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Saharan Africa: the role of vertical integration of smallholders with processors and marketers of high-value
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Agrekon, Vol 38 (Special issue) Delgado

SOURCES OF GROWTH IN SMALLHOLDER AGRICULTURE

IN SUB-SAHARAN AFRICA: THE ROLE OF VERTICAL
INTEGRATION OF SMALLHOLDERS WITH PROCESSORS
AND MARKETERS OF HIGH VALUE-ADDED ITEMS

C.L. Delgado1

1. INTRODUCTION

The point of departure of this paper is that African nations cannot afford to
ignore smallholder agriculture, however difficult its prospects may seem. Region-
wide, at the beginning of the 1990's, 85 percent of Africa's population was rural,
and more than a quarter of the labour force was actively engaged in agriculture,
overwhelmingly on smallholder operations, with the exception of South Africa
(United Nations Development Program figures cited in Bryceson, 1996). Even in
South Africa, where large private farms are common, more than half the
agricultural population of 2.5 million is estimated to work at least part-time on
smallholdings (Simbi, 1998). Smallholder agriculture is simply too important to
employment, human welfare, and political stability in sub-Saharan Africa
(hereinafter "Africa", for convenience) to be either ignored or treated as just
another small adjusting sector of a market economy, akin to the leather shoe
industry in the United States.

The thorny problems of promoting the growth of incomes in smallholder

agriculture in Africa have been exhaustively examined in a copious literature
inspired by a variety of concerns and ideological predispositions.1 The emerging
consensus from the shifting paradigms of how to promote growth in smallholder
agriculture in Africa is that it is not easy, that such development will need to
overcome a number of structural constraints arising from history and geography,
and that it requires a pro-active policy stance that goes beyond the very necessary
but insufficient-by-themselves market reforms of the late 1980s and early 1990s
(see for example Eicher, 1992; and Delgado, 1995). There is another, basically
compatible, literature that emphasises the need for smallholders in Africa to
become increasingly involved in the production for sale of high value to weight
items that also have high value-added, such as animal products, horticulture, and
beverage crops, tradable items thought to be in Africa's comparative advantage
(see for example Jaffee & Morton, 1995).
One analysis of the issues presented at the recent plenary meeting of the

1 International Food Policy Research Institute, 2033 K St., NW, Washington, DC 20006, USA.

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International Association of Agricultural Economists stressed that promoting

growth in smallholder agriculture in Africa through increased participation in
growing world markets for high-value items will require significant vertical
integration of smallholders to processing and marketing firms (Delgado &
Siamwalla, 1997). This is principally due to missing or dysfunctional markets for
some factors, inputs and outputs. This follows very much in the tradition of the
rather large recent literature on contract farming in Africa (see for example
Glover, 1990; Little & Watts, 1994; Grosh, 1994; Porter & Phillips-Howard, 1997).

In this context, market reforms of the Structural Adjustment type are absolutely
necessary, but they are not sufficient. In addition, a pro-active strategy of
institutional development will be necessary to increase the effective access of
smallholders in many areas to real opportunities for market participation (Ibid.)
The present essay is a very modest attempt to go beyond that earlier work to
distil some stylised facts about the why, where, and when of upwards vertical
integration that might be useful for promoting the growth of incomes within
smallholder agriculture in Africa.

The paper will briefly review the structural constraints facing smallholders in
many African countries, which are thought to manifest themselves in high and
often prohibitive transaction costs. Overcoming these transaction costs will then
be shown to be at the heart of a strategy for increasing the access of smallholders
to the assets, information, services and markets necessary to grow their incomes.
The principal tool for reducing transaction costs is institutional innovation. The
paper will show how different degrees of vertical integration in different forms of
producer organisations address specific kinds of transaction costs. Transaction
costs are also shown in order to be commodity-specific. The potential to produce
different commodities in Africa will be shown in order to suggest specific forms
of vertical integration with processing and marketing. The paper will conclude
with thoughts on where and how contract farming, a form of vertical integration
with processing and marketing, can be useful for promoting growth.

2. STRUCTURAL CONSTRAINTS FACING SMALLHOLDER FARMERS

IN AFRICA

A stylised picture of smallholder agriculture in Africa emerges from the

literature.2 Even if all its elements do not apply to all smallholder areas in the
region – and Africa's diversity suggests that they cannot – most of them probably
apply to most of the region. In any event, it will suffice for present arguments
that only one or two elements apply in any given situation.

The stylised picture is of agriculture dominated by subsistence production of

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starchy staples: coarse grains in the savannas and root and tree crops in the more
humid areas. Production of crops for both food and cash, and of livestock where
disease factors do not rule it out, occur on the same farm, which is often operated
by a nuclear family with one or more non-nuclear residents and one or several
adult male members away on migration. Property rights are some form of
traditional usufruct; production is primarily rainfed and monoseasonal. The large
numbers of rural people and their relative disenfranchisement under political
systems in the region suggest an ongoing tendency for policy disincentives to
smallholder agriculture. Infrastructure is typically poor, and markets for
agricultural inputs and outputs are often missing or unreliable. Cash earnings of
the household come in large majority from non-farm sources and from sales of
one or two cash crops, typically traditional exports, and from livestock.
Otherwise, production is typically highly diversified over small amounts of
production of 15 or more crops. Worst of all, over time the incidence of absolute
poverty seems to be increasing (World Bank, 1992) and farmers are becoming
more resource poor (Lele & Agarwal, 1989 and Eicher, 1992).

