Establishing an export-oriented value chain: Five things to consider

Ideally there has to be a competitive market in terms of planting materials and farmers need to have the option to select what they can afford while not compromising the ability to maintain the general quality parameters of the export value chain

Export oriented value chains are special with its economic value, technology involvement, number of stakeholders and its contribution to the national economy. Hence failure costs a lot and continuous failure is not an option at all.  

Many things have to be considered and thought through in establishing an export oriented value chain. Stakeholders in an export oriented value chain adopt different and sometimes unique strategies to make it successful by overcoming issues. 

The objective of this article is to highlight key factors that needs to be considered in establishing an export oriented value chain and special emphasis is given to fresh produce value chains. 

Is the supply security established?

Supply security is one of the most important elements of an export oriented value chain. Some export orders are established only after careful evaluation of the supply security. Therefore, it is important for an exporter to be confident about his ability to meet the export order and that comes from the relationship he holds with the producer. 

If the exporter himself is the producer then there is no need to rely on another party, but this rarely happens. Unavailability of land/space and transaction costs involved in production of a commodity gives enough incentives for an exporter to engage with small, medium and large scale producers. 

In securing the supply, the three most important factors are the quantity, quality and frequency. Export orders are broken in to quantities and they are either air or sea freighted in frequencies. Each order will have either a certain grade or grades based on the customer/export destination. For example, fruits and vegetables are usually exported twice a week using air freight to Middle Eastern countries in to several grades. 

A commodity such as bell pepper goes under grade 1 quality: which is above 150 g per fruit (this could even go up to 350 g per fruit). Most exporters do not have field staff that works directly with producers to assure this. Rather most exporters work with already established farmer organisations by the stare or provincial council’s agricultural extension officers. 

Agriculture extension officers have the incentive to see their farmer organisations performing better therefore they most of the time are very keen on seeing farmers engaged with export oriented value chains. 

Therefore, to a certain extent the agriculture extension officer provides the exporter the guarantee that the producer will meet his commitment to the exporter in securing the supply in terms of quality, quantity and frequency. Yet, there is always the probability for this model to fail, hence a proper system is needed. 

By far, the best solution for this is to implement a contract farming system. A contract farming system will have a legal agreement signed by the farmer and the producer specifying details on the product quantity, quality and frequency of supply. 

These agreements have to be well specified and farmers need to understand the consequences if the breach the agreement. For example, if a farmer did not meet the quality standards for three consecutive times, he or she will be taken out of the value chain (however this should not be a frequent situation since losing even a single farmer will put pressure on the quantity commitment of the export order).  

Unavailability of land/space and transaction costs involved in production of a commodity gives enough incentives for an exporter to engage with small, medium and large scale producers

One of the other important aspects of contract farming is the agreement on the price. Since this kind of an agreement fixes the price for a particular time period these are forward prices. Therefore, what is agreed before the cultivation begins has to hold on whatever the market price fluctuation is. This is important especially during the price increases in the local market. 

Incentives for producers is high to sell outside the forward agreement when the local market prices are increased, therefore forward price that is in the contract agreement needs to be well thought of (it should compensate the farmer to a level where he/she honours the forward agreement when the local market prices are high). 

Exporters can go in to the extension of specifying that legal actions will be taken if a farmer breaches the agreement but those activities will create extra transaction costs to the exporter and an opportunity cost in losing a farmer as well. Therefore, contract farming will still have a certain level of risk to the exporter. 

Therefore, some exporters have adapted certain mechanisms to transfer this risk to another third party. One way is to allow a third party to manage the contract farming agreement on a commission basis. This could be an organisation or could be an individual farmer. If it is an organisation, then it needs to have a field staff that has enough knowledge on agricultural production and authority to manage farmers in particular area. 

The other way to do this is to work with a farmer who is well known to the farmer community and have enough authority and respect, these are usually the ‘champion farmers’ in that area. In comparison, working with a champion farmer is less cost effective than working with an organisation. 

