Value Chain Financing: The Case of Selale area Dairy Value Chain

Transcription

1 Value Chain Financing: The Case of Selale area Dairy Value Chain By Getnet Haile Debebe December 2010 Addis Ababa

2 Value Chain Financing: The Case of Selale area Dairy Value Chain By Getnet Haile Debebe A project study submitted to the school of Graduate Studies of Unity University in partial fulfillment of the requirements for the Degree of Masters of Business Administration December, 2010 Addis Ababa

3 School of Graduate Studies, Unity University Value Chain Financing: -- The Case of Selale area Dairy Value Chain By: Getnet Haile Debebe Approval of Board of Examiners External Examiner Name 7!~,~ SJ;be{{Y/')) ) Signature~~. Date A ~/; )..-/1--0 Internal Examiner Name,'4(,'" Signatu~ Date d-, Confirmation Chairperson, Department Graduate Committee Name Signature Date

4 Letter of Declaration I, Getnet Haile Debebe, declare that this research paper on the topic "Value Chain Financing: A case Study of Selale area Dairy Value Chain" is completely a result of my work. I have carried out the paper independently with the support and guidance ofthe research advisor, Dr. Tades~e Negash Getnet Haile October, 20 I0 Unity University Addis Ababa, Ethiopia

5 Certification This is to certify that Getnet Haile Debebe has carried out his research work on the topic entitled "Value Chain Financing: A case Study of Selale area Dairy Value Chain" under my sup,ervision. This work is original in nature and it is suitable for the award of the Masters Degree in Business Administration (MBA). Tadesse Negash, PhD October, 20 I0 Unity University Addis Ababa, Ethiopia

6 i ACKNOWLEDGEMENT I am grateful to my family, especially to my wife, WODERYELESH HABTIHUN for her incredible assistance throughout this MBA program. I also want to thank Ato Yeshiwas Mamo who advised me to join this program. Ato Alemayehu Takele is a special person who provided me a lot of ideas and support during my study. It is important also to mention the cooperation of my colleagues at Target Business Consultants, especially in gathering of resources for the study and of covering part of my responsibilities in the company and at home too during my absence. Aster Habtihun, Teferi Admasu and Addis Yitbarek play important roles in this regard. Finally, I would like to thank my advisor, Dr. Tadesse Negash for his dedicated support and tolerance for my plenty of re-scheduling request for discussions during this study. His fatherly advices and sharp critics are unforgettable.

7 ii ACRONYMS AI CBE Coops CSA EIC FAO FINIDA GTZ ILO IIRR KIT LDE MCC MFIs NAIC NGOs SAI SDDP SMEs SNV UHT UNDP USAID WOCCU Artificial Insemination Commercial Bank of Ethiopia Cooperatives Central Statistical Agency Ethiopian Insurance Corporation Food and Agriculture Organization (of United Nation) Finland Development organization German Development Organization International Labor Organization International Institute for Rural Reconstruction Royal Tropical Institute (The Netherlands) Lame Dairy Enterprise Milk collection center Microfinance Institutions National Artificial Insemination Center Non Governmental Organizations Sebeta Agro Industry Smallholders Dairy Development Project Small and Medium Enterprises Netherlands Development Organization Ultra Heat Treated package United Nation Development Program United States International Development Organization World Council of Credit unions

8 iii ABSTRACT Value chain is a recent concept in Ethiopia. It has been promoted by different development organizations and Ethiopian Government with the objective of enhancing the livelihood of rural community and urban and peri-urban entrepreneurs. This study examines value chain financing, one of the important issues in the value chain study. The study is based on a case study on the Selale Dairy Business Value Chains. The chain extends from dairy farmers to end consumers of dairy products. Value chain as a concept examines the inter-relationship between the various actors involved from production, collection, processing, retailing and consumption. Whereas traditional value analysis focuses on a specific sector. Traditional farmers, commercial farmers, collectors including cooperatives, union and individual collectors, milk processors, other dairy product processors, supermarkets, kiosks, cafes and restaurants are identified as important actors. These actors are classified as direct actors, indirect actors and chain supporters who are working in the overall chain context which includes the macro level issues like the economic, the political environment, the legal framework, the physical environment, the culture and society and many more. In relation to the dairy sector, Microfinance Institutions (MFIs) and Commercial banks are identified as non-suitable to the lower level of value chain actors. Actors at the lower level of the value chain are the farmers, individual collectors, cooperatives and the Union (Selale Dairy Cooperative Union). There is a serious financing gap to this part of the chain actors. Whereas actors at the higher level of the chain, like processors are well financed. The lower levels of the chain actors are providing credit financing which reaches the processors. For the efficient flow of products and value additions all the way through the various actors financing services need to be available. The study recommends a triangular inter-relationship of actors with MFIs and commercial banks to share risks and to lower transaction costs, to fill in the financial gaps observed at the lower level of the value chain actors. In addition to financing, milk quality, unfair competition, marketing, weak milk consumption cultures, feed quality, access road and cost of inputs are identified as serious challenges to the dairy value chain.

9 iv Table of Content Page ACKNOWLEDGEMENT i ACRONYMS ii ABSTRACT iii CHAPTER 1 1 INTRODUCTION 1 Background 1 Problem Statement 3 Study Objective 4 Research Questions 4 Study Scope 5 Study Significance 5 CHAPTER 2 6 LITERATURE REVIEW 6 Value Chain 6 Value Chain Finance 9 CHAPTER 3 12 FRAMEWORK ON VALUE CHAIN FINANCE 12 Value Chain Context 12 Chain Supporter 13 Chain Actors 13 Financing needs 14 CHAPTER 4 15 RESEARCH METHODOLOGY 15 Background 15 Data Collection 15 Interview 15 Discussion 16 Document Review 16 Sample taken 16 Analysis and Design 17

10 v CHAPTER 5 18 STUDY FINDINGS 18 The Selale Dairy Business 18 The milk value chain 20 Chain Actors 21 Chain Supporter 28 Chain Context 31 Challenges and Opportunities 32 Financing Challenges and Opportunities 32 Non Financing Challenges and Opportunities 36 Milk Quality 36 Unfair competition 37 Marketing 37 Weak consumption culture for Dairy products 38 Feed cost and quality 38 Road accessibility 39 Machinery Cost 39 CHAPTER 6 40 CONCLUSION AND RECOMMENDATION 40 Conclusion 40 Chain Financing: Strong points 40 Chain Financing: Weak Points 41 Recommendation 43 Bibliography 48 Appendixes Interview: Farmer Producers Interview: Cooperatives Interview: Processors Interview: Microfinance Institutions Interview: Commercial Banks Interview Service Providers/NGOs Additional common interview checklists List of interviewees

11 1 CHAPTER 1 1. INTRODUCTION Background Value chain is a recent concept in Ethiopia. It has been promoted by different development organizations and Ethiopian Government with the objective of enhancing the livelihood of rural community and urban and peri-urban entrepreneurs. For many years, developing countries were striving for ensuring food security of the rural community through different development activities to improve farm productivity. There were remarkable improvements in farm productivity in the past. In some parts of the country, farmers were challenged with price decline for their produce as their supply increases beyond the market size of their village or nearby small town. This in turn diminishes the net value of return from their agricultural activities. On the contrary, such farm products are sold at a higher price elsewhere in the country. Market access is becoming major problems ahead of issues of productivity. That is why value chain concept becoming famous and kept dragging the attention of development organizations and governments, with the objective of addressing the market linkage problem of the rural community (SNV Annual Report 2009, Page 17, 20, 31) (World Bank 2009, P.34). What is value chain? According to Kaplinsky and Morris, value chain describes the full range of activities which are required to bring a product or service from conception, through the different phases of production (involving a combination of physical transformation and the input of various producer services), delivery to final consumers, and final disposal after use (Kaplinsky and et al 2000). Some describe value chain in a simple phrase as F to F ; which is from Farm to Fork, where farm indicates the producers and the fork indicates the end consumer. In the value chain there are direct actors (like producers, traders, processors, retailers and consumers), indirect actors (input suppliers, financial service providers, other service providers),

