This publication focuses on enterprises whose forest-based economic activities are undertaken generally at the individual or household level, normally employing either members of the family or close relatives and neighbours, and where salaried labour is usually negligible. Such enterprises are typically:
The diversity of activities differs from country to country. In most cases, diversity is the result of differences in forest-based raw material endowments or availability. Products can be divided into wood forest products, fuelwood and non-wood forest products. There are small-scale enterprises based on forest services, for example using the forest for tourism and environmental services.
The largest source of labour input for a small-scale enterprise is the family, both the proprietor or manager and family members. Their forest-based activities are usually carried out jointly with other processing, service or agricultural activities, so they seldom occur as separate enterprises. Their close integration with agriculture is reflected in the seasonal pattern of operations and dependence on agricultural incomes in order to generate much of the demand for their products.
Processing and marketing are the tools with which the raw materials are converted to appropriate products to meet market requirements. Processing provides the physical characteristics of the goods, while marketing adds all the necessary services and other immaterial features to them to make them complete products that satisfy the values sought in the market.
The following conditions should be present in order to identify investment opportunities in forest-based activities at a small enterprise scale:
Of the above conditions, demand potential and market prospect is usually the overriding one, and the only one external to the enterprise. A market analysis should include basic questions such as: What and where are the markets for these products? What means are available to transport the goods to the markets? Who are the competitors supplying the same markets? What are the specific strengths of the producer/gatherer compared to these competitors? Only when market prospects are found satisfactory or capable of improvement would further assessment of the other criteria be useful. All else being equal, the ability to achieve low production costs is likely to be the second most important attribute of potential viability.
Many small-scale enterprises operate on the informal market where the major source of finance is in the form of savings. When external finance is sought, it is normally from the informal or non-institutional credit suppliers. Also, at this level the greatest requirement is for working capital. As these enterprises develop and expand their financial requirements, the relative importance of savings decreases and the proportion of institutional to non-institutional credit increases along with the proportion of fixed to working capital.
When looking at expansion opportunities, small-scale enterprises face a wide array of potential problems, which can be summarized as follows:
Forest-based small-scale enterprises most commonly cite finance as their principal constraint in maintaining their competitive position and developing their activities, with shortages of raw material often taking second place. A real constraint in itself, finance may also be a symptom of other difficulties. Even though the focus of this publication is on microfinance, when looking at the overall development of these enterprises it is important to take into account that their problems interact. Box 1 describes the problems of small-scale enterprises in Brazil in accessing microfinance.
Forest-based economic activities include those relating to tree crop planting, production and processing, as well as harvesting and utilization of non-wood forest products. Ecotourism and environmental services are other possible uses of forests, based on the sustainable management and conservation of the natural resource. Small-scale enterprises have different kinds of microfinance needs, depending on the forest products and services generated and their related production aspects.
Timber and tree crop development includes activities related to nurseries, plantations and forest under management plans. Trees are long-term investments with benefits accruing over time. The main challenges of financing tree crops relate to the long-term nature of the investment, and the time lag between initial expenditures during establishment of a plantation (the gestation or immaturity period) and the time of full production. Forest products include short gestating crops such as oil palm, coffee, cocoa and tea, and long gestating crops such as rubber, coconut, fruit trees and timber species. For most tree crops, a substantial part of total development costs accrue in the first year, especially if irrigation works or fencing are necessary, in addition to the planting of seedlings, land clearing and levelling. Costs in subsequent years for weeding, fertilization, disease control, silviculture and partial replanting tend to be much lower.
The risk of investing in tree crops increases with the length of the immaturity period. The main risks are:
In tree crop development it is also important to consider the characteristics of the harvested product. Crops such as oil palm, sugar cane and tea require immediate processing because of rapid quality deterioration after cutting.
Trees are increasingly being planted to support agricultural production systems, community livelihoods, poverty alleviation and food security. Communities and smallholder investors, including individual farmers, grow trees in shelterbelts, home gardens and woodlots, and in a diverse range of agroforestry systems to provide wood, non-wood forest products, fuelwood, fodder and shelter.
Non-wood forest products have a biological origin other than wood, and may be gathered in the wild or produced in forest plantations, agroforestry schemes, and trees outside forests. Examples include food and food additives (edible nuts, mushrooms, fruits, herbs, spices and condiments, aromatic plants, game), fibres (used in construction, furniture, clothing and utensils), resins, gums, and plant and animal products used for medicinal, cosmetic and cultural purposes. Box 2 describes the use of shea nuts in Ghana, and the constraints facing shea processing.
