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4.1 Introduction

Despite its simplified nature, there are a number of key factors (or parameters) that must be understood and considered by the applicants if they are to adequately complete the project profile. These include: (a) the level and nature of the demand for the eventual project; (b) the relevance of supply constraints (where applicable); (c) the definition of project operations, such as the units of production and the production cycle; and (d) the types of costs involved. Each of these is examined in more detail below.

4.2 The Importance of Demand

The correct estimation of demand is critical for any type of project. No project is worth undertaking if it does not respond to a demand - either from the market (in the case of projects generating products or services for sale) or from potential users (for non income generating projects).

As a result, the estimation of existing or potential demand must comprise the first step in assessing the viability of an investment. A knowledge of the level of demand likely to be met by the project not only determines its overall feasibility, it will also play an important role in deciding the location of the project (e.g. a health clinic, transport service, or shop), the scale of the investment, and the nature of the item or service to be offered.

While it is not necessary at the profile stage to enter into a detailed analysis of demand, no profile should ever be prepared, or accepted, which does not explain the basic assumptions as to who would be the purchasers or users of the output of the project, and what their pattern of use would be. These key aspects are explored in more detail below:

4.2.1 Income Generating Projects

For income generating projects the two key factors are the quantity that can be sold (i.e. that will be purchased), and the price that the buyer will pay. For some products, such as grains, construction blocks or cooking oil, demand is rarely a limiting factor; the market is large and the sort of projects supported by RuralInvest are unlikely to meet more than a small fraction of total consumption. Furthermore, as the products are not readily perishable, they can be made available year round, and prices tend to change only gradually, reflecting variations in raw material and storage costs. Thus determining volumes and prices for these products is a matter of project output, and predominant market price (less transport costs to the market).

Perishable products, however, are a different story. Here available volumes, and therefore prices, can vary enormously, as the product is expensive if not impossible to keep for another day. Fresh vegetables may be very abundant and cheap in the winter, for example, when rainfall is adequate and temperatures moderate, but may be very scarce and expensive in the summer when irrigation and even shade netting may be required. For perishable products, therefore, it is critical to consider the seasonality of production for the proposed project, and relate that seasonality to the prices likely to be encountered.

Specialized products (including many processed foods, clothing and services) are the most difficult categories for which to determine market demand and prices. Prices are not standard for all goods or services of one type, but vary according to ingredients, quality, and the perceptions of the buyer. Prices may be estimated on the basis of the closest comparable product, although if no distinct and obvious difference exists which will attract the buyer, a significant price reduction may be necessary at the beginning to persuade purchasers to shift from the existing alternatives to the new product or service offered by the project. Sales volumes can be equally hard to estimate, especially if the product or service is new, or is entering a very limited market. In such cases, investment plans should not be over ambitious, and the minimum scale of production that is compatible with cost considerations is recommended, at least for start-up. Where services are concerned, it must be remembered that a service not sold during a particular time period (e.g. the use of a tractor for land preparation) is lost forever, so variations in demand according to season are critical.

4.2.2 Non Income Generating Projects

Although it may be difficult to estimate demand for a marketed product, where there is no market at all, estimating demand can be even harder. What will be the demand for an investment in watershed protection, or for a new primary school? The starting point in the absence of markets must be to identify who are the expected beneficiaries, both direct and indirect. Normally one thinks of beneficiaries in terms of families, so for every school child or patient at a medical clinic, there is a family which benefits.

Perhaps the best way to try and identify potential direct beneficiaries is to ask: "What are people doing in the absence of this product or service? Would they change over to become users (i.e. beneficiaries) of the new project?". Another key question is: "How many new users might be created if the project goes ahead?". Perhaps only a few children in the area currently go to school, as the only existing facility is some kilometres away in the nearest town. But how many might be tempted if the school was now within walking distance? It should not be forgotten that suppliers and workers are also direct beneficiaries, and should be included in the estimation.

An erosion control project might have few direct beneficiaries (e.g. farmers and householders directly affected by the erosion), but a considerable number of indirect beneficiaries (e.g. all those using the river or streams that would be protected). In fact, indirect beneficiaries often include the entire population of the area served by the project, whether it be a bridge, potable water, or a day care facility, so this number is often quite large in comparison with the number of direct beneficiaries.