12 2 enabling environments (policies, infrastructures, legal system etc). Existing value chain can be strengthened through the intervention of service providers, government, with the communication of the various actors. Value chain can also be created or deceased. In Ethiopia, different value chain initiatives have been accomplished in the past pioneered mainly by development organizations. Value chain studies were conducted for livestock, sesame seeds, milk, honey, teff, fruits and vegetables, poultry and other products in different localities. Interventions were made by government and NGOs for development and enhancement of value chains. So much learning and achievements are registered from the process (SNV 2009, Kahsay and etal 2008, IFPRI 2010). Value chain development is not however an easy task. It is mired by various deep rooted challenges. Among these challenges financing is at the forefront. Access to adequate and timely financial services for all actors in the chain is essential. Like the large producers and traders small producers and traders need finance for efficient performance in their respective spot within the value chain. But, such finances are not always available to mainly to those working in agricultural and rural value chain. Regular banks will not operate in rural finance as it is perceived as risky and costly. Microfinance Institutions are also inaccessible because of their low level of single borrower limit, limited coverage, and high interest rate. Risks related to agriculture such as crop failure, diseases and market fluctuations coupled with no or limited availability of insurance products and absence of strong collateral makes such segments unattractive to these banks. Commercial Bank of Ethiopia has been providing loan for unions and cooperatives in special circumstances like for the purchase of fertilizers against government guarantee (KIT 2010) (WOCCU 2009). According to Royal Tropical Institute and IIRR, most microfinance institutions prefer urban or peri-urban areas in a standard and group based system, which usually unfit for the needs of small farmers (KIT 2010). Value chain finance is then linking of financial institutions to the value chain, offering

13 3 financial services to support the product flow, and building on the established relationships in the chain. It means that the product flow in the value chain is used as a carrier to provide financial services. This way of financing can spread risk among the financial institutions and chain actors and provides alternatives to traditional collateral requirements. It provides tremendous potential for unleashing capital, scaling up and sustaining chain prospects, but it needs to be managed and organized well (KIT 2010). Problem Statement Lot of efforts is currently underway in linking the rural community to market with the objective of enhancing the livelihood of the rural community and of the growth of the overall economy. Value chain concept is at the forefront in these efforts. Establishment of market and collection for different product markets, provision of training on business, product quality, value chain governance, provision of seed money and technical assistance to different actors in selected value chains are among the type of efforts made (Target 2008). Remarkable achievements are declared by promoters and actors in the value chain because of such interventions (SNV 2009). However, sustainability and efficiency of value chains are challenged by a serious finance gap (KIT 2010). As indicated above, regular banks are not suitable for such actors mainly because of collateral issues and high cost of managing small transactions. Though microfinance are mushrooming in Ethiopia and doing well in microfinance, small and medium size businesses including cooperatives experience major problems in borrowing money for their operation and investments mainly in rural areas. This research is expected to find out the constraints, challenges, risks, best practices in financing of the rural producers, cooperatives and small traders in the context of value chain. The problem of finance gap is significant to a country like Ethiopia where agriculture constitutes about 43.2% of the economy and a source of living for about 84% of the population (CSA 2007, CSA 2009). In addition, small and medium size business is believed to be a backbone of developing economies (Thitapha 2002).. When it comes to specific dairy sector, the consumption level for dairy product is said to be low in Ethiopia. It is unclear why this happen while Ethiopia is among the largest livestock population country

14 4 Study objectives The overall all objective of this study is to address constraints, challenges and good practices of delivering financial services to rural producers and agribusinesses. It is the objective of this study to suggest innovative ways of value chain financing. In addition, the study: assists the development effort of the government and NGOs involved in value chain development in resolving finance gaps, assists value chain actors to benefit out of the proposed value chain financing options for the smooth flow of products and services, promotes the sharing of equitable the risk and cost of financing among actors and financiers, suggests approaches to banking and other financing institutions to benefit from a strong value chain at cost effective and low risk manner than they used to perceive, helps researchers for further validating and upgrading the findings of this research, and assesses the demand, supply and consumption patterns in the Selale Dairy Business Value Chain. Research questions i. What are the impact of banks and microfinance institutions in strengthening value chains of selected products? ii. What is the extent of finance gap of the rural entrepreneurs? iii. What are the potential cultural setups which facilitates the introduction of new financing products? iv. What are the legal, political, infrastructural and technological aspects in supporting the financial links of the various actors and in terms of risk minimization in the process of value chain financing? v. What are the possible courses of action to be accomplished or intervened by NGOs, government, microfinance institutions, banks, and actors?

15 5 vi. Does value chain financing bring a real impact on strengthening value chain? Study Scope The study is limited to value chain finance issues in the rural, peri-urban and urban areas of Ethiopia taking the Selale Area Dairy Business Value Chain as a case. Selale area is the largest milk shed in Ethiopia involving a range of actors. Accordingly, this case study represents dairy and other agricultural based value chains in Ethiopia in relation with value chain financing. Study Significance The financing part of value chain study is not well explored in Ethiopia. This research is expected to suggest workable approaches in addressing financing bottlenecks in value chain development. The research will give more information to financial institutions how they could benefit from the potential market by proper mitigation of risks and lowering of running costs of financing. The research is expected to give insight to the government and NGOs on how to intervene to address financing gap which has been one of the causes for failures to some value chain initiatives. The research identifies the relationship of the various interventions in relation with value chain finance and the efficiency of the value chain. Other researcher will benefit from this study to use it as a reference to undertake similar studies and will serve as filling some of the gaps that have been observed in earlier related researches.

16 6 CHAPTER 2 2. LITERATURE REVIEW Value Chain The term value chain is used by Michael Porter in his book entitled: Competitive Advantage published in Porter s value chain concept refers to the series of value created by a firm in terms of competitive advantage. Porter introduced a generic value chain model that comprises a sequence of activities. He classified them as primary activities and support activities. The goal of these activities is to offer the customers a level of value that exceeds the cost of the activities, thereby resulting in a profit margin. Primary activities include inbound logistic, operations, outbound logistics, marketing and sales and services. The primary activities are supported by infrastructures of the firm, human resource management, technology development and procurement. Unlike the meaning of value chain to business competitiveness, in the recent past development organization and practitioners are using the term value chain in a deferent perspective to address the activities, the actors, the stakeholders of a certain product or services from production (or farm) all the way through the various distribution points to the final consumers. In addition, indirect actors, service providers and enabling environments are part of the value chain analysis in this context. While Porter s value chain is emphasizing the competitiveness of a firm, the concept of value chain by development practitioners is focusing on the overall efficiency of a value chain for the betterment of all actors, with special emphasis to the rural poor communities, with equitable interrelationship among actors and service providers. This research proposal is focusing on the concept of value chain from development perspective. Various practitioners defined and formulated different approaches for value chain development. Kaplinsky and Mike Morris in their book entitled: Hand Book of Value Chain Research (2001, page 8) describes value chain as: the full range of activities which are required to bring a product or service from conception, through the different

17 7 phases of production (involving a combination of physical transformation and the input of various producer services), delivery to final consumers, and final disposal after use. Another similar definition of value chain, from International Labor Organization (ILO) Operational Value chain guide (2007, page 5) defined it as: a sequence of target-oriented combinations of production factors that create a marketable product or service from its conception to the final consumption. This includes activities such as design, production, marketing, distribution and support services up to the final consumer. The activities that comprise a value chain can be contained within a single firm or divided among different firms, as well as within a single geographical location or spread over wider areas. The value link manual of GTZ (Development organization of Germany) defined value chain as a sequence of related business activities (functions) from the provision of specific inputs for a particular product to primary production, transformation, marketing, and up to the final sale of the particular product to consumers (the functional view on a value chain). This particular definition is related to Porter s definition of value chain as it is related to a specific business perspective. The same manual, defined value chain as an alternate definition as the set of enterprises (operators) performing these functions i.e. producers, processors, traders and distributors of a particular product. Enterprises are linked by a series of business transactions in which the product is passed on from primary producers to end consumers. According to the sequence of functions and operators, value chains consist of a series of chain links (or stages)(gtz 2007, page 11). According to Kaplinsky and Morris, value chain analysis resolves the weaknesses of the traditional sector analysis, which doesn t look into the inter linkage between interrelated actors in a given market chain (Kaplinsky and Morris 2001, page 6). Value chain guide of the World Bank explains how value chain analysis differs from the traditional sector analysis: Identifying dynamic linkages between productive activities, value chain analysis transcends traditional economic and industry sectors by showing where value is added in production process.

18 8 Value chain analysis focuses on net value added instead of overall size and gross output. Traditional industry sector analyses often do not sufficiently determine the distribution of value added between activities, both within and between countries, or a country s current insertion in local markets. Value chain analysis thoroughly examines information flows among actors in the value chain unlike typical industry analysis. Segmenting the value chain allows for better understanding of the constraints and \opportunities within each segment, as well as the context in which the chain operates. (World Bank 2007, page 21) Some development organizations developed their own version of value chain. These include different methodologies to map the physical flow of commodities along the chain, output values at different stages of value chains, export market potentials, the regional spread of value chains, inter-firm cooperation, production efficiency, etc. For instance GTZ has a concept called ValueLinks. In its present state, it embraces the generic methodology of value chain promotion. Its application in different industries and in countries with varying degrees of economic development calls for additional situationspecific tools. Of particular interest is its application to business opportunities at the bottom of the pyramid. It is planned to produce sector-specific as well as country-specific versions of ValueLinks that address specific needs. USAID developed its Participatory Value Chain Analysis and it recommended quite extensive studies-based procedures for the design of value chain programmes like that of GTZ. Various organizations have commissioned various value chain analyses to identify their entry point for intervention in chain development (Altenburg 2007, page 33).

