Improving agroindustries in developing countries: Lessons from the Bank’s projects, 1972–83

Agroindustries play an important role, but, as the Bank’s experience shows, problems often arise in their planning and operation. What conditions do they need to function well?

Abstract

Agroindustries play an important role, but, as the Bank’s experience shows, problems often arise in their planning and operation. What conditions do they need to function well?

James G. Brown

Over the past decade the marketing, storage, and processing of agricultural products have become increasingly important to the economies of most developing countries. With technical progress in agriculture, marketable surpluses of agricultural produce have grown significantly, while rapid growth in urban populations and rising per capita incomes have enlarged and diversified the demand for processed agricultural products—whether food or raw materials for construction or industry.

In Bank usage, the term “agroindustries” covers agroindustrial processes such as grain milling, fruit and vegetable canning, oilseed crushing, and meat packing, as well as the functions of storage and marketing. While the share of agriculture in a country’s total output generally declines with economic development, as industry and services expand, agroindustries maintain or increase their share. They contribute a growing part of total value added in the agricultural sector, as consumers’ rising incomes create demand for more processing and better quality in food and nonfood products. In the least developed countries food processing may contribute less than five percent of GDP while agriculture contributes more than 50 percent. In Bangladesh, for example, these shares are four percent and 53 percent, respectively. In Argentina, at a much later stage of development, food processing contributes about 32 percent of GDP, and agriculture 11 percent.

Agroindustries can play an important role in the development process. As well as absorbing agricultural surpluses and meeting the needs of growing urban populations, these industries add value to domestic raw materials and can create employment at less cost than in many other types of industry. Being based on farm products, they can often be sited in areas where other industries would not be viable. They can also help to disperse the ownership of industry and to reduce dependence on imports for food and industrial raw materials. In practice, however, these benefits have often proved elusive and the results of many well-intentioned investments have been mixed. What factors contribute to the success or failure of these enterprises?

Raw material procurement

The most common and perhaps the most difficult problems faced by agroindustries pertain to the supply of raw materials. Other than cost, three aspects of raw material supply are of concern: quantity, quality, and seasonality.

Quantity. Harvests are affected by the weather. But the supply of products to agroindustrial enterprises also typically depends on a number of manageable variables, in particular the prices paid to producers and the producers’ perception—at planting time—of how easily they will be able to sell their products. Many farmers who produce their own food can choose to withhold supplies from the market if prices are not attractive. In the case of traditional crops, producers’ decisions can usually be predicted quite readily. If, by contrast, the commodity in question is new to producers, special support to reduce risks—both technological and market-related—may be needed to induce enough production. Again, if the commodity in question is new to producers, or if the enterprise is located away from traditional trade networks, the enterprise may have to make its own arrangements for buying and hauling raw materials, perhaps investing in its own transport capacity. Since this can be a costly undertaking, it must be considered at the time a proposed agroindustrial project is appraised. If the market for the crop in question is affected by an official support price, two further issues need to be considered: first, is the price set so as to stimulate production, or mainly so as to suppress or stabilize consumer prices, and, second, will the available infrastructure and financial resources permit the producer actually to receive the support price?

Quality. Agroindustries are concerned with the storage life and processing characteristics of their materials. Traditional crop varieties may have the loyalty of local consumers and certain appealing characteristics, but they may not conform to the requirements of the technologies used in processing. To ensure that supplies have the right characteristics for storage, processing, or sale in nontraditional or distant markets, the enterprise or government may need to undertake associated work in the agriculture sector proper—such as adaptive trials, the development of new varieties, the supply of improved inputs, and technical assistance to growers. Such efforts must be supported with a price structure that places a premium on the desired characteristics (such as low moisture content and uniformity in grain, or particular sizes and shapes in fruits and vegetables).

Enterprises may require laboratory facilities to assess the supplies they are purchasing, withholding a part of their payment to producers until quality has been determined. To avoid discouraging producers such a payment system must depend on mutual confidence, and the initial payments must be large enough to satisfy producers’ immediate needs for cash.

Seasonality. For enterprises based on crops and some animal products such as wool or milk, seasonality is a critical factor in the utilization of capacity, and therefore in the unit costs of their production. In considering plant size, a balance must be struck between the benefits from economies of scale that most industries could realize during periods of good supply, and the costs of unutilized capacity during the off-season. Over-optimism with respect to raw material supply and markets has led to widespread underutilization of capacity in agroindustrial investments.