Most locally oriented value chains adapt this model, for example beekeeping value chain. This, in simpler terms is a ‘collector’ but will have addition features than a regular collector such as being a farmer himself, respect of the farming community and agricultural knowledge. 

Are there enough incentives for farmers in terms of transportation costs?

Farmers respond to incentives. A profit-making farmer will not engage in commercial agriculture production unless there are enough incentives for him to do that. However, it is important to remember that all incentives are not monetary though it is one of the most significant incentive among all. 

Unless it is a contract agreement with a forward price, any producer will evaluate his/her options when comes to selling the harvest. Usually they go for the buyer that pays them the highest price, but there are other variables that could incentivise the producer. Unless all these variables or most of them are met, farmers will not come to the export value chain or will not remain with the exporter. 

One of the major cost components for a farmer is the transportation cost. This will vary based on the commodity but it is a significant component of the total cost for the farmer. This is one of the main reasons for collectors to exist in the value chain. Transport hire, loading and unloading charges are usually the components that comes under ‘transportation cost’. 

However, wholesale markets create other transaction costs such as ‘buyer establishment cost’. This is the cost that involves in negotiating a sale in the wholesale market and that is most of the time is driven by the relationships between the farmer and the trader in the wholesale market and could take different forms.  

A profit-making farmer will not engage in commercial agriculture production unless there are enough incentives for him to do that

Usually there is a commission fee. However, a commission fee is mandatory regardless of whether there is a relationship between the farmer and the wholesale trader. Most collectors have well established relationships with wholesale traders therefore farmers are sometime better off working with a collector rather than facing transaction costs in establish a relationship. 

Exporters usually expect the farmer to bring in his produce directly to their collection centre or to the pack house. Most exporters have their collection centres or pack houses close to the airport so they can minimise the cost of transporting from the production/processing facility to the airport. This creates a disincentive for farmers to directly work with the exporter, hence most farmers work with collectors (or larger producers that have established relationships with the exporter). 

Usually the price paid by the exporter would compensate functions of a collator, otherwise this would be taken away from the margins of the producer. Therefore, price plays a major role for a farmer to see the comparative advantage in working in an export value chain in comparison to working with the wholesale market. 

One way to overcome this is to establish production clusters and then establish collection centres for those clusters so farmers can themselves bring in the produce rather than working with a collector. Ideally these collection centres needs to be pack houses. This way exporter can directly sort, grade, clean and then pack the produce so it can be directly transported to the airport. This is already happening for some export commodities such as TEJC mango.

Do we have comparative advantage in the export market?

Export destination plays a major role in determining the distribution of value contributions in the value chain. If FOB prices are better, exporter has enough incentives to give batter price for the collector and he has the same to give more to the producer. 

Being a small country producer, Sri Lanka has little ability to influence the world market prices, therefore for most destinations and commodities prices are given. Volumes are not the comparative advantage, rather the quality and other added features are. 

These added features are usually value addition, certifications and traceability. Therefore, an export value chain must evaluate its position in terms of these features if expansion is one of their objectives. 

Export destination such as Maldives will have little restriction in terms of quality of the produce and will hardly incentivise the exporter in terms of certification, value addition and traceability. Therefore, if an exporter would only want to work with such an export destination, it will be very easy to establish the value chain, but will not pay enough dividend to the actors along the value chain. 

However premium markets such as the EU, the US, Japan and Dubai will demand more from the exporters. These countries will demand certifications, especially the EU region will demand certifications such as Global GAP. They will have strict MRL levels, especially countries such as Japan and USA. 

In addition, organic certification, traceability will give more economic value to the commodity thus the value share in the value chain can be increased. Then comes the value addition. Value addition will immediately add a higher price premium but that can be further increased with certifications and traceability. 

Different destinations will create different price premiums as well, for example Japan pays a higher price for black tiger shrimp from Sri Lanka for its distinctive colour and flavour. In establishing an export oriented value chain, these things have to be carefully considered. It’s important to see what the production possibilities for the commodity are so that investments and expansions can be properly planned.  