19 9 Value chain finance Value chain developing and upgrading initiatives are often challenged by financial service gap to small-scale rural producers and the Small and Medium Enterprises (SMEs). Standard banking practices for analyzing risk and requirements for fixed asset collateral are critical barriers in reaching these markets. The size of loan request of this group is big beyond the capacity of microfinance institutions. Various researchers studied the financial market gap existed for small and medium enterprises (SMEs), which has been caught between microfinance and corporate banking. These researcher suggests value chain finance sourced either from actors within the value chain itself or from external financial institutions which offers alternatives to these restrictive practices through unconventional methods for assessing risk and evaluating collateral. The value chain finance brought new business opportunities for the financial instaurations. According to Milder, to benefit from this opportunity, there is a need to change thinking change and amendments to some regulatory frameworks (Enterprise Development and Microfinance. 2008, page 1) According to KIT (KIT 2007, page 20), Value Chain financing has three types of finance for the actors in the value chain. These are chain liquidity, agricultural finance and value chain finance. Chain liquidity refers Short-term loans from suppliers or buyers within the value chain. Such financing within a chain is common between farmers or farmer groups and traders. These credit flows are generally called trade credit, or chain credit. They consist of short-term loans to ensure a smooth flow of products, keep the chain running and maintain long-term relationships between trusted business partners. They may be given in cash or in kind. Agricultural finance refers financial services from commercial banks, microfinance institutions and other financial institutions. And Finally, Value chain finance financial services that are based on cooperation in the value chain. According to Tropical Royal Institute and International Institute of Rural Reconstruction (IIRR) (KIT 2010, page 13), value chain finance means linking financial institutions to the value chain, offering financial services to support the product flow, and building on the established relationships in the chain. They further elaborated that the product flow

20 10 in the value chain is used as a carrier to provide financial services and way of financing can spread risk among the financial institutions and chain actors and provides alternatives to traditional collateral requirements. It provides tremendous potential for unleashing capital, scaling up and sustaining chain prospects, but it needs to be managed and organized well. World Council of Credit unions (WOCCU) claim that successful value chain financing when administered by credit unions are need to have solid financial institutions, organized producer groups with market potential, basic infrastructure (roads, electricity and telephone), legal systems that enforce contracts, end buyers who are willing to participate in the value chain, staff members, technical assistance providers and market data (WOCCU 2009a, Page 11). WOCCU identifies three value chain financing phases namely: Phase 1: Identify, evaluate, and prioritize value chains, Phase 2: Facilitate and leverage market linkages and Phase 3: Tailor, underwrite, and administer the loans (WOCCU 2009, page 3). WOCCU proposes more roles to the financing institution, mainly in researching, coordinating and managing the whole process. Whereas based on experiences of Royal Tropical Institute and IIRR, leading role or initiation for the value chain financing could come from actors in the value chain. Both parties agree the presence of strong trust and relationships between the value chain actors and the financial institutions. A concept paper prepared by USAID on value chain financing presents a conceptual guide for looking at financial flows, informally known as the 4-A Framework. The framework is intended to look financing from four angles, which are the enterprise, the entrepreneur, the financial product and the financial provider. The purpose is to group issues in four key questions. The key questions are (4As): Is the activity bankable?, Does the value chain actor have the needed knowhow or Acumen to get optimal return from this financing?, Is the financing needed Accessible to the user? And, finally, is the financing Available? (USAID 2007a, page 13).

21 11 Different experiences are presented on suggested value chain financing in a number of studies which most of them are based on practical examples in different countries. Some of good practices and examples could be replicated in other countries and some may not be workable for various reasons like the socio economic factors, the legal systems, cultures, the value chain governance and trust among the various actors. Accordingly, it is essential to identify which value chain financing schemes are workable and practical from Ethiopian context.

22 12 CHAPTER 3 3. FRAMEWORK ON VALUE CHAIN FINANCE Value chain finance connects the value chain actors involved in the process of production, trading, processing and retailing with financers who have different financing products the various actors. The value chain finance framework (see Figure 1) is developed based on average size value chain where five main actors are involved. In this framework, the relationship is expressed in terms of flows of products, finance and information. The Value chain finance framework has four main components. These are the Value chain context, the value chain supporters, the value chain actors and their financial relationship. Figure 1: Value Chain Finance Framework (Ideas from value chain framework and value chain maps of KIR/IIRR: Value Chain Financing Beyond Microfinance (KIT 2010) The value chain context: The value chain context covers the overall economic environment (inflation, interest rate, economic growth, competition etc) Political System, Security, Infrastructure, Natural Environment, the legal system and the likes. The value

23 13 chain context matter may help in the value chain by creating conducive environment, transparency, stable macro-economic environment and the likes. In the contrary, the value chain context could impose restriction or allowing corruption to flourish and unpredictable policy environment. Chain supporters: chain supporters are the service providers like banks, microfinance institutions, insurance companies, transporters, brokers; and other supporters including NGOs, government agencies, and research centers. The financial services they provide include loans, pre-financing, shareholdings, factoring, leasing arrangements, and so on. It is not just financial institutions that provide financial services; for example, an input supplier may give a farmer a loan in the form of fertilizer, in return for repayment plus interest after harvest (KIT and IIRR 2010). Chain actors: chain actors those directly involved in the production and sales of the product. Farmers at Selale area of Ethiopia, produce milk and sell it to their cooperative (Selale Milk Union) or to a trader. The cooperative or the trader transport/store the milk and sell to a processors (like Mama and Shola) 1, the processor pasteurize some of the milk and convert some to other dairy products and sell to retailers (like Supermarkets and kiosks) and finally retailers sell to end consumers. Chain actors are differing from chain supporters from ownership status they have to the product. Chain actors own the product. Ownership is transferred from one actor to the next actor in the chain. Supporters support actors in the chain in finance and other services but not own the product. Value and costs are added at each stage all the way to the end consumer. The number of actors involved from producer to end consumer varies depending the nature of the product and the established market chain. In the above example five actors are identified. The first actor groups are producers. Producers sell their products to 1 Sebeta Agro Industry is a milk processor known for pasteurized branded milk called Mama. Lame Agro Industry known for a pasteurized milk brand name called Shola.

24 14 traders; traders sell their products to processors. Processors sales their end product to retailers and retailers sell their product to end consumers. In some cases processors could sales their products to wholesalers and wholesalers sell their products to retailers. In a simple value chain; the actors are the producers the traders and the end consumers. The bold arrows ( ) represents the flow of products and the broken arrows ( ) indicate the flow of finance. Finance is flowing from buyers to sellers, from financers (bank and microfinance) to borrowers (value chain actors). Financing needs: The actors need finances for different purposes. The farmers need finance to buy inputs to production, traders need finance to buy the product and some capital items like equipments and vehicles, processors need finance to buy products from traders, and to by capital items like machinery, construction materials, vehicle etc, retailers need finance to for working capital and warehousing. One financial institution may support one or more actors in the chain. Outside the formal financial institution, actors often have trade finances like sales on credit and advance payments. The common financial relation between actors in financial institution and actors is a one two one (bilateral relation). The other type of relation is where one or more financial institutions are working together with more than one actor in the value chain. Farmers get a credit from microfinance institution and delivery the product to the trader and the trader pays the loan repayment to the financial institution behalf of the farmer, and remit the remaining value of the product to the farmers. This type of arrangement is called triangular value chain finance. The agreement covers product, finance, and information exchange and risk management. (KIT and IIRR 2010). This study is more interested in the value chain financing, where one or more financing institutions are working with two or more actors within the value chain with the objective of enhancing the chain efficiency, risk distribution, lesser running costs to financiers and affordable interest rates to the actors. Based on the above illustrated framework, the study will conduct assessment of the workability of the value chain financing approaches through various methodologies in the Ethiopian context. The assessment will be made on Selale area milk value chain.

25 15 CHAPTER 4 4. RESEARCH METHODOLOGY Background The research was conducted on Selale area milk value chains. Other value chains will be referred for comparison purpose. Selale area milk value chain is selected for the large number of actors involvement, especially at the level of producers and traders. In addition, this value chain is selected based on convenience and involvement of the rural and peri-urban community. The research is applied research, as it is intended to find a solution to alleviate the immediate financing problems of the small producers and SMEs, and it is also an analytical research which will identify the impact of various financing related interventions and phenomena on the selected value chains. Data Collection Assessment and discussion and interview have been made with different actors in the value chain. In the process the unmet needs and wants of actors with special emphasis to financing and the bottlenecks and opportunities are identified. The data collection enables to analyse the applicability of the various value chain financing approach developed and practiced in different countries. The data collection enables to assess the attitude and opinion of actors and chain supporters in proposed value chain financing alternatives. A pilot test has been conducted for the interview checklists before conducting a full scale data collection. The pilot test was made with one processor, one farmer group (focus group) and five households. Interview: interview was made with actors, financers, potential stakeholders including other NGOs and government offices who are working on the area of the selected value chains. Loan officers and heads of selected banks and microfinance institutions are interviewed. (Annex 8).