Seasonable variations in supply can also cause other types of problems. If backlogs occur during the peak season, supplies waiting to be processed deteriorate. Double- and triple-shift operations to cope with deliveries during peak periods create a high risk that the plant will break down, and thus must be carefully managed.

Projects assisted by the Bank have made several types of provisions to minimize the problems associated with seasonality:

  • Installing capacity to process a range of raw materials—such as different fruits and vegetables—as they become available. The cost of extra product-specific equipment, which is usually required at the first stages of processing, may well be offset by the reduction in fixed costs of capital per unit of output that results from reduced idle time, or by the increase in sales revenues from using the plant more intensively during its period of operation;

  • Providing assistance to growers to extend the harvest period through changes in the crop varieties grown and in cultivation practices, and by making better inputs available;

  • Adjusting producer prices according to a pre-announced schedule, to encourage deliveries early and late in the season; and

  • Drawing raw materials from different areas, with different climates or crop cycles, in rotation.

Operations

A number of problems arise in operations.

Technology. The Bank’s experience has shown repeatedly that one of the most critical issues in the choice of a technology is its compatibility with the environment in which it is to operate. For some difficulties posed by incompatibility, firms can take compensatory measures, at a price. For example, a firm’s technicians can be trained to maintain and repair complicated imported equipment, but the time and efficiency lost during their training must be weighed; deficiencies in utilities and other infrastructure can be offset by ancillary investment, but the costs of this may be prohibitive. However, certain features of the environment will be beyond a firm’s control. Examples include difficulties in importing replacement parts and interruptions in the supply of packing materials. Reliance on sophisticated technology may also reduce a firm’s flexibility and thereby limit its ability to cope with seasonal fluctuations in its inputs or changes in its markets.

Labor. Two types of labor-related problems have been common in agroindustrial enterprises assisted by the Bank. First, those that are public enterprises, in particular, have been under pressure to absorb excess labor. While increased employment is an important political and economic objective, especially in remote or depressed areas, inflated labor costs can have a devastating effect on financial performance. Second, labor turnover can seriously hamper the performance of individual enterprises even though it may benefit the economy at large.

These problems can be minimized if they are anticipated at the time projects are developed. Careful financial planning can provide the basis for negotiation with agencies concerned with maximizing employment. Providing housing and other on-site amenities for workers can reduce labor turnover. A sound argument exists for some cost sharing between government and the enterprise, both in the provision of these facilities and in training.

Agroindustries and the World Bank

This article is based on a review of agroindustries undertaken by the World Bank in 1984. The review examined 960 agroindustrial components in 483 agricultural projects approved by the World Bank between 1972 and 1983. The total cost of these components was $10.8 billion, of which Bank funding amounted to about $4.5 billion. This assistance to processing, marketing, and storage comprised 16 percent of the Bank’s total support to agriculture during the period.

The economic and social importance of lending for agroindustries has given rise to extensive government intervention. Though this article, like the review it is based on, does not address the strengths and weaknesses of public enterprises at large or discuss other market-regulating efforts that affect agroindustries, the reader will recognize many of the issues discussed as relating particularly to the circumstances of public sector intervention.

Number of agroindustrial components financed by the World Bank, 1972–83

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Source World Bank

The remainder of the total of 960 components featured multiple commodities and activities.

Infrastructure. In the siting of new plants, technical and financial factors may be subordinated to political considerations, ranging from conformity with government guidelines on the regional dispersal of investment to questions of land ownership. Many of the enterprises assisted by the Bank have suffered from their location; frequently they had poor access to road or rail systems, or poor water supply and facilities for waste disposal. Many lacked a reliable supply of electric power, suggesting that the cost of standby electricity generators should be explicitly considered in the analysis of investment proposals. Potential project sponsors should try to gauge the adequacy of the facilities likely to be available by looking at the location and experience of existing firms.

Finance. Production cycles and consequent fluctuations in cash flow are much more pronounced in agroindustrial activities than in most other types of enterprise. Liquidity problems at critical stages can have irreparable consequences not only for the use of capacity but also for maintaining the confidence of producers, which is essential to maintaining a stable supply of raw materials. Seasonal fluctuations in cash requirements also may not be compatible with the usual terms of commercial bank loans, and open lines of credit as well as flexible repayment terms may thus have to be negotiated.