3. THE EMBODIMENT OF THESE CONSTRAINTS IN HIGH

TRANSACTION COSTS

Relatively recent application of the concepts of the New Institutional Economics

(NIE) to smallholder agriculture in Africa has provided seminal breakthroughs in
our understanding of how structural constraints operate to constrain market
participation by smallholder farmers in Africa (Binswanger & Rosenzweig, 1986;
De Janvry, Fafchamps & Sadoulet, 1991; Hoff, Braverman & Stiglitz, 1993; Jaffee
& Morton, 1995). Market reforms are necessary to lift the most egregious barriers
to market participation by smallholders, but they often fail to address the more
hidden reasons for non-participation in markets, such as lack on information, fear
of unenforceable contracts, lack of skills for dealing with foreign buyers, and so
forth (Delgado & Siamwalla, 1997).

Furthermore, in many parts of Africa, while some markets for factors, inputs and
outputs may work well, key markets for agriculture (such as rural land and small
farm credit, for example) may not exist. In the context of missing markets, small
and large farm households in rural areas of Africa may not have access to the
same technology, information, asset base, input supplies, and market outlets,
since the market institutions that provide fungibility among resources (including
over time) are not all there. The same is true for farm households in different
locations.

Under these conditions, different farm households are likely to be subject to

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significantly different levels of transaction costs for producing and selling the same
output mix (De Janvry et al., 1991). Broadly defined, transaction costs are the full
costs of carrying out exchange, presumably including marketing costs (Coase,
1960).3 They include intangibles such as search, monitoring and enforcement, and
vary by product, type of agent in the marketing chain and individual agent
within a category of agents.

Transaction costs in marketing and processing in Africa typically arise because

market prices do not fully reflect the true costs and returns to participation for all
market actors, who have unequal initial endowments and for whom market
solutions (such as borrowing against receivables or knowing where purchasers
can be found) may not be available to all. An example is provided by dairy,
where the decision to commit to a given market outlet, which involves physical
movement of milk, places the seller at the mercy of the buyer in a thin market
with no refrigeration (Staal, Delgado & Nicholson, 1997).

The concept of transaction costs in exchange can easily be broadened to include

transaction costs in production, since asymmetries in access to assets and
information shape production as well as exchange patterns. Most high value-
added products in agriculture are characterized by a high ratio of transaction
costs to final value, because of the high degree of processing embodied in such
items (Binswanger & Rosenzweig, 1986 and Jaffee & Morton, 1995). Examples
would be animal proteins and horticulture. Production of these items tends to
increase returns to family resources, but poorer households may have more
difficulty diversifying into profitable new activities than more wealthy ones.

High transaction costs in either production or marketing of potentially

remunerative commodities exclude poorer farmers from participating in growth
opportunities. The real incentive they face to participate is much lower than the
nominal price in the market. These differential transaction cost barriers arise
primarily because of market failures that prevent market solutions to problems
such as a lack of access to credit. Transaction costs are the embodiment of barriers
to access to market participation by poor smallholders in some activities
undertaken by better-off small operators. They are also the barriers to entry for
smallholders as a group with respect to many of the activities undertaken on
large farms.

4. PROMOTING GROWTH THROUGH OVERCOMING HIGH

TRANSACTION COSTS: PROMOTING ACCESS

Asymmetries in access leads to the existence of differential transaction costs.

Overcoming the latter is essential for effective access to the things that small
farmers really need to participate in new and lucrative market opportunities

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otherwise made available to them by macroeconomic reform, growth and the

opening of world markets. Smallholders require improvements in four kinds of
access, as portrayed in Table 1, if they are to participate in growth.

Table 1: Four keys to increased smallholder market participation in Sub-

Saharan Africa and four organisational requirements

Access to Assets
Need for institutions to implement a net asset transfer to
smallholders that provides an incentive for increased
productivity.
Access to Information
Need for institutions to overcome the principal-agent problems
in sharing production and marketing information
Access to Services
Need for institutions to share the risks of service delivery to
smallholders and to overcome other economies of scale in
production
Access to Remunerative Markets
Beyond the removal of artificial barriers, need for institutions to
overcome economies of scale in processing and marketing of
high value tradable items

4.1 Access to assets

It is hard to see how any economically viable system can exist over time without
some form of exogenously determined, net resource transfer into the smallholder
farming system. Resource poverty is easily observable among large numbers of
African smallholders, even in relatively high potential agricultural areas, and
rural people are becoming increasingly resource poor in some areas. This is
especially true in Southern and Eastern Africa, and in the reconstruction period
following civil strife or drought in which so many persons in rural Africa now
find them.

Solutions to the asset-deficit problem of resource-poor smallholders must be

handled in a way that provides an improved incentive for market participation,
failing which there is the risk of adding to transaction costs rather than alleviating
them. One-shot asset transfers to smallholders -- land allocations in Zimbabwe,
financial allocations in South Africa, heifers in Uganda -- need to be structured so
that the beneficiary either has a strong incentive to use the asset for

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production or to transfer it to someone in the smallholder community who does.

This means separating the equity issue (equal transfers within target groups)
from the growth issue (getting assets into asset-starved production systems).
Viable solutions must include allowing recipients to sell their assets within target
groups, and providing credit to those within the target group who are able and
willing to expand their operations. In the case of physical transfers, it also implies
a rather heavy institutional infrastructure for follow-up to ensure that the asset is
used as intended.