Non-wood forest products are extremely numerous and versatile. They comprise unprocessed raw materials and consumer products, as well as further processed consumer or industrial goods. Many of the products are seasonal and have fairly small overall markets, which means that individual producers can seldom rely on one product for their livelihood. The resource base also varies greatly from complete wilderness to plantations.
Being nature-based, non-wood forest products can never be totally uniform in their characteristics, nor can their supply be regular and fully reliable. Natural forest-based, "non-domesticated" products and wilderness-based products in particular are less uniform in their characteristics than plantation-based products. There is therefore a tendency to move towards more uniform plantation-based production whenever potential markets become large and attractive enough and the production is found to be feasible in plantations.
Some non-wood forest products are ready for final consumption immediately after harvesting, while others need processing to be useful and acceptable to consumers, as discussed above. Some have to go through several stages of processing before becoming a final consumer product (for example, after being extracted from wood, essential oils are first converted to fragrances and then into perfumes).
In some cases, problems of variation in products and their quality can be overcome by applying product and quality standards and related grading. Another means for solving such problems is to ensure appropriate packaging and storage. Many products consumed as food items, medicines, and health and beauty care products are subject to restrictions and regulations on their use because they can potentially affect human health.
Producers of non-wood forest products include the gatherers who collect the products from the forests. They also comprise those primary-level processors who buy the basic raw materials from the gatherers and convert them into primary products. Producers are also the ones who convert the semi-processed primary products to value-added, semi-finished products or to final consumer products at the successive stages of processing and marketing.
The resource base is usually not owned by the gatherers, who only have formal or informal user rights. There is a consequent risk that they might lose access to the land. Resource management is therefore not the responsibility of the gatherers who always have an interest in its long-term sustainability.
Forests provide a wide range of environmental services, including the protection of watersheds, wildlife habitat, amenity values and carbon storage. The private sector has not so far shown much interest in conservation, but this is changing as forest owners begin to capture revenue from activities such as tourism, bioprospecting and carbon storage. In particular, the potential of ecotourism and recreation as alternative forest uses is attracting increasing private sector investment. Some countries have drafted legislation to encourage such investment. Costa Rica's advanced approach to promoting private sector participation in the provision of environmental services is of special interest (Box 3).
Small-scale enterprises engaged in ecotourism activities will utilize the forest as a source of environmental and cultural attraction, and will therefore be interested in the preservation of its natural and cultural capital. Similarly, environmental services relating to the benefits of forest conservation will entail the non-depletion of forest natural resources, and tolerate only a limited, sustainable exploitation of the forest and its biodiversity.
There are also processing activities that use the forest as a resource base, for example, sawmilling/pitsawing, carpentry/furniture-making, wood-carving and primary manufacturing. Their main constraint is usually accessing raw materials. These enterprises will not be treated separately in this publication but in most cases it may be assumed that their financial needs are similar to those of other rural enterprises.
Other traditional forest products include wood fuels. For smaller enterprises active in wood fuel, access to finance has not been identified as a main problem in carrying out their activity, although entrepreneurs will still need microfinance services for household purposes. Box 4 gives the example of charcoal production in Asia.
With the development of participatory forestry, the contribution of forests and trees to rural livelihoods has gained recognition. For many poor people in forested areas, markets for forest products and services offer one of the most promising options for reducing poverty levels. Small-scale enterprises can potentially improve rural livelihoods and provide incentives to manage and protect natural resources better at the same time.
Financial requirements can be divided into fixed capital and working capital. Fixed capital refers to investment in assets such as land, buildings and equipment, the economic lives of which extend from medium to long term. Working capital, on the other hand, consists mainly of cash, inventories of raw materials, work-in-progress, finished goods, and accounts receivable. Implicit in this definition is the notion that working capital funds are "self-liquidating" over the short term, a period approximating the enterprise's production cycle, whereas funds invested in fixed capital are only recovered from cash flow surpluses over the medium to long term.
While there are significant differences between countries, regions and sectors, in general small-scale enterprises tend to have lower relative financing requirements for fixed as opposed to working capital, because of their high degree of labour intensity (or, conversely, the low capital intensity). Small-scale enterprises often have fairly long production and marketing periods, which also lead to relative high working capital demand.