Management. Process management and financial management are closely related and in the Bank’s agroindustrial lending they have been the most frequently identified areas of concern. In agroindustries, the proper coordination of stocks and operations requires an intimate knowledge of the process in question, and the flow of materials is particularly important because most of the raw materials and intermediate goods used are perishable. Good coordination can minimize a plant’s requirements for working capital; conversely, excessive or unbalanced inventories, and unsatisfactory purchasing and processing schedules, can easily cause liquidity problems. Managers of agroindustrial enterprises need enough autonomy to make their own operational and financial decisions, in a timely manner.

The Bank’s experience with firm-to-firm management contracts is not extensive, but this form of assistance appears to offer several advantages over more traditional individual technical assistance contracts. By providing for a number of functions and elements in one agreement, it places greater responsibility as well as authority in the hands of the combined management of the enterprise. Because it typically involves incentive payments as well as basic fees, it can induce a level of commitment on the part of managers not unlike that of shareholders. Indeed, such an arrangement may pave the way for private equity participation, by fostering improved performance and by providing a period in which potential partners may gain first-hand knowledge of the enterprise and its environment at a low risk. Lastly, since the delegation of line-management responsibility to the contractor-manager must be spelled out in the contract, such an arrangement encourages consideration of the degree and nature of autonomy the enterprise needs to function effectively.

Marketing

The conditions faced by agroindustry, both in international and domestic markets, have changed dramatically in recent years. Traditional export markets have grown more slowly than in the past. Most commodity markets have been depressed, and there has been a increase in the protection of domestic suppliers of competing and substitute goods in importing countries. Substitution among raw materials and intermediate goods, on the basis of price and source of supply, has become more common. In most developing countries, consumers are demanding a greater variety of products and better quality.

Export markets. Many agroindustrial projects are now facing severe difficulties in exporting to the markets that were their original raison d’être. A major factor in this respect is the reduction in industrial growth in OECD countries, which has increased pressures to protect processing industries within these countries. For established suppliers, a thorough knowledge of regulations and trade structure may preserve access to markets, perhaps through changes in packaging or in distribution channels, if not in products themselves. But where a firm cannot gain access to its intended market, major product changes, probably involving new investment, may be the only alternative to closure. In many cases, firms need to pay more attention to the potential value of their byproducts and to selling in nontraditional export markets.

Domestic markets. Domestic markets appear to offer agroindustries growing opportunities for both product diversification and efficient import substitution. However, agroindustries designed to replace imports, rather than meet demand for new products, have often encountered difficulties. Tariff and tax regimes are apt to protect the assemblers and processors of competing imports, while controlled prices may not give producers adequate margins for processing and marketing. Exchange rates in many countries favor continuing imports of finished goods, while graduated tariff structures discriminate against local production of intermediate goods. In some products, legal standards copied from those of a foreign market may prevent local production in some respect that is unrelated to quality.

Agroindustrial firms that plan to produce for the domestic market also need to examine the facilities for distributing their products. For example, the cost of a specialized distribution chain for perishable products probably cannot be borne by a single enterprise or product line. Another factor is the structure of the distribution system; in some countries the main commercial distribution systems still radiate from the ports of entry, rather than from domestic centers of production.

Instability of production. To establish and maintain a position in the market, firms need to follow a predictable pattern of deliveries. If they do not, potential buyers will be reluctant to enter into definite contracts or to promote distribution through regular channels. The result is that products are discounted once they do reach the market. Firms whose production is erratic also face disadvantages in shipping: shipping charges can be significantly lower for large regular shipments, and irregular shipments may be delayed, being accommodated only as space is available.

Market research. Those planning agroindustrial enterprises need to make a careful examination of prospective markets. Market analysis may be too general, if it uses national or annual data or assumes that related products are more homogeneous than they actually are. The organization of the market is also vitally important. For example, if the wholesale market is managed by a few large houses instead of by many brokers and jobbers, a single supplier may not be able to secure a small share of that market. Regulations in prospective export markets also need to be examined, covering the gamut from health standards to labeling.

In conclusion …

Agroindustrial enterprises can make an important contribution to development. Many of their requirements for success are the same as or similar to those in other branches of industry, and those (the majority) that are in the public sector share many problems typical of public enterprises in general. But, being at the meeting point of the agricultural, industrial, and service sectors, agroindustries have a number of unique characteristics that can give rise to special problems. Many of these problems can be averted by careful planning of agroindustrial projects.

Finance & Development, June 1986
Author: International Monetary Fund. External Relations Dept.