Large Corporations Engaging Small Producers— Fruits and Vegetables in India and China

Live Case prepared and presented by Nancy Barry, President of NBA Enterprise Solutions to Poverty at the Harvard Business School Forum on the Future of Market Capitalism, October 9 and 10, 2009 S. Sivakumar (Shiv), CEO Agribusiness of ITC, was intrigued to see what he could learn from a week in rural China. Shiv had built the Agribusiness Group of ITC to US$1 billion in revenues, with sourcing and input distribution in over 40,000 villages through his world famous eChoupal system. ITC was already purchasing cereals directly from over 3 million small farmers, having introduced pricing based on quality, rather that the traditional weight-based pricing from middlemen. Over the last two years, through Enterprise Solutions to Poverty (ESP) Innovation Group for Agribusiness in India, which Shiv helped create, Shiv had been working with agribusiness CEOs of five other Indian giants. Together, they were building a major fruit and vegetable initiative with small farmers in India. Leaders of these companies were now traveling to China to see major fruit and vegetable companies of China, also engaged in ESP. Shiv knew that each of agribusiness leaders and their companies brought different experience, company cultures and strengths to the challenges ahead: Traveling with him were executives from:

Tata Chemicals Ltd is a subsidiary of the US$62.5 million Tata Group, one of India’s largest and most respected conglomerates. TCL’s revenues approach US$3 billion, largely in fertilizers and inorganic chemicals. TCL has built a successful agricultural input distribution system using its fertilizer output as the core. In 2007, Tata Chemicals entered into a 50:50 joint venture with Total Produce PLC, one of Europe’s largest fresh produce providers. The joint venture, Khet-Se Agriproduce, is geared to leveraging TCL’s relationship with farmers and presence in rural communities to create a state of the art supply chain and wholesale operation in fresh fruits and vegetables. TCL is focused on building solid production in bananas for domestic and export sales, in building out value chain operations with small vegetable producers for domestic wholesale, with a focus on building productivity, quality and earnings of smallholder farmers As an international joint venture, Tata Khet-Se is precluded from retail sales and is pursuing measures to mobilize push cart venders as a formal-informal sector alliance, building on the traditional mode of retail purchase in India. Mahindra and Mahindra, with US$6.8 billion in annual revenues, mainly from tractors and other automotive established MSSL as its agribusiness arm in 2000 with an initial focus on grape exports. Mahindra had built a successful collaboration and co-branding strategy with Capespan, to become India’s leading grape exporter with US$5.3 million in export sales, with MSSL the first to receive GLOBALGAP certification. Mahindra is using its tractor financing company to build out broad-based rural finance. At the same time, Mahindra had closed down its capital intensive hub and spoke agricultural input operations. Mahindra management was uncertain on how much of its resources to commit to agribusiness. MSSL is now focusing on pomegranates and seed potato operations. Bharti, with its US$1.3 billion in revenues coming largely from having become India’s largest mobile phone provider, is a new entrant to fruits and vegetables. Bharti is pursuing local and export sales of fresh and processed fruits and vegetables under a joint venture with Del Monte and is the Indian partner of Wal-Mart. As an international joint venture, Bharti-Wal-Mart is pursuing wholesale, with a separate company, Bharti Field Fresh, opening domestic retail stores. The CEO of Bharti is pushing to reach US$1 billion in revenues from fruits and vegetables in ten years.

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Jain Irrigation is slated to become the world’s leading drip irrigation manufacturer by the end of 2009, with revenues of over US$600 million. Beginning in 2004, Jain Irrigation has utilized its deep knowledge of farming and its connections with farmers to build export operations with small farmers in dried mango and dried onion, and has now become India’s leading exporter of both. ITC is one of India’s largest companies with 2008 revenues of over US$5 billion, nearly US$1 billion in its Agribusiness Division. ITC is considered by all to be the natural leader in this group of six industry leaders in agribusiness with small farmers. ITC has 30 years of experience working with small farmers in tobacco. ITC has invested in understanding the dynamics of small farmers and rural markets; its e-Choupal and Choupal Sagaar systems co-opted many traditional middlemen to become operators of ITC’s information service and hub and spoke platform for sourcing and distribution of agricultural inputs. ITC has been a leader in applying information technology to build efficient rural distribution platforms. 6500 e-Choupals reach 40,000 villages and 4 million farmers; this system has evolved to become a sourcing and distribution platform, now sourcing from over 3 million cereal farmers, and used to sell agro-inputs and fast moving consumer goods in rural areas. And having built solid early fruit and vegetable operations in mango, green vegetables and seed potatoes with its Choupal Fresh operations and small format stores, S. Sivakumar is the leader of the ESP Innovation Group on Agribusiness in India. Reliance Industries, active in the ESP Fruit and Vegetable initiative, was unable to participate in the China trip. The annual revenues of Reliance exceed US$34 billion, is India’s largest conglomerate, with major operations in oil and gas, petroleum and petrochemicals, and mobile telecom. Reliance was the first Indian giant to enter into “farm to fork” fruit and vegetable operations three years ago. Reliance had assumed that its unmatched executing capabilities in rolling out petrochemical plants and mobile phone distribution would translate into value chain operations with small farmers, with RIL’s CEO having targeted doubling the income of 10 million small farmers through Reliance’s disruptive business models over ten years. Early frustrations for Reliance included resistance by small shopkeepers, local politicians and consumers as it rolled out its small format Reliance Fresh stores before having organized procurement of quality produce.