The cash flow of a small-scale enterprise investment is determined by its economic lifespan, the length of the gestation period, expenditures during the immaturity period and the impact of seasonality. Large initial capital requirements (e.g. tree planting, machinery) may require longer repayment periods in relation to the annual cash flow created by the investment. Investment in multipurpose rather than single-purpose equipment is likely to produce a more even cash flow. Specialized equipment, for example harvesters, are highly capital-intensive and require higher minimum sizes of operation.
Forest communities and small-scale enterprises are mainly found in rural areas. One typical problem in rural areas is that the income sources are seasonal. Other problems might occur due to remoteness and isolation, poor communication infrastructures, poor market outlets and an unstable policy and macroeconomic framework. Living in rural areas often means limited access to institutions providing microfinance services.
The demand of smaller enterprises for microfinance will stem from the investments needed for their productive activities as well as from their development opportunities, and will be affected by the accessibility and costs of the microfinance services, including interest rates and transaction costs, which will determine the viability of the investments. Small-scale enterprises focusing on tree crops and wood forest products will in general be characterized by mainly fixed capital investment needs in the initial years, followed by working capital needs, for a duration longer than other rural activities and with economic yields starting several years after the beginning of the activity. For non-wood forest products, the demand for fixed capital is normally limited to processing equipment when needed, and financing needs of working capital are likely to be lower and with shorter returns. For smaller enterprises that are active in ecotourism, capital and financial needs will be mostly linked to activities not directly related to forestry, such as building of amenities, working capital to run the facilities, expenditures for utilities, training and capacity-building.
From a microfinance point of view, small-scale enterprises and forest households combining activities relating to wood products and non-wood forest products will have the advantage of diluting the risks of the investments and financial needs. The existence of income sources other than the forest is also positive, since by combining different activities rural people can further reduce and diversify risk and vulnerability. In such cases, loans for forest activities can be financed by other income sources. Another positive aspect of the co-existence of various economic activities within a household is the fact that activities with shorter-term returns, such as non-wood forest products, can provide the necessary cash flow to sustain longer-term returns linked with tree crop development and finance the necessary investments. Where possible, ecotourism activities can provide sources of short-term cash revenue, which are helpful in diversifying risks and stabilizing household income, and repay longer-term investments.
Conversely, being dependent on many different activities could have a negative impact on the forest activity and increase risk, because small-scale enterprises are exposed to the risks of many markets including non-forest markets. If one income source fails, it may have a negative effect on the others when the limited resources are used to make up for the loss. For example, a loan taken out for a cow that suddenly dies must be repaid with the income from other sources, such as the forest. Dealing with many different activities, therefore, means not having a strong specialization in any due to lack of time and resources.
Many rural people may not have the confidence to approach banks and other financial institutions because they perceive them to be powerful institutions. In communities not used to financial services, people may be afraid of getting involved in such activities. Accessibility of microfinance services is therefore affected not only by their physical distance and the costs involved in their provision, but also by social considerations and barriers such as illiteracy, women's disempowerment, and cultural and religious factors.
Poorer women and men have different needs for financial services and different access to infrastructure that supports their income-generation or business expansion schemes. Poor women are often less inclined than men to take loans because the structure of the formal credit system tends to be very hierarchical, and they may perceive the system as even less user-friendly for them than for other prospective borrowers. Low-income women tend to be less educated and less used to dealing with officials and formal procedures. While general illiteracy, usually greater in rural areas, hinders both women's and men's ability to fill in application forms for financial services, illiteracy levels are higher among women than men in most countries worldwide.
In many countries, since men generally own land and other fixed capital, women tend to lack the collateral required by formal financial lending institutions. Very often procedures in formal lending institutions require the signature of a male head of household, which makes it difficult for female-headed households to apply. On the whole, women tend not to know about their rights to apply for financial services, even in industrial countries and countries in transition.
Despite these difficulties, access to financial services can enable women to leverage their skills and ultimately develop their enterprises. By upgrading their skills, by gaining access to technology, raw materials, market information and business linkages, women can expand their economic role. Improving the economic position of women contributes to building their confidence and ultimately their social and political roles. It is important to stress that neither women nor men, including poor people, are a homogenous group and should not be treated as such when addressing their social constraints.