Recurring asset transfers, such as via unit subsidies, tend to be fiscally

unsustainable. They also require a heavy institutional infrastructure to administer
and are always subject to moral hazard, creating transaction costs along the way.
All asset transfers, as necessary as they may be, require institutional innovation to
preserve the incentive for production and to support the development of skills to
use the asset productively.

4.2 Access to information

Knowledge is power; technical and market information is a productive (and

remunerative) element of human capital in farming. Smallholder farmers in
various parts of Africa have been shown already to have access to production and
marketing knowledge for traditional, food-oriented, agricultural activities (see
Mellor, Delgado & Blackie, 1987, for example). Yet for new commercial items and
non-traditional exports, individuals with higher levels of schooling, greater
experience in the work world, better access to management and technical advice,
and better knowledge of market opportunities will probably grow their
operations more easily than those without.

An important issue in the present context is to look at possible incentives for

more information-rich individuals to share their insights on a continuing basis
with the less well off. This is especially relevant where a commercial sector
actively engaged in farm business transaction exists alongside a smallholder
sector that is only partly integrated with the market.

Traditionally, economists have thought of sharecropping in South Asia as a

means to share the landlord's asset and information wealth with the landless in
an incentives context that obviates the need for monitoring labour effort (see
Binswanger & Rosenzweig, 1986, for example). Differences in land tenure and the
social acceptance of existing property rights in Africa suggest that sharecropping
of the South Asian variety will not emerge any time soon. However, variants
might be encouraged in the dual production systems of Southern and Eastern
Africa, when large commercial farms employ large numbers of labourers in a

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political context where there is an underlying symbiosis of interest in political

stability, and the property rights of commercial farmers are under political
scrutiny.

An interesting example is the experimental use of farmers' dams in the Western

Cape province of South Africa for raising trout, using aquaculture methods in the
dry season (Hoffman, Brink & Salie, 1998). The Small Farmer Aquaculture
Programme promotes the formation of a contract between a commercial farmer
(who provides the dam and water), an aquaculture farmer from either the farm
labour pool or the smallholder sector (who provides the labour and reaps the
benefits). It then associates information inflows from the Division of Aquaculture
of the University of Stellenbosch. While the present numbers are small and the
economics uncertain, this program is an innovative attempt to associate the assets
and information of the formal sector in a business relationship with the
smallholder sector.

Generally, the feasibility of providing political and social returns to large

commercial farmers in return for transfers of technical and business skills to
smallholder farm operators, and even sharing of infrastructure, should be
vigorously explored. Structurally, such sharing of skills and sharing of business
information seems far more likely to work where exportable items are involved
or more generally where the two sectors are not competing against each other for
a limited market. The sharing of valuable information (and assets) to achieve
political and social benefits would seem to be at the forefront of needs for
institutional and political development; improving smallholder access to business
information on a large scale requires institutional innovation beyond traditional
State schooling and extension services.

4.3 Access to services

The state of infrastructure in most smallholder areas is still precarious,

population densities are relatively low (compared to Asia or Europe, say), there is
generally a low value of economic activity, and a high variation in demand
stemming from high climatic fluctuations in largely semi-arid rain-fed agriculture
in the region. These factors make provision of agricultural services a risky
proposition often abandoned by the formal private sector, especially in remoter
areas.

The traditional policy response in the past in large parts of Africa to serving the
less choice physical locations is exemplified by pan-territorial pricing of inputs by
parastatal concerns, or the provision of credit on non-economic bases (see Lele
1991, for example). This is clearly unlikely to be a feasible strategy in the future.

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Even where subsidised State programs and formal sector private institutions for
service provision have not reached smallholders, indigenous institutions for
sharing risks and dealing with market failures have frequently been observed. In
some cases, they can be shown to be efficient in resource allocation, as in the case
of credit pools in Northern Nigeria (Udry, 1993). However, indigenous
institutions that are alternatives to the market tend to be highly location specific
(Swegle, 1994).

Despite the success of a location-specific indigenous institution in some cases,

and "Western-style" market entry of the private sector (such as cases of fertiliser
sales to higher potential areas in better years), a major problem remains for
deciding on desirable institutional forms for agricultural service provision where,
to date private sector response to the needs of individual smallholders has been
low and the emergence of alternative institutions not yet much in evidence. An
example that is fairly ubiquitous in Africa is that of input supply (including
delivery) in units that the individual farmer can both afford and use in a single
season. One solution is the pooling of purchases across farmers, which requires
an institutional arrangement to deal with the inherent principal agent problems
that arise. An alternative is the emergence of village level stockists who can sell in
smaller amounts, but then the problem of risk sharing arises. More generally, the
issue of promoting smallholder agriculture through improved access to
production services requires institutions to share risks and to overcome
economies of scale in input and service supply. A system of interlinked input
supply, credit and output marketing contracts may be necessary to overcome
moral hazard.

4.4 Access to remunerative markets

Everyone agrees that better access to remunerative markets -- high-value items in

the comparative advantage of African resources to produce where demand is
growing -- is necessary for promoting growth of smallholder agriculture.
Disagreement begins with whether promotion of this goal requires a set of
institutional innovations beyond the removal of overt barriers to smallholder
participation, such as erstwhile laws in Eastern and Southern Africa designed to
protect the commercial sector from competition with the smallholder sector (see
Rukuni & Eicher, 1994 and Jaffee & Morton, 1995 for examples of the latter).