26 16 Key informants who have rich knowledge in the selected value chain are interviewed. The interview was intended basically to gather information that is not available from documents (Annex 8). Discussion: Discussion was made with Selale Dairy Cooperative Union (SDCU) and with its six member cooperatives leaders and individual members on the operation of the cooperatives on financing schemes available for them and challenges to access to finance. It is also attempted to assess the organizational effectiveness and business competence of the target actors to engage in market chain in their respective areas of interest, by looking into their governance, management practices, external relations, sustainability, level of trust in within the chain etc. Interview checklist developed in accordance with the type of respondent. Various rating scales will be deployed depending on the type of information required during the development of the interview checklist. The checklist has been developed for the Various respondents including service providers (other than financial institutions), financial institutions (bank, MFIs and insurance companies), farmers, collectors, processors, retailers, households and Government agencies Document Review: From secondary resource, value chain financing initiatives made so far are assessed. Value chain studies made in the selected sectors will be reviewed for better understanding of the challenges and opportunities within the chain. Documents like value chain development reports and studies made to the respective selected value chain, banking regulations, policies and proclamations from National Bank of Ethiopia, value chain financing experience of different countries (plenty of these documents are collected) and similar studies made, specifically in Ethiopia in relation with value chain financing. Sampling taken Sampling has been selected from different group of actors. Table 1 summarized the sample group and size of the different actors and chain supporters interviewed for this study.

27 17 Group Interviewee Number of Interviewees 1 Dairy Cooperatives in Selale area 5 2 Focus group (farmers): With average of 10 farmers in each focus 5 3 Households 57 4 Supermarkets 16 5 Kiosk 7 6 Café 22 7 Processors 4 8 Private Collectors 2 9 Union 1 10 MFIs 2 11 Commercial Banks 3 12 NGOs 3 13 Government offices 6 Total Interviewee 133 Table 1: List of interviewees Analysis and Design Critical analysis made on the existing financing products available to the dairy value chain actors. Potentials for value chain financing in the Selale area dairy value chain has been analyzed. Existing and potential relationship of various bodies in relation to financing (government, MFIs and NGOs) has been examined. In addition, the challenges and impacts of financing problem to the respective value chain is also analyzed. Available financing products are analyzed in terms of size, outreach, cost, risk and costs (interest charges). The workability and applicability of the various value chain financing methodologies adopted in some countries will be thoroughly analyzed on their applicability to the Ethiopian context based on the information gathered. Value chain financing scheme suggested based on the analysis.

28 18 CHAPTER 5 5. STUDY FINDINGS 5.1. The Selale Dairy Business Selale area is one of the largest milk shed in near to Addis Ababa (Olga and et al 2010). This area is under the Semen Shoa Zone of Oromia Regional state. Most of the Woredas are in Selale region along the road from Addis Ababa to Debre Markos. The shaded area in Figure 2 below shows the milk shed along the main road. The population of the Semen Shoa zone of Oromia as per the 2007 census (Central Statistic Agency 2007) was about 1.4 million. Figure 2: Map of Selale area milk shed (rough sketch). Map source: Encarta 2009

29 19 A number of projects, especially the Smallholders Dairy Development Project (SDDP) are accountable for the development of milk production in this area. The project was operational between the year 1995 and 1998 with the objective of improving the standard of living of the smallholder farming families under friendly development approach (Ahmed and et al 2003). During the project period, dairy stock and breeding bulls were distributed. To enhance the marketing of the milk, the project facilitated the formation of farmers group (between 10 to 30 farmers) to form a milk collection center (MCC). Later on some of these farmer groups are transformed into a farmers cooperative. Milk processors operating in Addis Ababa and surrounding area are the major buyers of these farmer groups. The prices of milk were erratic and reached to level where the farmers could not afford to supply as the cost of maintenance of dairy cow is increasing. The coming of many processors in the dairy sectors attracted completion for milk collection. The farmers group organized and formed a cooperative named Selale Dairy Cooperative Union (SDCU) in SDCU has started its activity in 2002 by 9 cooperatives of 512 members and to date increased to 20 cooperatives of 1,454 members. Together with the active members, the number of milk producers and suppliers to the union has increased to 3,359 households. There are a lot of households which are not a member of cooperatives and there are more than 15 cooperatives in the area which are not a member of SDCU. Member of the Unions are mainly supplying milk to the union through their respective cooperatives. They sell the remaining milk to other buyers when they produce extra milk beyond the requirement of the union. Based on the data gathered from the Selale zone livestock development, health and marketing office, the dairy cows population as of end of Ethiopian Fiscal Year (EFY) 2001 was about 1.04 million (See Table 2).

30 20 Table 2: Dairy Livestock population in Selale area (North Shoa Zone of Oromia Regional State) Dairy cows Local Dairy cows Cross breeds Total Cows 401,587 29, ,954 Heifers (above 12 months of age) 469,789 11, ,848 Female Calves (6-12 months) 62,453 2,947 65,400 Female Calves (Less than 6 months) 60,135 3,673 63,808 Bull 2,525 2,525 Total 993,964 49,571 1,043,535 Source: Selale Zone Livestock Production, Marketing and Health Office According to Selale Zone Livestock office, the estimated milk production per day is 352,000 liters and 558,000 liters from local dairy cows and cross-breed dairy cows respectively. Currently more that 50,000 liters of milk are sold on a daily basis to processors and other collectors. Out of this, about 10,000 liters of milk is supplied by SDCU, and significant portion of milk is collected by processors like Sebeta Agro Industry (SAI) and Lame Dairy Enterprise (LDE) their own collection centers. Based on the opinion of the zonal livestock office experts, the majority of milk produced is consumed at household level in the form of milk and butter. Part of converted milk products like butter and ayib are sold through informal markets The milk value chain The milk produced from the dairy farms will pass different channel before it reaches the final customer. The milk value chain in Selale area is depicted in the figure 3. The milk value chain is classified in three major groups. These are actors, chain supporters and chain context. The chain actors are also further classified as direct and indirect actors. The various bodies involved in this chain are explained hereunder.

31 Chain Actors Direct chain actors Farmers (producers): there are two groups of dairy farmers, namely traditional farmers and commercial farmers. Commercial farming in Selale area is now growing though their number is not significant. Most of the commercial farms are delivering their whole milk directly to restaurants in Addis Ababa. It is estimated that there are about 20 commercial dairy farmers along the main road to Debre Markos. Commercial farmers cow holdings range from 40 to 100 cows with a daily milking of about litres per cow. Most of the commercial farmers are selling their milk to big cafes and restaurants in Addis Ababa. The traditional farmers involved in the milk value chains are those who hold a cross bread cows which are commercial viable to supply milk as a routine daily business. Based on the study, the average total cow holding per household is about 5 to 7, and out of which 3-4 cows are milking cows. These farmers are milking an average of 8-10 litres of milk per day per cow. Some of the farmers are organised in a cooperative and some of them are not. Those organised are supplying fully or partially to their cooperatives. Partial supply is mainly due to the quota (supply cap) set by the cooperative, which in most cases is determined by the number of shares members have in their respective cooperatives. Farmers who deliver only part of their milk production to their cooperatives are supplying the remaining to individual, local or industry collectors. Local collectors: Local collectors are collecting milk from farmers in the nearby MCCs and resell to hotels and cafes in the same town they have collected the milk. The volume of milk they often buy is small and limited to local supply. Hence, their role in the chain is not significant.