At the end of the day, a commodity has to be price competitive in the international market

Let’s look at an example commodity. Bell pepper is a vegetable that has a higher export potential. It’s been demanded by hotel and restaurant sector and also by supermarkets (this commodity has a higher local demand as well). Bell peppers are grown in Sri Lanka under poly tunnels. These are not greenhouses therefore it’s not grown under fully controlled environment. 

While green houses have the ability to manage production as well as pest and diseases under its controlled environment poly tunnels have lesser capacity to do these. Therefore, poly tunnels are more exposed to pest and disease attacks, therefore calls for higher use of pesticides. On average 10-15 chemicals are applied in bell pepper cultivation. 

Majority of bell pepper goes to the Maldives and some Middle Eastern countries which do not demand certifications and does not have MRL regulations, therefore for the moment it seems fine. But obviously export to other premium markets needs more factors in place. 

With the current levels of chemical applications under poly tunnel systems, it’s highly doubtful whether bell pepper can be grown under the organic system or Global GAP for that matter. Therefore, even the traceability can be established and value addition can be done, it’s not enough to penetrate the premium markets such as the EU. Hence under the current cultivation system with poly tunnels we might not be able to extend the production to achieve the full potential of the value chain. 

Now, the option is to go with the newest technology (with greenhouses and precision agriculture where things can be controlled at very micro levels) but there is a trade-off with the investments. Half of the current producers will fall out from the value chain with the inability to invest. 

However, this does not mean Sri Lanka will not be able to produce organic bell pepper, there are producers who have already invested in new technology and trying to achieve these certifications and premium markets. This is where one of the interesting arguments in establishing export oriented value chains comes in to discussions. Export oriented value chains are not for all the producers.  

To be in an export oriented value chain farmers needs to achieve economies of scale. This can be either with a larger production volume where costs can be brought down significantly or increase efficiency though technology adoption. They need to be trustworthy and honour agreements with the exporters for example honouring a contract farming agreement. 

They need to have the ability take on production and market shocks. Repeated pest and diseases attacks are there in any agricultural value chains however plenty is at stake in producing an export commodity. Therefore, if we consider the previous example of bell pepper, not all farmers can take repeated attacks of pest and diseases under poly tunnel systems and not all of them can invest on greenhouses and precision agriculture. May be what we can do is to cluster farmers in to two or three categories and orient them towards different value chains such as pesticide based bell pepper, Global GAP certified bell pepper and organic bell pepper. This can only be done after careful evaluation of the farmer in terms of previously mentioned factors, and also the potential of the exporter to penetrate the premium markets. 

At the end of the day, a commodity has to be price competitive in the international market. If most are producing pesticides based bell pepper and we can’t be price competitive then our expansion plan should be to penetrate the organic bell pepper market. A comparative export parity price analysis will provide this information for exporters. 

Do markets and policies support the access to essential inputs?

Planting materials, fertilisers and other chemicals are two of the important inputs in producing agricultural commodities in addition to many other. 

The focus here is on planting materials. Planting materials either can come as seeds or plants itself. 

For example, TEJC mangoes are planted as trees (which are well established under a separate nursery system) and bell pepper comes as seeds that needs to go through producer’s own nursery system before establishing on the ground.  These two commodities are central to the discussion below. There are several bell pepper seed types imported under different companies (Bell pepper seeds are hybrid seeds imported by several companies and they do not produce a second generation. Therefore, every planting season needs a new seed lot). Most of the time same colour and shape is produced by these varieties but imported under different entities so these are basically ‘different trade varsities’. It’s not obvious that there is a price difference in these seeds as well. 

In addition, different trade types will have different germination rates. Farmers’ experiences will tell what would be more susceptible for pest and diseases and what will produce more during the cultivation cycle. 

However, there is always the tendency for these trade varieties to go out of the market. Sometimes farmers adapt well to a particular trade variety and suddenly it not available in the market anymore and farmers now need to adopt to another one. This shift between different trade types create many transaction costs to the farmer. 