Adding transaction costs to the analysis highlights that incentives involve both
the cost and benefit sides. Following the adoption of majority rule in South
Africa and real exchange rate devaluation in Zambia, coupled with the
elimination of subsidies to maize-growing during the first half of the 1990's, it is
worth speculating why large commercial farmers in Zambia apparently shifted

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with little difficulty from maize for domestic milling to production of oilseeds for
export to the previously unattainable South African market, whereas
smallholders retreated increasingly into subsistence production (Delgado &
Siamwalla, 1997). Quite possibly the large commercial farmers found it easier to
export than the individual smallholder in Zambia.

A major component for promoting growth in smallholder agriculture in Africa in

the post-Structural Adjustment era is facilitating the ability of smallholders to
shift out of increasingly non-viable things that they did under previous economic
environments, and into increasingly remunerative new opportunities in the
export and import-substitution sectors (Delgado & Siamwalla, 1997). High value
(and high value added) activities in African agriculture typically require large
amounts of processing and often involve goods where quality needs are quite
specific. Such goods are typically associated with high transaction costs
(Binswanger & Rosenzweig, 1986 and Jaffee & Morton, 1995). As will be argued
below, this fact and the institutional needs discussed above for promoting
improved smallholder access to assets, information and services will argue for
commodity-specificity in institutional innovation and a "new" (re-found)
emphasis on sub-sector approaches for promoting African smallholder
agriculture in the post-Structural Adjustment era.

5. VERTICAL INTEGRATION AND PRIVATE AGRICULTURAL

PRODUCTION IN AFRICA

In Africa, as elsewhere, there is a plethora of different institutional arrangements

governing the organisation of agricultural production4. For present purposes,
only three main forms are considered, which are felt to account for the brunt of
agricultural production in the region and to which most forms can easily be
assigned. They are chosen because of their very different abilities to handle
different sorts of transaction cost, stemming from their different links to
processing and marketing. They are independent smallholder operators (IS),
small operators linked by contract to processors or marketers (CF), and large
farms or plantations that are relatively specialised and somewhat vertically
integrated (LF).

5.1 Independent small operators (IS)

This is the most predominant form of production in the region, and results from
the relative abundance of land (until recently, at least) and the relative absence of
labour-augmenting technology in most areas outside State farms and those zones
settled by Europeans (Eicher and Baker, 1992). IS corresponds roughly to the
"stylised picture" above. Such farmers are "independent" in the sense that they

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buy their inputs and sell their produce independently wherever they choose
(among whatever options are available to them), for whatever they can get.

Where the transaction costs associated with processing and marketing are low, IS
supported by various forms of institutional development in service provision is
probably the most desirable form of organisation. The institutions in question are
most likely in the realm of public goods provision, such as agricultural research,
extension and input supply ("prime movers" of agricultural development, in the
language of Rukuni & Eicher, 1994). The latter help overcome structural
constraints on the production side. Where the problem is on the marketing and
processing side, high transaction costs suggest the attractiveness of vertical
integration.

One problem with a large part of the previous literature on various forms of
smallholder organisation in Africa prior to 1990 is that studies of schemes
typically assessed the value of initiatives relative to a hypothetical ideal (a better
scheme), and not a more realistic counterfactual of "benign neglect" of the
organisational needs of smallholders (or real laissez faire). The "IS" alternative
considered here is an attempt to consider that counterfactual as currently
observed in the majority of smallholder farming situations in Africa, where no
contract farming is present.

5.2 Small operators linked by contract to processors or marketers (CF)

These farmers are like IS, except that for at least one input or output they have a
contractual relationship with other farmers, merchants or processors for factor or
input supplies and/or output sales. Typical arrangements are contract farming,
producer co-operatives, and outgrower schemes with or without a nucleus estate.
Within these forms, there are many variants in Africa at the present time, and
they provide some of the most lucrative opportunities available to smallholders
(Hussi et al., 1993; Grosh, 1994; Little & Watts, 1994; Glover, 1994; Swegle, 1994
and Jaffee & Morton, 1995).

A common thread of these forms of organisation is that the farmer agrees to sell
the product of a specific acreage of a crop to a processor or a marketer (including
a larger farmer or a co-operative), usually at the time of planting (Grosh, 1994).
The farmer typically gains the benefit of assured supplies of the right inputs at
the right time, frequently credit against crop deliveries, and an assured market
for the output at a price not always known in advance, but applied equally to all
farmers in a given location and time period. Extension is usually part of the
services provided, typically at higher rates (and quality) than State extension
services. Little & Watts (1994) and Grosh (1994) estimate that densities of

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extension agents to farmers are from 5 to 20 times higher within contract schemes
in Africa than outside them. To the extent that high-value export items are often
involved, the farmer also gains market access and avoids the hazards of being
stuck with a perishable crop with little domestic demand. Contracts with
processors often overcome the access barriers to assets, information, services and
markets faced by smallholders wishing to produce high value items (Jaffee &
Morton, 1995).

The processor/marketer gains the advantage of an assured supply of the

commodity at harvest at a fixed price, quality control and the option of making
collateralised loans to farmers. Such arrangements eliminate the principal agent
issues faced by collectives and large farmers in monitoring effort by the grower,
provide better relations with local communities than operating a large farm,
avoid the expense and risk of investing in a plantation, share production risk
with the farmer, and help ensure that farmers provide produce of a consistent
quality (Minot, 1986; Glover, 1994; Little & Watts, 1994 and Grosh, 1994).

Parallel non-contract markets for traditional exports may not exist, except for
non-comparable rejects from the export circuit, so price comparisons may be
difficult (Glover, 1994). Where such parallel markets exist, such as for food crops,
the contract price is usually slightly lower than that prevailing on parallel
markets (peanuts in Senegal would be such a case - see Badiane, 1997).