32 22 Figure 3: Dairy Value Chain (Selale area) Source: Based on the study findings Individual Collectors: Individual collectors are mainly operating between Sululta and Debre Tsigie. Individual collectors collect more milk and sale the milk in Addis Ababa, unlike local collectors. Most of these individual collectors have their own pickup vehicles to transport the milk they collect to Addis Ababa. Individual collectors are collecting from farmers (from both members and non-members) and cooperatives. Union leaders are often insisting its member cooperatives not to sell to these individual collectors as they are often distorting the selling price and eroding the bargaining power of the Union. Cooperatives/Union: Most of the cooperatives are transformed from the originally formed farmers group who form collection centers in different parts of Selale area. Some of the cooperatives formed the SDCU. SDCU is the only union in North Shewa Zone of

33 23 Oromia region. It is protected by law to have only one Union in one zone and one cooperative in one Kebele. Kebeles are the lowest unit in Government Administration. Cooperatives and unions are formed in accordance with proclamation no of 147/1991 (Ethiopian calendar) and directive no 106/1996 (Ethiopian Calendar). There are about 35 dairy cooperatives in Selale area and twenty of them are a member of SDCU. Cooperatives are managed by board of directors and administered by 5 elected executive members. In addition to the executive members audit and inspection committee elected by and reported to the General Assembly is undertaking audit and inspection activities. Cooperatives employed additional staffs for milk collection (milk technicians), cashiers and guards. Executives are non salaried on a voluntary basis in accordance with principles of cooperatives. Allowance may be paid to coop executives for field works. The number of members in coop ranges from 50 to 200. During slack time, cooperatives keep buying from their members and convert the unsold part into other durable products like butter and ayib (local soft cheese). Processor Collectors: Some of the dairy processors are established their own milk collection centres in Selale area. Sebeta Agro Industry and Lame Dairy Enterprise have a number collection centers. In some of their collection centers they have chilling units to maintain the quality of the milk. Some of the processors are transporting the milk using a truck equipped with cold tanker. These processors are collect for their own consumption (processing). The processors believed that the establishment of the collection centers helped them to enhance bargaining power from the unions, had they have been fully dependent on them. Processors like Family, Bora and Lema do not have collection centers in Selale area. Processors: These categories of actors are classified into two categories. Large scale and small scale processors. Small scale processors are mainly engaged in converting the raw

34 24 milk into formajo(cheese). Berta and Penguins are classified under this category. These processors are mainly delivering to supermarkets and large hotels. The other group of processors are mid and large size processors with a capacity of processing about 5000 litres per day. There are about six dairy processors in Addis and surrounding with a processing capacity ranging from 5000 to 50,000 litre of milk per day. Those who convert raw milks into pasteurised milk after skimming. During the pasteurization process, the average fat content of 3.5 will be skimmed into a milk of 2.5 fat content. Hence, cream will be the product after the pasteurised milk, which is also a saleable product. Most of the processors do not have their own dairy farm. Sebeta Agro Industry has its own dairy farm which meets about 10% of its milk requirement 2. All of the processors are generally delivering the pasteurised milk using their own delivery vans to supermarkets, kiosks. Some of the processors have their own sales outlets in different parts of Addis Ababa. Cafés and Restaurants: Local cafes in small towns of Selale are sourcing milk from local collectors and farmers. Most of the cafes, hotels and restaurants in Addis Ababa are sourcing milk from individual collectors. There are large numbers of cafes, restaurants in all towns. Hot milk and macchiato are the famous drinks which triggers the demand for milk by cafterias and restaurants. Based on the survey, cafes and restaurants purchase liter of milk each per day. Large size cafeterias are buying up to 40 liters per day. During fasting seasons their demand falls. Most of the cafeterias and the restaurant use raw milk directly delivered from producers and milk traders. When there is scarcity of whole milk, some cafes and restaurants use powder milk, which are not often preferred by consumers. Pasteurized milks are not used by Cafés and supermarkets. 2 Genesis farm, which is located at Debrezeit town, has its own dairy farm. It is not yet commenced pasteurized milk processing.

35 25 Regional Retailers: regional retailers are buyers from regional towns like Mekele, Dese, Debre Zeit, Dire Dawa, Awassa, Nazareth and others. Most of them are collecting pasteurised milk from the factory gate of processors. The processors themselves distribute directly to some of these towns. Pasteurised milks of Sebeta Agro Industries is the leading pasteurised milk favoured by regional retailers for its long shelf life (about three days). These retailers are further supplying village kiosks and mini markets at regional towns. Supermarkets: There are about 100 supermarkets in Addis Ababa. These supermarkets are buying a about 50 to 150 litres of pasteurised milk per day or every other day. Because of the perishable nature of the milk, most of the supermarkets order the safest stock size to avoid possible loss. Mama pasteurised milk is the only product (of Sebeta Agro processing) where Supermarkets are willing to buy more as its shelf time is three days (unlike a shelf life of one day). In addition to local pasteurized milk and other dairy products, super markets are also sell imported UHT and bottled milk. Sales outlets: Few of the processors have their own sales outlets. Lame Dairy Enterprise is well known for its milk shops with a brand name of Shola. Kiosks: There are thousands of kiosks in Ethiopia. These kiosks are major sales outlet of substantial volume of milk. The delivery vans of the milk processors are delivering milk door to door to these kiosks. Households and individuals are major customers of these kiosks. According to processors complain, these kiosks are enjoying the higher portion of the profit margin from the final consumer price. Consumers: Consumers are final users of milk. These are consumers at the level of household and cafes and restaurants. Most of the household regular consumers are those who can afford to expend Birr 120 and above. This threshold is the value of ½ litre of milk per month. Most of the households prefer the whole milk supplied by house to house

36 26 suppliers of urban dairy cow holders. Most of these urban dairy cow holders are reside in the outskirt of Addis Ababa. Institutional buyers: These are big institutions like; hotels hospitals, universities and airlines. Majority of them are sourcing from dairy processers. Lame Dairy Enterprise for instance supplies Black Lion Hospital, and has special milk specifically pasteurised to children attending at the children unit of the hospital. Indirect chain actors Input suppliers are classified as indirect actors in the dairy sector. The most important inputs in the production of milk are animal feeds, breeding service (bull and Artificial Insemination) providers, Vet drugs suppliers and Vet service providers. Vet Services providers: The Government is the main service provider in the region. There is at least one vet clinic and few vet posts in each Woreda (The second level administration unit higher than Kebele of regional governments). One development agent at a post of assistant vet is assigned for three kebeles in all Woredas of the zone. There are one or two private service providers in each Woreda with limited services like injection and examination. All of these private vet service providers are drug store operators. Vet drug suppliers: There are few importers of vet drugs. All importers of vet drugs are concentrated at Addis Ababa. There are one or two privately owned drug stores in each Woreda, in addition to drug stores of the livestock office of the government. Their average weekly sales is Birr Their sales reaches peak during a market day. There are also illegal traders of vet drugs. Some of them are selling on open air in such manner that the medicines are exposed to sunlight, heat and dust. Some are selling at their shops just like the rest of the commodities without having the technical knowledge. The livestock office of the government is in charge of controlling illegal vet drug suppliers and ensures that genuine drugs are available at drug stores. According to the information gathered from the Zonal Livestock Development, Health and Marketing Office, the

37 27 Government drug stores have annual revolving budget ranging from 20,000 to 70,000 for the purchase of vet drug supplies. Breeding Services: Breeding services are provided in two ways; the bull service and Artificial Insemination (AI). The natural approach of bull service is provided by cross bread bull owners (famers). The bull owners charge from Birr 20 to 40 per met. Artificial Insemination (AI) service is provided by the agricultural offices. There is normally one AI technician in each Woreda and some of the Woreda have two AI technicians. Because of limited budget allotted for AI service, the annual AI service is between 600 and 1000 per Woreda. This figure represents below five percent of the demand. Government charges Birr 4 per AI services. Based on the information from the National Artificial Insemination center (NAIC) (state owned), the cost of production of a single AI service is about Birr 38. NAIC is supplying AI main supplies (the semen and liquid nitrogen) to agricultural offices for free and at a cost of Birr 4 and 7 for the semen and liquid nitrogen respectively. Feed: the major portion of feed supplies comes from hay. A Selale region is endowed with hay supply. Other animal feeds like wheat bran, edible oil seeds cake, concentrates and minerals are also required. Residue of local beer like drink (Tela) is also important feed item. Processed animal feed suppliers are few in numbers. There are 3 to 8 retailers of animal feed in each town of Selale region. For all of the traders, feed sales are a side business in addition to their retail products. In addition, cooperatives also distribute animal feeds to their members. Members are opting for the feeds of the cooperative for its genuine quality and better price. Machinery and Equipment Suppliers: There are few local suppliers for small dairy equipments like cream separators. Heavy machines and equipments are imported from Europe and Asia. With the devaluation of Birr, the import cost of these machineries (milk processing units, chilling units, cooling tanks, Clean in Process (CIP) units, etc) is becoming expensive. Suppliers of these machineries are often provided training and technical assistance for erecting and commissioning of the plant.

