Inclusion of Small-Scale Dairy Farms in Supply Chain in Bulgaria (A Case from Plovdiv Region)
33 Pages Posted: 30 May 2007
Date Written: May 2007
This paper incorporates the New Institutional Economics framework into analysis of a case on effective market inclusion of numerous small-scale dairy farms into big food chain. It presents a business model developed by a private entrepreneur from Plovdiv region in Bulgaria. Dimitar Madzarov LTD was set up in first years of post-communist transition, and successfully expended and modernized up to the highest industry standards. This enterprise has managed to adapt to dynamic market and institutional environment governing effectively relations with supplying farmers and downstream partners. The major features of the new business model include:
- starting up and developing a competitive dairy processing enterprise for locally produced milk. Processed milk has risen 20 folds since the beginning currently comprising 50 tons milk a day. Production comprises cow (60%), sheep (30%), goat (8%) and buffalo (2%) milk processed in a big range of traditional and original dairy products (brined cheeses, yellow cheeses, soft cheeses, processed cheeses, curds, butter, katuk). More than 1000 livestock farms located up to 30 km supply the dairy, most of them being semi-market and small-scale holdings (49% are with less than 5 cows and 39% with 5-10 cows).
- installing collecting, cooling, and controlling facilities for all kind of raw milk in the neighborhood to small-scale farms as well as within groups of farms and bigger farms.
The company has built 80 terminals in different locations in proximity of the dairy farms equipped with 2-3 tanks for milk, and staff and devices for analyzing major indicators of delivered milk. In addition, 150 tanks have been installed within individual or groups of dairy farms. They have been rented for free to farmers and entirely maintained by the company while raw milk is collected by the dairy trucks daily or every other day.
- modernizing milk supply and processing quality according to the top industry standards and the superior EU requirements. The dairy is among the few enterprises which introduced the high international quality standards (HACCP, Good Production Practices, and ISO 9000), and got a license for EU export. Currently, a third of the processed milk fully corresponds to the EU requirements.
- building an effective system for governing relations with individual farmers. An effective system for coordination, stimulation, control, and conflict resolution with suppliers has been developed including: building a good reputation and trust, constant communication, regular group discussions and training of farmers, using written delivery contracts, significant relation specific (on farm) investment, individual verification (quality tests) and registration of delivered milk, punishment for offenders, regular payment mode, differential pricing stimulating extension of farms and milk supply, interlinked interest-free crediting (advance payment) against marketing of milk, providing assistance to farmers in construction and preparation of public support projects, encouragement of farm grouping etc.
- setting up a company mark and an own label, and building a reputation for high quality and authentic origin products. A company mark and own label have been designed and registered, and a good reputation for high quality and safe products built among leading food retailers, wholesale traders and exporters, and final consumers in the region and nationwide.
- introducing a great variety of specific, original and locally produced dairy products in a big selection of packages into regional, national, and international markets. Huge assortments of specific local and newly developed products have been introduced contributing to revival of traditions in production and consumption of divers local dairy products. Furthermore, a great range of packaging has been used to suite to the specific requirements of big food chains, exporters, and final consumers. Marketing of the great part of dairy output is governed through long-term delivery contracts with leading food stores (60%) and exporters (30%).
The inclusion of small-scale producers has been proved by a farm survey. It confirmed that a great part of the suppliers are holdings with few heads of animals. As much as 94% of farms sell the entire or considerable fraction of the produced milk which is much higher than in Plovdiv region. Unlike the common situation in the region, specialization into dairy rather than other farming or off-farm activity is typical almost for all holdings farming is single or major occupation and income source. There as been also a significant increase in number of suppliers as well as milk production and marketing in participating farms.
We also identified the major factors for development of the new business model. For the dairy manager those are: entrepreneurship, experience and skills, high technological discipline, available resources, introduction of innovation, effective control, incentives and sanctions, building good reputation as well as development of markets and formal regulations. For farmers those factors are: experience and skills, development of the dairy, the closer integration with the dairy, and respecting laws and private contracts.
There has been a significant evolution of contract relations between the dairy and suppliers. Now a written form is commonly used and long-term mode, fixing quality, quantity, pricing and sanctions are wider (than before) applied. More than before farmers get premium prices, long-term stable prices, and see sanctions (linked to quality and safety) included in the price terms. Major conflicts have been associated with the low milk prices and decreasingly with milk quality. Most common changes the farmers had to make to start selling milk to the dairy in the past were in hygiene of production, farms management, and milk quality. Currently, most farms have to improve the hygiene of production and milk quality in order to carry on selling to the dairy. A good part of farms are to increase number of animals and volume of production as well as improve animal welfare and environmental care. That requires progressive changes in breed of animals, technology of breeding, and labor organization in a bulk of suppliers. Adaptation to the new dairy and formal requirements are being associated with additional costs and investment, and raising labor amount and intensity. The biggest efforts and time of suppliers are associated with production activity, quality control, planning farm activity, studding formal requirements and adaptation to new formal requirements, introduction of innovation, relations with control authorities and bureaucracy.