The ways that prices are fixed and negotiated vary greatly across contract
farming arrangements, and matter greatly to the interests of both sides. Fixing
prices ahead of planting either means the risk of an undesirable intake for the
processor, or the risk that farmers will choose to break the contract and sell on
spot markets if the latter price rises above the contract price. Grosh (1994) cites
the case of wholesale breakage of Asian vegetable contracts in Kenya in the early
1980's that eventually led to vertical integration of the processing industry.

Fixing prices ahead of planting decreases risk to the farmer, but may also mean
lower income than otherwise in the event of a bad season. Many schemes use a
double tranche system, with an initial payment at delivery, and a second tranche
later in the year, after final realisations to the processor are in. This typically
reduces processor exposure in highly fluctuating terminal markets such as coffee,
cocoa, cotton and specific vegetable oils. In theory at least, it also permits a higher
margin to be passed on to farmers in the form of profit sharing (Glover, 1990).

Several characteristics of successful contract farming schemes linking small

farmers and processors have been identified by the two main inter-country
surveys of contract farming in Africa (Glover, 1990 and Little & Watts, 1994). Two

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key issues are the freedom to grow other crops (principally food items), including
using scheme resources to do so, and the level of farmer participation in decision-
making. Generally, schemes that have tried to limit farmer activities on non-
contract crops have not fared well over time. Conversely, schemes that have
involved substantial farmer participation in management have tended to work
more smoothly and to increase production of the contract crop in a more
sustained fashion over time.

The latter point recurs frequently in detailed comparisons of contract farming

(Glover, 1990; Little & Watts, 1994 and Porter & Phillips-Howard, 1997). Of 18
schemes surveyed in the 1980s by Glover and collaborators in East and Southern
Africa, only one exhibited strong participation by member farmers in the
management decisions and Boards of the schemes (Glover, 1990). The differential
success of cotton schemes in different countries of francophone West Africa can,
in part, also be traced to different degrees of participation in decision-making by
farmers; the latter varied across countries and over time within countries (Lele,
van de Walle & Gbetibouo, 1989).

Porter & Phillips-Howard (1997:235-236), based on a comparison of outgrower

schemes in Northern Nigeria and in the former Transkei (Eastern Cape) in South
Africa, similarly stress the problems that arise when those doing the hard work
are not adequately represented in the decision-making. They draw a number of
sensible and probably widely applicable conclusions in looking at the details of
handling the division of power between processor and farmers in the design and
policy oversight of specific contract farming schemes. Several will be repeated
here for the convenience of the reader.

First, educated people from the area, speaking the predominant language of the
farmers, need to be associated in the senior management. Second, resettlement of
farmers for contract farming runs the danger of making participants too
subjugated to scheme management to have effective participatory control. Third,
payments need to be made to those who do the work. Since that is frequently
women, and such direct payments are occasionally resisted by men in local
communities, the gender issue cannot be avoided.5 Fourth, farmers as well as
management need to be associated with the monitoring of quality standards.
Fifth, the pay and benefits of hired labour working on participant farms needs to
be included in the monitoring and deliberations carried out by scheme
management. Sixth, participants should be free to grow other crops, especially
food, outside the scheme (a point also made by many other authors).

Another form of contracting between small farmers and processors that merits

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special mention occurs in the case of specialised producer co-operatives, such as

dairy co-ops that process and market milk (Hussi et al., 1993 and Staal, Delgado &
Nicholson, 1997). Many of the same issues applicable to contract farming are also
applicable to producer coops. In particular, coops often play a similar role to
contract farming schemes in facilitating access to assets, information, services and
markets, especially for perishable items.

Producer co-ops are unlike contract farming schemes, however, with respect to
negotiations among different partners. If the issue in contract farming revolves
around the power of farmers to negotiate with the processor, in producer co-ops
it is the power of members collectively and individually to hold coop
management accountable. Producer co-ops in Africa have had a generally
unhappy history, because of difficulties in holding management accountable to
the members (i.e. moral hazard), leading to inappropriate political activities or
financial irregularities in management (De Janvry, Sadoulet & Thorbecke, 1993;
Glover, 1994 and see Akwabi-Ameyaw, 1997, for a recent example in Zimbabwe
that is all too typical). The degree of moral hazard seems to be greater if they are
general enterprises rather than organisations created for specific purposes, such
as farmer-run local milk marketing co-ops in Uganda and Kenya (Staal, Delgado,
& Nicholson, 1997). As in the case of contract farming, the degree of effective
farmer participation in the oversight of scheme management is the key to success.

5.3 Large farms or plantations that are relatively specialised and somewhat
vertically integrated (LF)

The final form of producer organisation considered here involves large

commercially oriented private farms that have some form of vertical link with
processors or export marketers. At one extreme, there are multinational fruit or
rubber concerns that operate plantations to supply their own processing plants.
At the other, there are large farms or ranches in Eastern or Southern Africa that
have exclusive (or near exclusive) contracts with a separate processing company.
Few truly large farms in Africa exist outside some form of vertical integration
with processing, except perhaps in South Africa after dissolution of the pre-
majority rule Marketing Boards.

Large farms and plantations in Africa have tended to exist only where the local
peasantry lost control over local agricultural resources. In some historical cases,
this was a radical loss, as under some forms of colonial rule or ethnically based
land expropriation (Kenya, Zambia, Zimbabwe and South Africa, for example), or
expropriation by the State (Ethiopia, Tanzania). In others, the lack of rural
representation in governance helped foster a dualistic agriculture of IS, on the
one hand, and large enclave plantations on the other (coastal West Africa, for

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example).