38 28 Packing materials suppliers: Packing materials used for packaging of dairy products including pasteurized milk are imported from abroad. Like the machines, depreciation of Birr during the past few years increases the local cost of packaging. There are local importers of packing materials who customized the packing to the individuals design. Some of the processors are directly importing the packing by themselves Chain Supporter Microfinance Institutions (MFIs): There are about 30 MFIs in Ethiopia and most of them are operating in specific regional states. About four MFIs are operating in Selale area. As per Directive No. MFI/18/2006 of the National Bank of Ethiopia, the single borrower limit of MFIs is to the extent of 1% of their paid up capital. In the same directive, the group borrowing limit is to the extent of 4% of their paid up capital. MFI, like Busa Gonofa, has reached to a level that it can provide a loan to a single borrower to the extent of Birr 200,000. MFIs are suitable for rural borrowers as they don t demand physical collateral to extend the loan. According to NBEs directive3, MFIs are allowed to provide loan without collateral. Based on the discussion made with some MFIs officers, MFIs are mainly granting the loan against group collateral than without collateral. From the focus group discussion made for this study, some farmers are not happy with MFIs as they do insist for group formation for group collateral arrangement and that the interest rate is much higher than the regular banks. Based on the interview made with some of MFIs, they often limited their borrowing to a new client to an average of Birr 3,000. For their credit worthy long term customers, they extend loan to the extent of Birr 20,000. Dairy farmers seek loan for the purchase of annual feed supply and heifer. The cost of feed and heifer is much higher than Birr 3,0004. Hence, MFIs are not generally suitable enough even to primary level of the dairy value chain actors (the farmer producers). 3 NBE Directive No 17/ One heifer costs from Birr 6500, or 15,000 if pregnant. Annual feed purchase price ranges from Birr 3,000 to 7000 depending on the number of milking cows the farmer has.

39 29 Commercial Banks: There are 15 banks in Ethiopia. Three of them are state owned and the rest are share companies. In Selale area CBE has three branches (at Fitchie, Sululta and Muketuri) and Oromia Cooperative Bank has two branches (at Sululta and Kuyu). The borrowing share of private commercial banks is growing for the last 10 years. Public banks are still leading in terms of borrowing size. Commercial banks deal with businesses and traders with a good credit truck and who can submit valid collateral for their loan. Unlike MFIs, commercial banks extending loan in millions. Processors and retailers are getting financing from commercial banks. Loans are provided to processors against valuable collateral like building. Based on the information from Commercial Bank of Ethiopia, cooperatives and unions access loan from its branch all over the country against guarantees of Regional Government. The most valuable assets of commercial dairy farmers are their milking cows, heifers and calves. Based on the survey, the current market value heifer in Selale area is above Birr 6000 and the market value of a pregnant cow is ranging between 12,000 and 15,000. These assets should have to serve as collateral for getting bank financing. Based on the survey made for this study, Ethiopian Insurance Corporation is the only insurance company providing livestock insurance. 5 Based on the survey, most of the farmers do not aware of the livestock insurance. Some Banks are providing loan against other collateral arrangements. Commercial Bank of Ethiopia provide loan to farmer organization against regional government collateral. Bank of Abyssinia provides loans to businesses against collateral of USAID for selected small businesses. Some Banks, including Commercial Bank of Ethiopia are providing loans against collateral of international organizations such as ICCO/Terafina, Oxfam Novib/ and Cordaid (MicroNed 2005, MicroNed 2008). 5 Nyala Insurance is under pilot test for the provision of livestock insurance. Nile Insurance is not proving livestock insurance service.

40 30 There is a possibility of getting loan to farmers organizations to secure loan against collateral of government, donors like USAID and international bank who are programs in assisting SME and rural traders in developing countries. Insurances: There are nine insurance companies in Ethiopia. Eight of them are private companies and one of them is state owned. Most of these insurance companies are insuring processors and retailers. Based on the survey dairy farmers and their dairy cooperatives do not use insurance services. NGOs: the role of NGOs in the development of the milk value chain is tremendous. Organization like SNV, USAID (through land o Lakes), AgriTera and international organizations like FAO are providing a lot of support in strengthening the milk value chain. The type of support provided includes Capacity building through training, Facility provision, financing, and other technical supports. The government of Finland (through FINIDA) was responsible for the significant dairy development made in Selale area. FINIDA had also granted a seed fund to farmers groups which later on transformed into cooperatives. Selale Union has received financing support for working capital, revolving funds and capital items from various donors including United Nation Development Program (UNDP) (Getnet 2009). Government: The role of government in the livestock sector is immense. Government is the major service provider on Vet medical supplies, Vet services and AI services. Recently an agency called Livestock Development, Health and Marketing is formed by Oromia Regional State. This agency is dedicated to livestock and its structure reaches to zones and Woredas. There is one development agent for live stock serving three Kebeke in all Selale area. Cooperative Agency and offices are providing technical support to the coops and union on marketing, management, accountancy and auditing services free of charge. In addition this structure also initiates and facilitates the formation of coops and union. Zonal and Woreda Administrations are providing lands and other supports to coops and union.

41 31 National Artificial Insemination Center (NAIC) is the major provider of AI supplies mainly the semen and nitrogen in the country. These supplies are provided by NAIC free of charge to agricultural offices throughout Ethiopia. Farmers pay Birr 4 for a single AI service where as the cost of AI service delivery excluding labor cost is about Birr 20. The difference is subsidized by the Government of Ethiopia Chain Context The chain context addresses the overall macro level issues which frame the scope of the operation of the value chain. These include the relevant policies, proclamation, the legal system and enforcement tools in place, the political system, national standards, the infrastructure available, the economy, the security, and cultural issues. Some of the relevant chain context to the Selale area milk value chain are described below. The cooperative law (proclamation): The cooperation law has paved the way for the formation of the coops and unions with a lot of incentives and support. The legal system: The legal system is ensuring the compliance of contractual agreements and maintenance of the harmony in business dealings. There are complaints however in relation to the lengthy lead-time to get a verdict because of the capacity of courts. National Standards: There are standards for dairy products developed by the Ethiopian Standard and Quality Organization. During the survey some of the professionals in the dairy sector expressed their concern on the weak or absence of enforcement on the quality standard of pasteurized milk. The lack of enforcement could encourage unethical processors to avail substandard products at the expense of consumers and fair competition. Infrastructure: The renovation of the road to Debre Markos has contributed a lot in increasing the turnaround of trucks in delivering milk from Selale area to Addis Ababa. The absence of road outside the main road has affected many households to reach the

42 32 milk market. Some are travelling up to two hours to reach the milk collection centers. Based on the survey farmers and their organization claimed that the mobile technology has helped them for a better communication. Lack of chilling centers at the various milk collection centers considered as a major setback in expanding the milk collection radius from the main road. Many of the towns along the main road (Selale area) have accessed the hydropower electicity. Economic Environment: the growth in the economy is expected to increase the household income of the society which in turn increases the demand for milk products. The demand for milk is increasing. It is however difficult at this point to claim that the growth in milk demand is a result of the economic growth. There are contradicting information gathered from consumers that the ever increasing milk price was the main factor which forced them to stop buying of milk. Culture and Society: The fasting seasons of the Ethiopian Orthodox Christians is the slack season for the milk and milk products. Based on the survey conducted, the demand for milk declines by about 25% during fasting seasons. There are about 200 fasting days and out of which 65 days are seriously observed (Abiy and Filseta) by most of the laities Challenges and Opportunities Financing Challenges and Opportunities The magnitude of the financing problem varies from actors to actors. It is essential to view the financing challenges by actors in the chain. Processors: For established processors with a better collateral base and successful past credit history, financing is not as such a challenge. Most of the processors are quite comfortable in this regard. For new comers, however, financing is a challenge especially when they don t have the required quality of collateral.

43 33 There is a long tradition of buying milk on a 15 days credit term from milk suppliers. New entrants into the business are enjoying this well established credit financing by milk suppliers. As a result, the working capital requirement of processors is limited to packing and other operating costs. The credit cap (ceiling) imposed by Government of Ethiopia since the beginning of 2009 limit commercial banks to extend loan as much as they could (IMF 2010). As a result, financing is a challenge to new entrants (processors). Most of private banks outstanding loan is approached to the cap. It is leant that this cap is not applicable to Commercial Bank of Ethiopia (CBE) if the loan is meant for agriculture sector. Some of new entrants complain that the procedure for financing are more stringent in state owned banks than private banks, and they feel that the challenge is remained a concern. Based on the information from National Bank of Ethiopia, agricultural loan has grown in the last ten years period from Birr 1.2 Billion in 2000/01 to Birr 5.7 Billion in 2009/10. As shown in Figure 4 below, the growing trend of agricultural loan is halted since This is mainly due to the loan cap policy issued by the government to control inflation. Though there is increment on the share of agricultural loan (from 8% in 2000/01 to 11% in 2009/10) it is much lower than what the sector deserves in terms of its coverage in the national economy (about 45%) and representation (80% of the population). Million Birr Fiscal Years Source: National Bank of Ethiopia Figure 4: Loan provided to Agriculture sector by all banks between 2000/ /10