Challenges
These industry leaders have recognized that if they are going to succeed, they will need to find ways to shorten the value chains and deal more directly with producers. In their desire to fill their small format stores, several companies fell back on purchasing from the traditional government markets and middlemen. The result was low quality, low freshness, and no price advantage. The ESP Fruit and Vegetable initiative involves commodity-specific approaches to increase quality, productivity and efficiency of direct procurement from small farmers. Key components are different aggregation models, include producer companies; collaborations with banks to enable small farmers to make the needed investments in green housings, shade nets and irrigation; and introduction of crop insurance, tracing, and certification measures. While ESP and agribusiness leaders of India realize that these measures will provide a solid base from competitive operations, in many cases doubling the incomes of participating small farmers, there is a sense that greater innovation in business models will be important in creating rapid growth and competitiveness in fruits and vegetables. ESP, which also works with leading agribusinesses in China, has organized a trip in September 2009, to explore what methods and lessons can be learned for Indian fruit and vegetable operations.

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Shiv and the other agribusiness leaders realize that Indian and Chinese farmers face some similar realities in building fruit and vegetable operations with small farmers. Characteristics People making under US$2 per day Percentage of people dependent of agriculture for majority of livelihood Percentage of farmers with under 1 hectare of land India 880 million China 620 million

Over 60%

About 60%, declining

Over 80%, 87 million small holdings accounting for 52% of fruit and 61% of vegetable production. Large farms average 7 hectares. 100 million, growing by over 10% pa 6% pa growth since 1990, from 76 million mt to 170 million mt in 2008. Second only to China in output and growth. High in vegetables, some tropical fruits

Over 80%--farmers had given about 0.3 to 0.5 hectare of land for rights of use by government.

Number of people in middle class, and annual growth Annual growth in fruit and vegetable production, ten years

Exponential growth: 146 million in 1990 to 502 million in 2004.

Competitiveness in productivity in fruits and vegetables

High in temperate fruits

Lessons from Agribusiness Leaders in China
Shiv joined the other Indian agribusiness leaders in China in early September 2009, meeting with the leading wholesaler and retailer in Beijing, and visiting ten companies in three provinces where fruit and vegetable operations are concentrated. Two of the three are Western provinces, in the part of China where poverty is concentrated. Each company visit illuminated a facet of the rapidly evolving agricultural sector in China:

COFCO, on the Fortune 500 list since 1994, is the large import-export government-controlled agribusiness with US$ billion in revenues in 2008. In 2005, COFCO purchased controlling interests in Tunhe, a leading tomato paste producer operating in thinly populated northwest China. COFCO Tunhe has forged highly effective collaboration with Heinz and other leaders in tomato production and processing. In 2007, COFCO Tunhe purchased 2.2.million metric tons of fresh tomatoes from over 200,000 mainly small farmers who worked 33,000 hectares. By 2009, with encouragement from Heinz to improve quality and productivity, COFCO Tunhe had taken advantage of the available large tracks of government land to move rapidly to one third large plantation farming, one third contracting with farmers for efficient production on COFCO controlled land, and one third in integrated operations with small farmers. Productivity on large farms has been double that of yields from small holdings.
The Wumart Group, Beijing’s largest retail chain, has grown rapidly, with over 104 superstores and 330 mini-marts and revenues of US$1.4 billion at end 2008. .Piloted over the last two years, Wumart is moving from traditional reliance on fruit and vegetable wholesalers, launching its direct sourcing model, primarily in Shandong province. This direct procurement operation works with specialty cooperatives and the small farmers associated with these

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cooperatives. Specialty cooperatives in Shandong have leased land from some small farmers to establish larger proprietary production units; these same specialty cooperatives, closely linked to local government, are working with several thousand small farmers to promote investments in small, modern 0.1 hectare greenhouses, improved planting materials, inputs and methods. Wumart has established the largest sourcing-distribution center in northern China, in Shandong, to organize these operations. As a result of this direct procurement, Wumart has been able to reduce consumer prices by 5 to 10%, earn more per unit, shift consumer perception to establish supermarkets and small Wumart stores as the place for fresh produce (with farm to final sales in under 24 hours) and increase produce sales by over 50%. As a result of this success, Wumart is converting its community mini-marts to fresh produce focus stores with fresh produce sales expected to contribute over 50% of revenue. Farmers get prices set 10% to 20% higher than prices in local markets, and have long term relationships with Wumart.