Four aspects of large farm agriculture should be noted for present purposes. First,
the rise of participatory local government in Africa, coupled with increasing land
scarcity, suggests that LF forms of organisation will gradually disappear over
time in the region, unless there is some strong technical justification for their
existence. Second, some rural activities are characterised by economies of scale in
production that favours large farm forms of organisation under African
conditions (wheat, for example).

Third, many more commodities have characteristics suitable either to CF or LF

organisation. Understanding the reasons for this is then critical to designing
institutions for assisting smallholders. Fourth, where LF institutions are found in
Africa, they represent a potentially tappable source of skills (as well as assets) to
help organise smallholders in CF schemes for commodities that could be
produced either under LF or CF.

6. THE INFLUENCE OF INDIVIDUAL TRANSACTION COST FACTORS

ON THE NEED FOR VERTICAL INTEGRATION

Since transaction costs create the need for institutional innovation to facilitate the
participation of smallholders in markets, it is useful to review the specific factors
in rural Africa most likely to be associated with transaction costs, and how they
shape the type of producer organisation most suited to dealing with them.6

As discussed above, the transaction costs facing smallholder agriculture in Africa

stem in large part from structural aspects of the economic and political
environment facing African producers. This is shown in the bottom of Table 2 in
terms of missing or dysfunctional input or factor markets and poorly integrated
output markets, combined with a property rights and enforcement regime that is
often not favourable to the expansion of market-oriented farming activity.
Missing markets necessitate some form of organisation other than smallholders
left to their own devices.

The absence of property rights and enforcement makes any form of contracting
risky and generally discourages commercial activity. The absence of participatory
local governance favours a dual production system composed of large
commercial farms and smallholders left to their own devices. Both land scarcity
and having a large share of the national labor force in agriculture tend to favour
the emergence of some form of production system based on small operations.

Table 2: Transaction costs factors in sub-Saharan Africa and their probable

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influence on producer organisation

Presence of the factors at left is likely to

favour the form of organisation indicated
Contract
Vertically
Transaction Cost Factors institutions
integrated,
(their presence suggests that these between
Independent more
costs are high, ceteris paribus) small
small specialised
operators
operators large farms
and
or
processors/
plantations
marketers
Commodity characteristics in
production:
• High labour intensiveness yes yes no
• Economies of scale in no no yes
production
• High returns to extension/ no yes yes
farm/research linkages
• Complex purchased input use no yes yes
required
• High investment requirements no no yes
Commodity characteristics in
processing/marketing:
• Quality specificity no yes no
• Perishability/need for co- no yes yes
ordination with processor
• High value to weight no yes yes
• Principal market is export no yes yes
• High economies of scale in no yes yes
marketing
Economic and political
environment:
• Land scarcity yes yes no
• Agriculture a larger share of yes yes no
labour force
• Poorly integrated output no yes yes
markets
• Missing input or factor no yes yes
markets
• Absence of property rights/ yes no no
enforcement
• Absence of participatory local yes no yes
governance

Sources: A selective synthesis of views from Minot (1986), Binswanger &

Rosenzweig (1986), Little & Watts (1994), Glover (1994), Grosch (1994),
Jaffee & Morton (1995) and Delgado & Siamwalla (1997).

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Beyond the environmental factors that contribute to transaction costs, it is

important to recognise that individual commodities have both production and
marketing characteristics that create transaction costs, ceteris paribus (Jaffee &
Morton, 1995). Labour intensiveness favours smallholder organisation, whereas
both economies of scale and heavy investment requirements in production
produce the opposite effect. Situations where there are especially high returns to
co-ordination among research, farming decisions and extension tend to favour
either contract farming or large-scale vertical integration. The same is true of
situations where purchased input use is complex, requiring knowledge and
timely availability of specialised items.

Perhaps the most commodity-specific transaction costs arise in marketing and

processing. High quality specificity, as in dairy products, tends to discourage
both independent smallholders and large-scale vertical integration. Contract
farming reduces the need for labour supervision while increasing the access of
producers to needed inputs and skills. High perishability also tends to discourage
independent small-scale operators, because of the high risks involved in not
having an assured processor market.

A high value-to-weight ratio tends to be associated with greater risks in

marketing and a more specialised clientele, leading to contractual or vertically
integrated forms of organisation. Similarly, the absence of domestic markets for
export items makes it risky to produce outside a marketing structure that can
handle these items. Finally, items such as cut flowers and vegetables that are
exported to Europe tend to be characterised by economies of scale in marketing,
as are other perishables that require a cold chain for handling. Such economies of
scale tend to lock out independent small operators.

Since individual commodities produced on small farms in Africa have different

characteristics, it is possible to explore the type of producer organisation that
would appear to be most fitted to specific commodities.