TEJC mango plants are available in plant nurseries in many parts of the country. However, according to the introducers of TEJC mango, they are the only plant nursery that produces the best F3 generation plants. These plants have the capability to produce the best quality TEJC mango with its unique colour, taste and size. 

Without these special characteristics, TEJC mango will not be able to qualify to enter in to the export market to compete with mangoes that are coming from India. 

Therefore, this provide a disincentive to any grower to buy plants from another nursery. This could very easily create shortages in the market place and at the same time distort the market by creating a monopoly in terms of producing planting materials. 

Ideally there has to be a competitive market in terms of planting materials and farmers need to have the option to select what they can afford while not compromising the ability to maintain the general quality parameters of the export value chain. In terms of bell pepper seeds, one company is responsible for importing one trade variety. Trade variety that has the highest germination rate and that has the highest potential for an increased yield is significantly high in price compared to other varieties.  Therefore, most farmers make a trade-off between the price of seeds and the potential yield. This could have a significant impact on farmer’s profits. 

Seed importers face many challenges in introducing new seeds varieties to Sri Lanka. There is a tedious process to bring in a new variety and it can take up to 6-18 months to get a variety approved. This involves plenty of paper work and also field testing that disincentives seed importers. Even after all of that, it might fail in the open field with farmers due to many reasons therefore seed importers have enough incentives to stick with a seed variety that they already got approvals for, as much as possible. This will at the end limit the potential of the export value chain and may prevent from gaining comparative advantage in the international market with new varieties. Farmers work with incentives therefore they should have the option to select the trade variety that incentivises them most.

Are other support services in place?

Agricultural advisory services are a must for any commodity, however this is very important for export oriented value chains given the economic value of the commodity. 

Therefore, how to manage the cultivation process including fertiliser, pest and disease management is important to achieve the full potential of the commodity. 

Usually, agricultural advisory services are provided by the officers from the department of agriculture (either State department of provincial councils). However, given the human resource capacity and the number of farmers they have to cover, it is nearly impossible to provide individual attention to all the farmers. However, much attention is required by farmers who are in an export oriented value chains. 

Therefore, what is the solution? It is clear that exporters have little incentive to have their own extension and advisory services unless they are working on their own production/plantations. Therefore, another approach is needed. 

One way to go about this is to work in collaboration with the input suppliers. For example, bell pepper seeds are sold by different seed importing companies and they have to invest on research as a necessity in getting approvals to import. They are motivated to promote their seed varieties which is their profit base. 

Therefore, in establishing export oriented value chains, exporters can work in collaboration with seed importers to transfer knowledge to farmers. This knowledge can be transferred to the government’s agricultural advisors as well. 

On average post-harvest losses are more than 30% in many agricultural value chains. This is not a desirable situation for export oriented value chains. While produce is transported to wholesale markets in gunny bags this is not acceptable in an export value chain. Agricultural crates need to be adapted by all who work on an export oriented commodity. This will facilitate the establishment of traceability as well. 

In addition, especially fresh fruits and vegetables needs to travel long distances to reach their final destinations (while maintaining the quality) and travel time is important. This will never be possible under normal transportation and storage systems thus it is essential cold transportation and storages are adopted. 

At the same time, airports must have enough capacity and facilities to handle export commodities, and this is again important to fresh value chains. At the moment airport is lack in terms of physical capacity to manage the quantities therefore things need to be at the airport at least five hours earlier. 

Cold storage at the airport is very limited and most freights need to wait for loading in ambient temperatures (luckily the airport is now working on an expansion plan with extended cold storage facilities). 

Sea freight takes a long time and does not provide adequate cold storage facilities therefore exporters have to depend on air freight when it comes to fresh commodities and that increases the freight cost. This at the end will reduce the comparative advantage of the export commodity in the international market. 

Therefore, both air and sea freight facilities needs to be enhanced in terms of capacities and cold storages and transportations. Without this, most fresh export commodities will not be able to penetrate other premium destinations and will have to stick with the Maldives and handful of Middle Eastern countries.  

(The writer is an agriculture economist. He can be contacted via [email protected],)