Longda is China’s leading exporter of processed vegetables, mainly serving demanding consumers in Japan. Its products include flour, freeze-dried foods, frozen fruits and vegetables, noodles, peanut oil, processed pork, prepared foods, and soy sauces. In 2008, Longda’s annual revenues totaled US$720 million, with 70% of its diversified operations in food products. Longda used to be an export focused fruits and vegetables producer. Now it has diversified into wood and packaging business, though foodstuff still accounts for over 70% of its sales. Over the last five years, Longda has moved aggressively to establish its own farms, each averaging 10 to 20 hectares in the populated Western Provinces, with larger fields in the sparsely populated Northeast and Northwest. The majority of these farms are contracted back to farmers as farm managers, working larger than traditional tracts under the direct supervision of Longda. Longda has established and implements in both types a protocol of “uniform seed supplies, uniform field management, uniform pesticide spray, uniform fertilizer and uniform harvesting”. Longda has built up a complete trace system based on the integrated supply chain. For any one packaged processed product, the bar code can help you find where the vegetables come from, when they are planted, what fertilizers were used and who grows it, etc. It can achieve traceability “from table to the field”. Longda supports farm operations through input supplies on account, participates in financing investments selectively. Longda would provide seeds, fertilizer and other necessary agricultural supplies as account sales, and shares risks with contract farmers. Longda uses basic, labor-intensive processes to cook and package its vegetables for export to Japan; the technology innovation is in Longda’s rigorous measures to ensure sanitary conditions in its processing plants. Guang-You Sweet Potato and Food Products in Sichuan and Huasheng Apples in Shaanxi. Guang-You uses its proprietary technology to extrude vermilli pasta directly from
the sweet potato. Huasheng is China’s leading fresh apple exporter, with China now producing over 70% of the world’s apples. Both companies use efficient, relatively simple methods for processing or packaging. Huasheng works with over 600,000 small apple growers and GuangYou works directly with over 400,000 small sweet potato producers. Both pride themselves on successful, t simple hub and spoke systems to work directly with small producers in upgrading productivity and quality through extension services, improved inputs, seeds and saplings.

Tingbo Kiwi. Mr. Zao, a successful lawyer and serial entrepreneur from Sichuan, has established a 700 hectare kiwi plantation in Sichuan. When Mr. Zao established these operations in 2007, he had no prior experience in agribusiness. He has built a tight collaboration with the leading kiwi company of New Zealand. His strong connections with the Sichuan government enabled Mr. Zao to lease a relatively large tract of land from 3,000 small farmers, with lease payments set to equal how much the farm family would have earned growing maize, the dominant local crop. Tingbo hired back about 1,000 of the farmers to cultivate segments of this large holding under tight supervision from Tingbo; those farmers that are not able to achieve the required quality and productivity will be replaced by other farmers. Tingo has provided these farmers with leasing fees, housing, and a flat rate during the three years needed for the kiwi plants to bear fruit. The farmers will now be moved to compensation based largely on yields and quality.

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What the Indian agribusiness leaders learned
Shiv and the other Indian agribusiness leaders were amazed with what they saw. Some of their observations: • Where are the poor people? The infrastructure in rural areas across the province of Shandong, and three hours outside of the capital cities of Sichuan and Shaanxi, is superb. Modern freeways make transport of fruits and vegetables cheap and quick. Farmers have water and electricity and live in homes that look simple but comfortable. In cities, no slums are to be seen; in rural areas, no one looks miserable. While income levels may be similar to those in India, the Chinese government has provided supporting infrastructureroads, water, electricity—that make the de facto living standards in China higher and more conducive to good agricultural practices. New aggregation models abound. Over the last two years, the Chinese government has encouraged small farmers, each with an average of half an acre (quarter of a hectare) to lease their land to other farmers, specialty cooperatives and corporations, with a major move to medium sized farms by many companies, making efficiency and traceability in value chains easier. In China, over 200 million young people from single child families have migrated from rural to urban areas, giving the central government the opening to encourage aggregation of small farms. Simple, effective protocols for working with large numbers of small farmers are in place. Several companies have opted to continue working with large numbers of small farmers, using strong organization to provide inputs, advice on productivity enhancing methods, and procurement—with large companies working directly with small farmers and through producer associations. Technology is being introduced at several points in the value chain. Past abuses have made companies obsessed with methods to ensure traceability and food safety, through testing with internationally reputable companies, greater control over production processes, means to trace produce through the different stages, and radical clean methods in simple processing facilities. Improved planting materials are being introduced by the companies and specialty cooperatives. Relatively expensive greenhouses, and simpler ones, enable small farmers to produce a third crop.

What next for India?
S. Sivakumar and the other Indian agribusiness leaders are seeking strategies that reflect the following premises: • • All the aggregation models in China could be adapted to Indian realities, with some requiring government policy change and support On the output side, the objective is to build competitive value chains that have a positive impact on productivity and net incomes of large numbers of small farmers. Shiv believes that the means are combinations of any or all of the following: higher productivity, lower costs, lower risks, and better quality. Different crops have different optimal levels of aggregation at different points in the value chain e.g. some crops require heavy investment and high technology at different stages while others require labor-intensive care.

Shiv sees three broad business models: companies work with small farmers, companies lease and farm the land, and companies adopt a hybrid model leasing the land and then allocating it back to farmers as entrepreneurs on contiguous plots of economic scale.

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