7. COMMODITY-SPECIFIC TRANSACTION COSTS AND VERTICAL

INTEGRATION

Ten commodity-specific transaction cost factors are listed in Table 2. Twenty-four

commodities (or commodity groups) commonly produced in rural Africa are
listed in Table 3. The transaction cost factors in Table 2 were then applied to each
of the 24 commodities in Table 3, by scoring each commodity characteristic cell as
a "yes" if the characteristic was judged typically to apply to that commodity in

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Africa, and "no" otherwise. The number of "yes" answers were totalled separately
for each commodity's production and marketing/processing

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Table 3: Evidence of the influence of transaction costs on producer

organizations for specific commodities under African conditions

Transaction costs arising in Predominant forms

Activity Production/ Processing/ of production in SS
technology1 marketing1 Africa2
Coarse grains 0 0 IS
Small ruminants 0 1 IS
Root crops 1 0 IS
Swine (backyard) 1 1 IS
Poultry 3 1 IS
Oilseeds 2 3 IS
Sugar-cane 3 2 CF, LF
Cattle 4 1 CF, LF
Rice 4 1 IS, CF
Wheat 4 1 LF
Bananas (sweet) 4 2 LF, IS
Cotton 4 3 CF
Robusta coffee 3 4 LF
Pineapple 4 3 LF, CF
Cocoa 4 4 CF
Swine (industrial) 4 4 LF
Palm oil 4 4 LF
Aquaculture 4 4 CF
Tobacco 3 5 CF, LF
Export vegetables 5 CF
Arabica coffee 4 5 CF
Dairy 5 4 CF
Tea 5 5 CF
Cut flowers 5 5 CF

Notes: 1 Scored on a range from 0 to 5, with 5 being the highest (see "sources").
2 IS = "Independent smallholder/operator"
CF = Small operators contracting with processors" such as producer
coops, contract farming, outgrower schemes, etc.
LF = "Large (more specialised) farm, ranch or plantation, with vertical
links to processing, marketing".
Sources: The transaction cost scores are derived from the simple addition of "yes"
answers to the prevalence of the commodity characteristics listed in respect
of the commodity in question. Judgement as to whether the ten commodity
characteristics listed in Table 2 apply to specific commodities in Table 3 are
largely personal, but is also supported by the literature cited below in many
cases. The judgement as to the predominant form of organisation in Africa is
gleaned from the literature and from personal judgement. See Minot (1986),
Little & Watts (1994), Grosch (1994) and Jaffee & Morton (1995) in particular.

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characteristics, and reported in Table 3. The result is a rough guide to which

commodities in African agriculture are most subject to transaction costs, and
whether these arise more in production or processing/marketing. Clearly there is
no particular justification for equal weighting of different factors (nor any clear
alternative), so all results should be taken as approximate and too exact a ranking
on the basis of numerical scores is not possible.

Results suggest that coarse grains, small ruminants, root crops, backyard swine
and poultry have relatively few transaction costs associated with them and are
therefore most suitable for independent smallholder production. As suggested
above, these farmers may need institutional support to be able to grow their
incomes, but vertical integration into these commodities is probably not very
helpful.

Table 3 also lists the predominant forms of production observed in Africa for
each commodity, as inferred from the literature cited and personal experience.
The match is good, except that oilseeds are in the intermediate zone where both
independent and contract smallholder farming is observed. Sugar-cane falls on
the contract farming side of the line.

Cattle are a large investment for individual smallholders, and there are
economies of scale in herding, so the practice of contract entrustment to
specialised herders who cumulate the cattle of several owners is very prevalent in
West and Central Africa.7 Rice and wheat also have high transaction costs arising
in production, which are best handled through some form of vertical integration.
But rice has high labour requirements and quality specificity to it, which suggests
that contract farming by smallholders is preferable to large farms. Wheat, on the
other hand, has economies of scale and less quality specificity, making it ideal for
large commercial farms under African conditions.

Bananas (especially those for export), pineapples, industrial swine production,

and palm oil are characterised by economies of scale in production, the need for
specialised extension, fairly monitorable labour inputs, and high investment
requirements that make production on large plantations with vertical integration
attractive.

Cotton, cocoa, aquaculture, tobacco, export vegetables (green beans, asparagus,

etc.) and arabica coffee have considerable transaction cost aspects in both
production and marketing that make them hard for independent smallholders to
undertake. Because of the quality specificity, the relative absence of economies of
scale, and the difficulties of monitoring producer effort, they are better suited to
contract farming by smallholders than to large farms.

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Finally, dairy, tea and cut flowers are all high transaction cost items with high
skills needs and relatively high investment requirements, as well as high labour
intensity and very high quality specificity, which pull in opposite directions
organisationally. They are high value activities that can be undertaken either
through contract farming by smallholders or on large farms. A policy regime
oriented to smallholders should pro-actively promote the former.

8. CONCLUSIONS

Smallholder farmers in Africa are numerous and poor. Structural adjustment

reforms that remove the worst market disincentives to smallholder agricultural
production are necessary to promote growth in the sector. This paper has argued
that they are not sufficient, because of the many structural constraints on
increased market participation by smallholders in the region. Missing agricultural
markets for some factor inputs or outputs have created complex sets of incentives
for smallholders faced with a need to gain higher agricultural incomes, or to
migrate out of agriculture altogether.

It was argued that certain (but not all) commodities that are produced in Africa
are especially subject to high transaction costs in both production and marketing,
because of the interaction of intrinsic commodity characteristics with Africa's
structural characteristics. In particular, high value-for-weight and high value-
added tradable commodities, of which the potential profitability has been
enhanced by structural adjustment, are typically among those items with the
highest associated transaction costs. Examples would be milk and meat on the
importable side, and fish, vegetables, coffee, tea and cocoa on the exportable side.