According to their own estimates the majority of farms enjoys higher income, better quality of production, greater stability of sells and prices, better possibility for modernization and adaptation to formal requirements, and care for animals and environment, than comparable farms in the region. The integration with the dairy has led to progressive improvement of the relative situation and now more farms feel they are better off then it was in the past.
More than a half of farms intend to extend the current farm activity, and 30% aim at keeping activity unchanged. Besides, majority plan to modernize their farm. Both owners of the dairy and farmers envisage a closer integration. Unlike the common situation, the farms declare having a high capacity for adaptation to new EU requirements expecting positive impact of CAP on their income, product quality, volume of production, improvement of care for animals, and social status of farm household. All these suggest a high sustainability of the studied mode and participating farms.
That positive Bulgarian model could be effectively replicated in other transitional and developing countries with widespread semi-subsistence and small-scale farming, lack of farmers (marketing and processing) organizations, shortage of adaptive and innovative processing enterprises, deficiency of public support to small-scale farms, and increasing demand for quality local dairy products. An effective transfer could be achieved after an appropriate popularization of the pace and factors of its development.
Our recommendations to prospective business entrepreneurs are to use Dimitar Madzarov LTD experience in governing relations with the suppliers and buyers. Crucial for the success of farmers integration would be: investment in relation specific capital such as good reputation, near or on-farm milk collecting facilities, training of farmers; and building effective communication, stimulation, control, payment and sanction mechanisms; and interlinking marketing of milk supply with a credit and service supply by the dairy. All these would develop mutual trust, overcome uncertainty and risk, stimulate dairy specific investment (adaptation) by farmers, minimize costs of transactions, facilitate and intensify bilateral trade.
In addition, effective public and/or international assistance policies could considerably accelerate the successful replication. First of all, such policies should be directed to support private initiatives and entrepreneurship through providing information, education, advise, sharing positive (and negative) experiences as well as funding small-scale innovative business projects.
Secondly, no restrictions have to be put on business entrepreneurs to invent and apply effective private governing modes with suppliers and buyers which most suit to the particular conditions of their mutual trade. Public intervention is to be focused on improvement of the general regulations, fight against gray sector, control on critical points within food chain, effective enforcement of laws and private contracts, financial and other support to prospective initiatives aiming at inclusion of small-scale farmers in modern food chains).
Third, identification of big transaction difficulties (failures) in market and private transactions between farmers and processors, and assistance through market and price information, setting up and enforcing prospective quality and safety standards, independent control and arbitration, price stabilization schemes etc.
Fourth, considerable efforts is to be put on small-scale farmers information on market and business opportunities, training in farm (business) management and contracting, providing technical and financial assistance for adaptation to new consumers, processors, food chains, export, and institutional requirements. For instance public premiums for high quality products or preferential credits for enlargement and modernization of farms could significantly speed up transformation. In order to guarantee the access of small-scale (rather than large) producers in public support program a special criteria tailored to their particular conditions have to be applied such as: maximum size, particular structure of production, available cost-sharing potential, existing project preparation capacity etc.
Fifth, when certain public goods are to be supplied by farmers (e.g. preservation of environment and biodiversity, keeping traditional productions and varieties etc.) they have to be effectively funded by the state budget. Here neither pure administrative measures nor market competition and private (voluntary) initiatives can be effective. Likewise when significant non-productive investment are to be made in benefit of the entire food chain (e.g. adaptation to new safety, hygiene, animal welfare etc. standards) then they are to be funded by the public or shared by all actors (farmers-processors-retailers-final consumers).
Finally, public support is to be provided to grouping, cooperation, and association of small-scale farmers through assisting initiation, registration, organizational development, independent control, tax breaks, funding common projects and collective actions etc. Furthermore, public support is to embrace larger joint initiatives and collective actions of farmers and rural actors joint projects for environmental and biodiversity preservation, for integration of farming with agro-tourism and retailing, and other agrarian and rural development plans.
Keywords: inclusion of small-scale farms into food chain, private governance, vertical integration, transaction costs, new institutional economics, transition of dairy sector and farms, Bulgaria
JEL Classification: Q12, Q13, D23, L14, L22, L66, M13, M31, O13, O17
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