Small-scale enterprises have special characteristics since they are usually run by poor rural people and are often managed along with other farm activities. All activities are in strong competition for the limited resources. Since the enterprise and the household cannot be separated, their activities affect each other. While financing may be made available by a credit source for a particular purpose such as forest-based production, in practice it is not possible to enforce that the money lent is used exclusively for that specific purpose. Problems may therefore arise from the high fungibility of funds as micro-entrepreneurs seek to meet conflicting demands from their enterprise, household and other activities.
Small-scale enterprises provide direct benefits to local economies only when the products can be successfully marketed and when the marketing is managed by the producers to ensure that the benefits flow to the local community. Low-income and socially disadvantaged groups often lack the necessary basic knowledge and resources for efficient marketing.
Depending on the specific country, other social factors may significantly affect the provision of microfinance services, such as health considerations in the case of South Africa (Box 5).
Policies and credit instruments specifically destined to leverage smaller enterprises are lacking in Brazil. In addition to being rare and inadequate, producers are unaware of the available lines of credit, and particularly, how to access them.
Most of the finance for small-scale enterprises comes from owners or reinvestment of profits. The main impediment for such enterprises when accessing microfinance services is the difficulty that banks have in assessing the risks of lending to them, because they are ill-equipped to assess the value and cost of operations, borrowers' accounting capability, borrowers' reputation, the economic situation in the ephemeral timber frontiers, the securities or guarantees offered and the legal framework in the case of non-repayment. The difficulty in providing collateral and guarantees, and the high interest rates are also regarded as major impediments.
Financing options newly available for small-scale enterprises through the recently instituted Programa de Plantio Comercial de Florestas (PROPFLOR) and Programa Nacional de Fortalecimento da Agricultura Familiar (PRONAF) credit lines, have the potential to better integrate rural producers into forest production. They could be expanded in terms of resources and complemented with technical assistance and simplified access mechanisms. Furthermore, these lines could be extended to all regions of the country and to all forestry activities, including management and marketing of non-wood forest products.
The participation of small-scale enterprises is fundamental for the formation or consolidation of "forestry clusters". Integrating forestry activities is an indispensable condition for the socio-economic development of regional communities and of forest and industrial enterprise sustainability. The determination of the Lula Government to focus attention on making microfinancing available to informal sector enterprises through the National Development Bank is an important first step. However, social lending to date in Brazil has mainly focused on microcredit for the urban poor, leaving rural forest-reliant groups completely ignored. Efforts are therefore needed to support enterprise investment opportunities for rural producers and their enterprises.
Source: May, Goncalves da Vinha and Macqueen, 2003
Almost pure stands of shea trees are frequently seen in the typical "agroforestry parklands" in northern Ghana, together with crops such as yams, millet, sorghum, maize, cassava and legumes. A typical crop rotation starts in the first year by clearing woodland or fallow land, leaving specific individual trees of certain species on the farm after the controlled burning of cut vegetation at the base of unwanted trees. In this cyclical farming system, the management (protection, pruning and removal etc.) of the shea trees mainly occurs when fallow (rarely virgin woodland) is cleared.
Harvesting is usually carried out by women on the family land, preferably on land that has already been cleared for planting. For those women without a family, and in times of low yield, harvesting may also occur on fallow or unmanaged land. Typically, the fresh fruit is collected early in the morning, de-pulped and then carried back to the household in head-pans after farm chores have been completed. The fresh fruit are heaped until enough has been collected to justify boiling the nuts.
In spite of the high density of on-farm trees, the overall yield of dry kernel per hectare is low, preventing individual subsistence farms from producing suitable quantities for a reasonably sized commercial operation. Those women interested in processing larger quantities, either for selling to local markets for national consumption or for processing to export as butter, are therefore unlikely to have built up large stores of shea kernel from village harvests and often have to compete on the open market for purchase.
This need to purchase raw material results in the main challenge facing even the most organized of shea butter processing cooperatives; the need for "pre-finance". In the case of market sales, a group of around 30 women will usually manage to locally purchase a few bags of kernel, process them into butter and then take them by public transportation to the larger centres for sale at meagre profits. The only groups that have successfully been able to produce realistic quantities of traditionally processed shea butter of reasonable quality are those that have been helped by external agencies and are lucky enough to receive advance orders with assistance on pre-financing.
Source: FAO, 2004
Costa Rica's pioneering efforts to capture values associated with its forest environmental services are admired by policy-makers and academics throughout the world. Its earliest attempts focused on developing the country as an ecotourism destination, promoting private investment in infrastructure related to forest tourism and charging tourists for access to its forests.