The difficulties smallholders face in finding reliable markets for perishables is one
source of such transaction costs, due to the low bargaining power of a farmer
whose product is spoiling. Other examples are the problems of labour
supervision for labour-intensive and quality-specific commodities, difficulties in
obtaining credit for investment-intensive items and input-intensive items in the
absence of land markets, and economies of scale in the processing of many export
items that shift market power to processors. More generally, asymmetries in
access to information and assets where markets do not permit fungibility among
farm resources create both transaction costs, and the need for institutions that
specifically promote the vertical integration of farm production with processing
and marketing by reducing these costs.

Many traditional products of small farms in Africa are probably constrained by

factors other than transaction costs, which were judged to be low in both
production and marketing/processing for coarse grains, root crops and domestic

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small stock. Not surprisingly, low value starchy staples and domestic small stock
are ubiquitous products in Africa's smallholder agricultures. Public policy will
probably have to become more involved in public goods provision in these
sectors to promote growth. However this was not investigated here.

On the other hand, vertical integration of smallholder producers with processors

and marketers was judged to be a promising avenue of growth through the
diversification of smallholders into production of commercial quality products in
other sub-sectors. Examples would be: aquaculture, export-quality green
vegetables, sugar-cane, cotton, cocoa, arabica coffee, tea, dairy and cut flowers.

These are sectors where smallholders are otherwise unlikely to be able to become
involved due to lack of the appropriate assets, information, access to services and
possibilities of marketing. They are also sectors where the lack of smallholder
involvement in some countries and time periods has led to these items being
supplied by large vertically integrated farms. This situation is unlikely to be
politically sustainable over time. Furthermore, the distribution of transaction
costs suggests that large farms will probably have problems competing with
contract farming solutions in the future, if they can be substituted.

Pineapples, bananas and palm oil for export are likely to remain economically
viable in Africa, but more so on large farms than small ones, even when vertically
integrated. Wheat, to the extent that it is cultivated, is unlikely to become a
contract crop for smallholders.

In the discussion of contract farming, it is important to keep in mind the

predominant alternative form of organisation in Africa, which, institutionally
speaking, is benign neglect. As local participation in governance improves in
rural areas of Africa, the pressures to provide access to assets, information,
services, and markets will become much stronger. Because of both the high level
of resources needed and the transaction costs inherent in having major actors
without a direct economic stake in a business activity, public sectors are unlikely
to be able to meet expectations. Contract farming schemes with access provision
by large commercial farmers, processors and other rural business agents will
become more common. Policy should attempt to channel and leverage this
energy, rather than to compete with it.

To the extent that policy actors are involved with the design and supervision of
contract farming schemes, it will be important to establish the conditions for good
governance and the fair representation of all stakeholders on governing boards,
including farm labour of both genders. Finally, experience embodied in the
literature and from observation in the field suggests that contract farming

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schemes will do best where they do not attempt to organise farms completely or
to change production patterns, but where they represent an additional
opportunity for smallholders anxious to have access to assets, information,
services and high-value markets.

Finally, the conclusions above would seem to be a return to the conventional

wisdom of the 1960s in Africa, to the extent that the promotion of smallholder
commercialisation is being advocated through single-commodity sub-sector
approaches (albeit participatory, in the late 1990s!). This may be compared to the
integrated rural development paradigms of the 1970s, or the output price
paradigms of the 1980s. Further work should perhaps re-examine some of the lost
institutional insights of an earlier era that in many places may have been more
favourable to the growth of incomes of the rural poor than the decades since.

NOTES

1. Some examples with a region-wide focus, a diversity of premises and an agricultural

economics view include: De Wilde, 1967; Lele, 1975; Eicher & Baker, 1992 (first circulated
in discussion paper form in 1982); Mellor, Delgado, & Blackie, 1987; World Bank, 1989;
Lele, 1992; Eicher, 1992; and Delgado (1995, 1997). More specific studies - certainly with
higher direct relevance for policy in the specific locations they are dealing with - have also
addressed issues at the regional and national levels, such as the seminal work on Zimbabwe
edited by Rukuni & Eicher (1994).

2. The literature in the previous note is an example.

3. A non-exhaustive list of relevant transaction costs affecting the exchange of agricultural

and livestock products in developing countries is: (a) spoilage, (b) quality differences
depending on processing, (c) lumpiness of initial investments, (d) lags in production, (e)
seasonal variability, (f) search costs, (g) screening trade partners, (h) bargaining, (i)
monitoring and (j) contract enforcement (Hoff et al., 1993; Jaffee and Morton, 1995). In
addition, locational issues such as (k) transport, (l) handling, (m) packaging, and temporal
costs such as (n) storage, should be included.

4. A comprehensive review is outside the scope of the present paper. Detailed source materials
at different levels of economic conceptualisation (typically inversely related to usefulness
for practical application) are Hoff, Braverman, & Stiglitz (1993); Hussi et al. (1993); and
Swegle, 1994.

5. This issue was reportedly a major sticking point in at least one Uganda dairy co-operative
observed by the author in 1996, until the institution of a joint checking account for
husband and wife was introduced in the local rural bank, with co-op milk payments made
directly into that account, which was independently accessible by the wife (Staal, Delgado,
& Nicholson, 1997).
6. The material in this section draws heavily on the sources listed in Table 2, and especially

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on Minot (1986), Little & Watts (1994), Grosh (1994) and Glover (1994).

7. Entrustment contracts for cattle are common in West Africa in part because political
history has made the cattle-herding Fufulde-speaking ethnic group dependent on sedentary
groups for access to land, leading to enforceability of contracts (Delgado, 1979). Like many
indigenous institutions, it is specific to the set of market failures that produced it, and is
breaking down as an option as the Fufulde-speakers gain independent rights to land in
modern West Africa.

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