44 34 Based on the discussion made with the credit managers, it is learnt that the limitation of the appropriate staffing in every field of agriculture and the inherent risks associated with it, the volume of financing service provided to the agriculture sector are low as compared with other sectors. Commercial Dairy Farmers: Commercial dairy farmers have access to commercial banks. Most of their assets are dairy cows stock. The problem they often encounter is collateral issues. Their physical assets are limited to ordinary barn and few types of equipment. Some of the farmers are unaware on the possibilities of using the cows as collateral. Based on the discussion made with Retail Team of Ethiopian Insurance Corporation (EIC), tagging system is a must before granting the insurance policy. At the level of commercial dairy farmers, tagging is more feasible than traditional dairy farmers. Retailers: Retailers, mainly supermarkets, have access to bank loans mainly when they have collateral for the loan. As much of their property is on inventory items, they are known for no or limited valid collateral assets like building. As most of the retailers stocks are fast moving, it is not convenient to get a merchandise loan. In addition, their balance sheet is often show a large amount of current liabilities, which are resulted from large credit purchases. Retailers benefit from the consignment purchases. On a consignment arrangement, retailers pay after they sell the product. Hot products are always sold on a cash basis. Since the last two years, because of the rationing f foreign currency and a long waiting line for currency permit, imported products are in short supply and importers are distributing on a cash basis. As a result of this, there is a cash stress on retailers. When it comes to dairy products, consignment sales are not convenient because of their short shelf live. Because of this, some of the milk processors are selling their products on a short credit period and some of the milk processors with big band names are selling on a cash basis. Some of the supermarkets are not willing to receive milk products during the afternoon as they run out of cash. Some of the supermarkets prefer to finalize the

45 35 daily purchase issues during the morning session and spare the afternoon for other tasks. These situations deterred the supply of milk products. Supermarkets on the other hand, often run out of milk during late afternoon, which are peak hours for supermarket sales. According to the experience of one milk processor, their frequent attempts to sell milk to supermarkets during the afternoon were not successful because of the reasons mentioned above. This contributes in creating a gap between demand and availability of the product while supply is there. Collectors: individual collectors buy milk on cash basis. Unlike the processor collectors, they are not benefited from the 15 days credit purchase from the farmers. According to the tradition, farmers are willing to deliver on credit only to established companies. Hence, collectors have to finance themselves. These collectors are delivering their milk to processors on a credit sales basis like the farmers are doing. Accordingly, they need to have a working capital at least to the extent of 15 days milk purchase. For individual collector with a daily milk collection of 500 liters need about Birr 37, The source of financing for many of these individual collectors is own equity and loan family or relative. The traditional revolving savings scheme, which is called Ekub is best used approaching in raising working capital. Cooperatives and Unions: Cooperatives need financing for expansion and purchase of equipments. Some of the cooperatives have taken a loan from the Union. The purposes of the loans were mainly for purchase of office buildings. Coops get credit facility for the purchase of inputs (feed and vet supplies) from the Union. Coops also sell their products to the Union on credit. The annual dividend distribution from the union is among the important cash inflow which improves the liquidity of the coops. Coops actually distribute part of the dividend they received to their members. According to the existing coops proclamation, 70% of the income is distributed as a dividend to members and the remaining will be retained by the coops and unions. 6 A milk price of Birr 5 for 500 liters for 15 days.

46 36 None of the coops in this value chain are received loan from other sources. As the amount of financing is higher than what the MFIs are wishing to borrow, and because of the absence of strong collateral, their frequent attempts to get loan from banks were not successful. Farmers: In most of the cooperatives interviewed, credit and saving committee exists in the organizational structure of the coops. Only few of them are functional. The size of the loan and its administration differ from coops to coops. Some coops borrow to the extent of Birr This loan is useful only for the purchase of animal feeds and small dairy equipments. The loan is small to buy heifer. The expensive part of capital investment at the level of farmers is purchase of heifer. Apart from the natural breeding out of the stock they have, purchase of heifer is the short cut to expand the milking cow size. Some coops provide loans to members as much as three times the amount of cash deposited by the borrower. Farmers, especially new entrants and members in the milk supply system, are suffering from cash shortage for the purchase of day to day inputs, as they have to wait for 15 to 18 days to get back their money. Member farmers are often benefited from credit purchase of feeds from coops with a credit period of 15 to 60 days. The credit period varies from coops to coops. Some farmers are not interested to take loans from MFIs as they believe that the interest rates are so expensive (above 16%) and are short terms. In addition, some of them are not happy with the group collateral arrangements Non Financing Challenges and Opportunities Milk Quality Milk quality problem is a concern to actors at all levels including the farmers themselves. Though there are improvements over the years through the various interventions made by different NGOs, Government and the coops, farmers are losing a lot of money because of rejected milk at the milk collection centers because of quality. Most of the quality

47 37 problems are hygienic issues, milk handling, and other problems in relation with the health of milking cows. Adulteration is a concern in the milk value chain. Adulteration is an international mixing of foreign matters to the milk to boost the volume of the milk. As the techniques adopted for milk quality test at all levels are elementary, which are limited to accept and reject. Some coop farmers believe that quality based payment system is essential to encourage famers to be quality conscious in addition to individual farmers initiates to improve milk handing activities. Currently, milk quality projects are undergoing with the participation of coops, union and international organizations. Unfair competition There is competition among farmers for buyers when milk supplies increases and there is high competition among processors and collectors when supply is falling. Based on this survey, the trust among the various actors in the value chain is not strong enough and mired with fear and suspicion. Accordingly, the collaboration among actors is weak. Marketing The milk marketing issues is a paradox. Consumers are complaining about the shortage of milk supply and whereas, producers, especially at farmers level are complaining about the lack of market for their milk. Based on this study, the weak distribution system deployed by milk producers is responsible for weak link of the supply to the needy consumers. Uneven supply of milk, which is caused by the seasons (dry and wet seasons), and the uneven demand of a certain group of consumers because of the fasting seasons contribute a lot for the uneven delivery of milk. Some households do not think of milk in their menu as it disappear often from the kiosks or supermarkets and do not noticed when it is excessively supplied.

48 38 Weak consumption culture for Dairy products Some household members also lack appropriate exposure to sustainable milk and other dairy products are used to lead a life without consuming dairy products. As a result most respondent professed that they are not familiar with dairy products and hopeful to enjoy the product if things are improved and had the opportunity of to reach them. Some says that: I have never tried it and some say that I am afraid I may not like it. Such feelings are a result of weak popularity of milk in many households. Population growth, urbanization and income growth are among the major factors that result to an increase in milk demand. It seems that these factors are increasing increased in the case of Ethiopia. However, the consumption of dairy product in Ethiopia is less as compared to other African countries and far less than the world consumption. The present national average capita consumption of milk is 19kg/year as compared to 27 kg for other African countries and 100kg to the world per capita consumption 7. The recommended per capita milk consumption is 200 litters per year 8. There is initiative by SNV and USAID to increase consumption behavior on dairy products. This includes creating awareness about the nutrition values of the product, introducing more product varieties. Billboards and radio milk promotions are underway in this regard. The demand development and inducement will certainly stimulate retailers to buy more milks and this will intern encourages existing processors to expand and new processors to enter into the sector. The increasing processing capacity encourages farmers and collectors to work more in the area of production and collection (SNV 2009). Feed cost and quality The price of feed increases two fold in the year 2010 from what it has been three years ago 9. Apart from the price, farmers are complaining on the quality of the feed. Coops are 7 FAO, The milk per capita, based on the 2008/09 survey is liter (CSA 2009). According to the forecast of FAO, the annual production is far below the survey made by CSA. During the period from 2001 to 2007, based on FAO forecast, cow milk production is growing at an average rate of 2.6%, which is equivalent to the Ethiopia s population growth rate (2007 census). 9 UNIDO

49 39 striving to avail feeds from genuine sources. Because of the limitation with working capital, the volume of feed supply per month per coops is between 50 to 100 quintals. Road accessibility There are number sites in Selale area with a high milk potential, but which are a bit far from the main road. As the collection time at MMC is fixed, which is often at early morning, many of the farmers at distant Kebeles could not reach on time. Selale Union is considering establishment of chilling centers which enables the coops to keep the milk for longer hours and to have the collection time more relaxed to allow distant Kebele farmers to supply their milk. This plan is only improve slight portion of the problem as the walking distance ranges more than 5 hours to some of the potential suppliers from the collection centers, which will be unbearable to reach on foot walk. Machinery Cost The ever increasing foreign currency rate is becoming a challenge to new entrants into the market a processor. Some of the equipment, including stainless buckets is expensive to Coops and the Union let along to the farmers.

50 40 CHAPTER 6 6. CONCLUSION AND RECOMMENDATION 6.1. Conclusion Chain Financing: Strong points Different financing schemes are available to the milk value chain actors. The financing schemes differ from actors to actors. Supplier credit (credit sales) is playing important role in chain financing. Farmers are selling their milk products on credit to their coops, coops are selling on credit to Union, and Union is selling to processors on credit. This credit sales facility is not extended to the level of retailers. Limited working capital is found to be one of the main causes which deter some of the supermarkets to buy more milk during the afternoon. There is a triangular relationship of credit financing between farmers and Union. Union Channeled feed supplies on credit to farmers through coops. Farmers do not required to settle their debt in cash, rather the value of the feed deducted from the value of milk to be paid back to farmers. The Union withhold from the milk sales. Generally speaking, there is a strong trustworthy and well established credit sales management system. Farmers trust the credit sales system, and processors repay on time. Credit and savings established within the coops are benefiting both the depositors and borrowers of the coops when functioning well. The credit and saving brings interest income and ensures accumulation of cashes for future investment. These investment alternatives are purchase of heifers and dairy equipment or other non-dairy investments. Members of the credit and saving scheme have the potential to borrow as three times as they have deposited in the scheme.

