Thinking Forward through the Past

Thinking Forward through the Past

The FINANCIAL -- Under the Soviet system, farmers worked under strong central control; everyone knew what to do. Important economic decisions were not left to the market, or decided by self-interested individuals. Instead, the government, which owned or controlled much of the economy’s resources, decided what, when and how to produce. Along with providing necessary inputs, the state ensured that farmers had access to markets for their goods.  

After the collapse of the Soviet Union, state-provided coordination was abolished. The newly shaped market system brought a lot of imperfections in the agricultural input and output markets. Farmers lost access to finance and good quality inputs, lands were fragmented in several post-Soviet countries (e.g., Georgia, Armenia), and farmers were left with small parcels of land (1.25 ha on average in Georgia’s case).

Vertical Coordination (VC) as a response to market imperfections

The state-controlled agricultural supply chains of the Soviet Union (and other countries with similar systems) can be considered as the most extreme form of vertical coordination (VC). Everything was directed and coordinated by central authorities. Abolishing state control in the 1980’s and 1990’s removed much of the VC in the agricultural value chains. 

Interestingly, going back to higher coordination of agricultural value chains means moving closer to modern agri-food systems. In recent decades, the structure of agricultural markets has been changing worldwide, and today’s agriculture is increasingly characterized by a higher level of coordination among the value chain actors. These changes are mainly driven by consumers, who increasingly demand product safety, quality and traceability. At the same time, supply side constraints, such as lack of capital and knowledge, which causes problems with consistent supply and quality of produce, are often addressed with VC between buyers and farmers. For example, in contract farming schemes, buyers supply farmers with animals, feed, veterinary services, seedlings and other inputs. In most cases, the provision of extension services is also a part of such schemes. 

Does VC increase efficiency of actors?

Although it is very difficult to identify these effects, there are studies showing that VC increases productivity and output (and consequently incomes). This mainly happens because farmers have better access to inputs, receive timely payments, and are better prepared to make new investments (FAO 2014). Other (indirect) effects may come from risk reduction and better access to credit, as suggested by several research papers (Gulati et al., 2005; Minten et al., 2009). These effects will potentially result in investments in both farm and non-farm activities, which are very important for rural development and economic growth. In addition, there are also positive spill-over effects from VC. For example, after farmers get some management advice for hazelnut farming, they may use this knowledge for other crops as well.

Is VC just a way to squeeze farmers?

VC adds value to the final product; higher value is generated throughout the chain. However, it is not always clear who gets this value and whether it is distributed equally among the participants. Do all participants share the gain, or does VC lead to even higher monopoly power of the processing company (or trader)? It’s not unusual for buyers to wield market power, squeezing small farmers to get very small share of value added. Nevertheless, VC is still attractive for small scale farmers with limited land and financial resources. Farmers can benefit from high quality inputs, knowledge transfer, improved access to finance, and reduced marketing risk. As for agribusinesses, they might often prefer to work with larger (and modern) farms to reduce their transaction costs. However, in Georgia (where most farms are small and have low productivity), agribusinesses have no choice other than to work with small farms (as a way to ensure sufficient supply of raw material). Agribusiness might also want to work with smaller farmers because larger farmers have higher bargaining power and require higher prices, offsetting the lower transaction costs when working with them.

Can Georgian farmers benefit from vertical coordination?

The collapse of the central planning system and breakup of the large state cooperatives and kolkhozes led to the abolishment and disintegration of Georgian agriculture. There are, however, a few examples of successful VC that have been implemented in Georgia in recent years. 

One of the success stories is the meat production system implemented in Racha (in Shardometi village) by “Blauenstein Georgia.” Their production is focused on high quality meat products. Blauenstein Georgia outsources the fattening of animals (Swiss and German breeds) to a small number of local farmers, who must meet minimum land requirements and have access to water and asset ownership, to ensure that they have the ability to feed and take care of the animals to the requisite standard (as prescribed by Blauenstein). Farmers involved in this scheme are trained by Blauenstein Georgia. Farmers are provided with inputs, veterinary services and all other needed support. When the calves reach a certain weight, Blauenstein Georgia buys them for slaughtering and selling. 

The main challenges of this type of model are ensuring good coordination between actors, and avoiding side selling. Having strong leadership from the buyer’s side often takes care of the coordination problem. Strong buyers such as Blauenstein Georgia are creating new market opportunities and providing higher margins for farmers. This is one way to avoid side selling.

Vertical coordination, such as the example of Blaunstein Georgia, has a lot of potential for Georgian agriculture, where many smallholders have substantial knowledge gaps, limited or no access to finance, outdated technology and are using unsustainable agricultural practices. The private sector should be taking the lead in developing vertical coordination, while the state should be a facilitator and coordinator of this development. Government should encourage farmers to upgrade their technology and knowledge, and expand production through involvement in these kind of schemes. 

At this stage of the development, VC (even with tight contracts and the dependency of farmers on buyers) could be a win-win situation for everyone working in Georgian agriculture. After farmers gain sufficient knowledge, acquire enough financial resources, and adopt new technologies, they might decide to start their own value-added activities (e.g., processing or selling by themselves). Nevertheless, they still will have gained valuable experience through involvement in many stages of the value chain, which means higher value-added and higher benefits for farmers. Engagement in cooperatives (horizontal coordination) is another possibility for gaining higher market power and higher benefits from the chain. Further development of agricultural cooperatives in Georgia might do a good job in this regard.