given at http://www.icra-edu.org/page.cfm?pageid=anglores. You are welcome to use these materials for non-profit purposes; we only ask you to send us a short email at Secretariat.ICRA@wur.nl, or leave a comment on our webpage telling us how you have used them and how you think they could be improved Thank you!

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