It has also been developing infrastructure for selling rights to explore its forests' genetic reserves, for selling carbon sequestration services and, at the domestic level, for selling rights to watershed protection. Although the government has played a critical role in providing the framework for capturing finance and has been the main supplier of forests in the case of bioprospecting and carbon sequestration, the private sector has also become increasingly involved. Currently, the National Network of Private Reserves covers 250 000 ha, equivalent to half the privately-owned natural forest area.
Fiscal and financial incentives have been a part of the Costa Rican forestry agenda since 1979. Initially, reforestation was stimulated through tax deductions, soft credit, redeemable bonds, municipal forest funds, and a forest development fund. In 1990, the incentive structure was changed to place greater emphasis on good forest management and the protection of forests for their environmental services.
For small- and medium-scale producers, the most significant fiscal instruments have been the Prepaid Forest Bond Certificate (CAFA) and the Forest Development Fund (FDF). The CAFA was introduced in 1987 as a redeemable bond worth US$520 per hectare for smallholders with plantations less than 25 ha. The FDF was introduced in 1988 and promoted reforestation by community development organizations. Only projects of more than 100 ha and involving more than 20 farmers were considered, and the grant covered about 70 percent of the cost of reforestation. Together, the CAFA and the FDF have encouraged the reforestation of 45 000 ha. Despite apparent success, the schemes have been criticized for being economically inefficient. As much as 50 percent of the area reforested did not achieve the growth rates or density levels required to be economically viable.
While carbon sequestration payments are currently made to the government, and the government pays private landowners separately under the payment for environmental services scheme, it is possible that future funds may be directly transferred to private landowners.
In addition to selling environmental services to foreign buyers, a Foundation for the Conservation of the Central Volcanic Range (FUNDECOR) was set up to organize payments of hydroelectricity companies to local forest owners in the Central Volcanic Range for forest watershed protection. Two projects, Don Pedro Hydroelectric S.A. and Rio Volcan S.A., both owned by the Global Energy Company, paid FUNDECOR US$10 per hectare for environmental services. This payment was passed on to local forest owners to ensure the protection of forests in adjoining hydropower water catchment areas.
Source: Landell-Mills and Ford, 1999
The economic cost of charcoal production may vary significantly depending on the type of production system. In a traditional system the producer collects the wood free of cost, uses his/her labour to dig the pit to convert the wood into charcoal, and transports the final products to the market for sale. There is no cash investment in this type of operation. The production cost is virtually zero in such cases (except for tools purchased for common household use that are also used for wood cutting and pit digging), unless one has to pay a nominal fee to the forestry department as a government royalty for wood and to obtain a permit for making charcoal in the forest. This cost, which rarely occurs, would then be the only cash investment in charcoal making. The producer of charcoal under such a system simply works to convert free time into a marketable product, in the absence of other cash-earning opportunities.
As long as the market price of charcoal is high enough to encourage this type of production, poor people will see it as an attractive option to earn cash. The producer has to consider whether he/she can recover the cost of inputs to the manufacturing process from the returns when the charcoal is sold in the market. This makes the investment more risky and the risk increases as the scale of operation expands. This type of producer will try to maximize the returns from his/her investment by introducing innovations, both technological as well as managerial. Wherever this type of operation exists, the opportunity for further development will be high and desirable.
Source: Bhattarai, 1998
Finance institutions provide a range of financial services to the forest sector. In South Africa, however, lack of financing opportunities for forest-based small-scale enterprises has been identified as one of the key constraints to their development.
Many remain crucially dependent on loan finance or equity that they can access, such as private loans from the informal sector, in their personal capacity. Many emerging entrepreneurs are underskilled and lack business experience, preventing them from gaining access to capital. Furthermore, in South Africa most poor rural households do not own their land, but rather, it is held in trust or is owned communally. This means that the land itself cannot be used as collateral to secure loans, and emerging entrepreneurs trying to establish small-scale enterprises are even further disadvantaged.
Financing institutions suggest that the AIDS epidemic creates major financial risks that have to be part of the total risk evaluation process of creditors. Specifically in a small business where the owner/manager plays such a crucial role, the impact of AIDS is bound to be far more serious than for larger companies where management and labour are more flexible. Despite all good intentions to improve the market for financing small-scale enterprises, AIDS may have a seriously adverse effect in the coming years, including increased dependence by affected households on direct access to natural resources for survival.
Source: Lewis et al., 2004