51 41 Traditional Ekubs are well established cultural source of finance which enables farmers, mainly town dwellers, to accumulate cash and possibly getting of such cash according to a draw. The money involved in the Ekub scheme is dependent on the financial capability of its members. Early winner of Ekub benefited from early receive of a non interest bearing loan, and those who received at a later rounds are still benefited from a forced Ekub payment. Some of the coops and the Union has benefited from seed fund and capital financing. The SDDP project has granted a seed fund for the establishment of farmers groups which finally grown into cooperatives. Processors are supported by various NGOs on training and technical advices which would have been a big investment to the processors. Commercial banks finance dairy processors and retailers. Processors have access to commercial banks and financing is not considered as a challenge to their business. Chain Financing: Weak Points A number of MFIs are operating in Selale area. Their loan amount is not big enough to accommodate the financing requirements of the lower level actors, the farmer. Group of persons are serving as collateral though this arrangement is not popular among the dairy farmers. Commercial Banks are not suitable to farmers, coops, the Union and other collectors because of their demand for valid physical collateral. Apart from the collateral, transaction costs of managing the loan is not affordable especially if they extend loans at the level of farmers. As there are commercial bank branches operating in Selale area, cost of managing loans to coops and the Union doesn t seem expensive. Though it is not applicable to CBE (for agricultural loans only), private banks have reached the limit set by National Bank of Ethiopia for a loan cap. Hence, it is not an easy task for actors who are new clients of commercial banks to access financing, even if they managed to avail collateral, until such time that the loan cap is lifted.

52 42 It is evident that the success of banks customers, processors in this case, is dependent on the success and efficiency of the whole value chain. Among the serious challenges to the dairy sector is financing gap. Because of this, actors in the chain would either remain a standstill or dropout of the chain. When actors are dropping out, it affects the price and volume of milk supply. At times when some collectors are dropped out, processors were forced to operate below breakeven. Unlike private companies, cooperatives and unions are managed mainly by elected executives with a limited term in office usually two terms of two to three years each. There is no warranty that the passion and strength of the existing leaders will be transformed to the new leaders. As a result of this, some of the financiers are worried about the sustainability of management harmony, capability and governance of these organizations. Such thinking has barred financier not to explore possible businesses with coops and unions. In addition to financing, milk quality, unfair competition, marketing, weak consumption culture for dairy products, feed cost and quality, road accessibility and cost of machinery are among the challenges of the dairy value chain at Selale area. Financing need is inter-related to the prospect of the milk and milk products marketing. If the marketing issues are resolved, financing challenges will become more serious. Otherwise, financing demand, especially at the lower level of the chain actors will drastically decline as there is no reward for more investment in milking cows. It is a sign of commitment from the government side to have an agency which is dedicated not only to production and livestock health, but also to livestock marketing. If the efforts of various stakeholders results in increase in demand for dairy products, financing will be at the forefront in the least of challenges to the dairy sector.

53 Recommendation 1. To extend a loan to Union through processors, banks reputable customers. The short sighted financing culture of commercial banks needs to be revisited. They need to look beyond their credit worthy customers. It is important to look further and ensure that the value chain where their customers are operating is sufficiently financed and operating smoothly. By doing so, they will ensure that the business plan of their customers is on the right truck. It is recommended that commercial banks to extend a loan to Union through processors, banks reputable customers. The Bank provide the loan to the Union, the Union repays the loan in the form of milk and milk products to the processor. The processor withholds the loan repayment amount from the milk products value and pay back to the bank. By doing so the bank will benefit from dealing with one more organized customer while it is extending its credit services to wider scope in the value chain. This relationship is depicted in Figure 5. Figure 5: Proposed value Chain financing scheme with the involvement of commercial banks It is a win-win situation at all level. Under this proposal, processors will benefit from having a reliable and financially strong Union. The Union will get a loan without physical collateral. The commercial banks increased their outreach at a lower cost.

54 44 To implement this proposal, trust has to be build between the three parties (bank, processors and Union). The Union needs to demonstrate organizational competence and good governance. The initiate for the implementation of the scheme could come from any of the parties. 2. Value chain financing with the involvement of Commercial Banks, MFIs, cooperatives and farmers To curb the financial capability of the MFIs, it is recommended that the MFIs and commercial banks to work together using the established chain relationship between the farmers and the cooperatives. Commercial Banks extend loan to MFIs and MFIs extend loans to farmers, coops withhold the loan repayment from the milk payment and repay to the MFI, MFI then settle their loan to commercial banks. Figure 6 depicted this relationship. Figure 6: Proposed value Chain financing scheme with the involvement of commercial banks and MFIs. This proposal will work if commercial banks revise their years old collateral based financing, at least when they are dealing with reputable MFIs. If collateral remain a concern, international banks, organizations and Regional Governments are options for loan guarantee. As indicated in the various part of this study, value chain financing is beyond sector financing. It is all about the efficiency of the whole value chain. In recent past, government was granting collateral guarantee for loans taken by coops and unions.

55 45 This collateral facility was available mainly for the purchase of agricultural inputs. It is recommended that the facility need to be extended to financing of the coops and unions for marketing problems too. The suggested value chain financing enables commercial banks to reach more potential borrowers in the sector with limited cost of loan management and shared risks. The local knowledge and flexibility of MFIs will compliment the banks limitation and will simplify the credit management. MFIs will save running costs as they do not need to travel to collect repayments from the respective borrowers as coops are in charge of collection. As a result cost of borrowing will be minimized at the level of MFIs. Similarly, linkage could be created further between the Union and the cooperative. This proposal is extension of the second proposal. MFIs are granting the loan to coops. Famers are getting credit facilities for the purchase of feeds and other supplies from the coops. MFIs are collecting the repayment through the Union. Unions are withholding the repayment amount from coops when effecting payment for the milk delivered by the coops. Coops further extend loan to farmers, to be settled from the milk payment. Figure 7 depicts this relationship. Micro-finance Loan provided Commercial Banks Repayment Loan Provided Loan Provided Farmer (Producer) Cooperative Union Processors Super Markets,kiosks and shops Consumer Product Flow Cash flow Figure 7: Proposed value Chain financing scheme with the involvement of Coops, Union, commercial banks and MFIs.

56 46 From figure 4, 5 and 6, one can understand that the value chain financing is benefiting major actors in the value chain. In all the recommendations, retailers are not directly benefiting from the value chain financing scheme. Based on the study, credit sales financing to retailers will not bring a long lasting solution for low level of milk purchase by retailers, mainly supermarkets. As the shelf life of milk is not more than three days, and the liquidity problem of most of the supermarkets is significantly high than the value of their daily milk supply, it is unlikely that such scheme will bring a long term inducement to the volume of milk product purchases by these supermarkets. This doesn t mean that the value chain financing could not be technically feasible to this part of the actors. Strong linkages, communication and trust building among the processors and retailers needs to be established to ensure credit facilities are bringing more sales. 3. Other recommendations Abolishing the credit ceiling: It is stated that the current credit cap is a problem of commercial banks to provide more loans as possible. As the cap is a recent phenomenon, with the objective of curbing inflation, it is assumed by many bankers as it will soon be lifted (IMF 2010). Improving the single borrower limit: Based on the research findings, the lower level of dairy value chain is a missed sector for financers as it swings in the middle of MFIs and commercial banks. Upgrading of MFIs single borrowing limit is a paramount importance to address the financing gap of actors in the dairy sector especially those at the lower level of the chain. This is achieved through increasing of the capital of the respective MFI 10, and lifting of a self imposed (internal policy of the MFIs) limits Building a collateral base: It is recommended that coops and the Union to build their fixed asset base to enhance their collateral capability. This can be achieved through reducing the distributable profit of both the coops and the Union. 10 The Directive of NBE demands a maximum single borrowing of 1% of the capital of MFI

57 47 Sustainable management: Coops and the Union have to demonstrate their sustainable institutionalized business management to a level where financiers could depend on working with them and entering into a long term commitment. Non-financing Issues: It is recommended to address other challenges of the value chain, especially the marketing components through coordinated efforts by various stake holders. Demand development, quality improvement, enforcement of standards, a national body specifically concerned for dairy, like the Kenyan and Indian dairy board are recommended course of actions. Recent effort in advertising and introduction of nutritional value of milk need to be strengthened at least to reach the level where our neighbors are achieved few years ago in terms of milk consumption per capita.

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63 Table of Contents 53