4.3 Supply as an Influencing Factor

Although not as universally important as demand, supply can also have a considerable bearing on the viability of a project, particularly one producing outputs for the market. If operations will require inputs of raw materials (for example, milk for a dairy processing plant), or considerable quantities of labour, it is important to consider the availability of that supply. Where are dairy farmers selling their milk now? What will be the incentive for them to sell instead to the new plant? Do the men and women of the community have the free time to work in the project?

As in the case of the sale of outputs from a project, input availability may also change by season. Will labour be scarce at certain times of the year as workers disappear to harvest their fields, or migrate to work on larger farms in the lowlands? Will milk production decline in the dryer and hotter summer months? A processing plant for fruits and vegetables may be able to operate only a few months per year, as insufficient supply may be available for the remaining months to keep the factory in operation.

4.4 Describing Project Operations

In order to prepare a project profile, a few key terms used to define the parameters or characteristics of the project must be learnt. The four most important terms are described below:

4.4.1 Project Beneficiaries

Project beneficiaries are those who will derive some benefit from the implementation of the project. Two types of beneficiaries can be defined: direct and indirect.

Direct Beneficiaries: Direct beneficiaries can be defined as those who will participate directly in the project, and thus benefit from its existence. Thus all persons who will be employed by the project, supply it with raw materials or other goods and services, or who will use in some way the output of the project can be categorised as direct beneficiaries. The patients expected to attend a health clinic, or the children expected to attend a local school (and their families) would be classified as direct beneficiaries. So would the nurse or teacher who works in the clinic or school. Direct beneficiaries of an access road might include those expected to pass along the road (drivers and passengers), as well as farmers and other sending goods on trucks along the road.

Indirect Beneficiaries: Indirect beneficiaries are often, but not always, all those living within the zone of influence of the project. Thus, although a health clinic might expect to treat only 1,500 patients, indirect beneficiaries may well include all those within 5km., 8 km. or even 10km. of the clinic (depending on how easy access is to the community where the clinic is situated), as they will benefit not only from the better health of those treated (who will come from their communities), but also might well be patients at some point in the future. The indirect beneficiaries of an access road might include all those in the communities reached by the road, as well as those living within a few kilometres on each side of the road.

It is often only possible to make broad estimates of indirect beneficiaries for two reasons: (a) there is no clear line separating those influenced by a project from those beyond this zone, as the boundary will depend on the person and the degree of need or importance of the project output. One person might be willing to travel 15km. to reach a health clinic, while another may not go beyond 8km; (b) for many categories of project, there may be no clear distinction between a beneficiary and a non-beneficiary. Someone who lives 5km. below a project that is protecting a watershed might be seen as definitely a beneficiary, but someone who lives 50km. downstream may not be. But where is the boundary of influence? 10km.? 20km? If a project protects biological diversity in a natural forest area, who are the indirect beneficiaries? These questions are not always easy to answer, but at least we can be aware that such uncertainty exists.

4.4.2 The Units of Production

The unit of production defines the way in which production costs are expressed. For example, if a person tells you that a rice crop requires 100 kg. of fertilizer, your first question might be: 100 kg. for what area? What you are asking for is the unit of production. For field crops the unit of production is usually the hectare, or whatever other measure of surface area might be used locally. Thus we may be talking of 100 kg. of fertilizer per hectare. The numbers inserted in the profile for costs therefore depend upon the unit of production chosen.

While crops are usually straightforward in their units of production, other activities may not be so simple. For example, a project to produce poultry might measure costs per bird, per 100 birds, or per poultry shed (containing, perhaps, several thousand birds). A transport project might define costs per truck, or per ton kilometre. When we talk about units of production in a processing plant or workshop, the unit of production could be the entire plant or workshop, but this can have disadvantages. If later on you wish to expand (or decrease) the size of operations, you must recalculate all over again. A better way is often to define the unit of production as being the same as the sales unit (e.g. a kilo of cheese, or a shirt).

The important thing to remember is that once defined, the unit of production should be used as the basis for all cost calculations.

4.4.3 The Production Cycle

While the unit of production defines how we measure costs and income, the production cycle defines the period over which we measure them. For many crops this is not difficult - it is the period from preparing the soil for planting until the final harvest. For maize, for example, there might be one production cycle per year lasting four months. For tomato, there might be two production cycles per year, each lasting 3 months. This means that the fertilizer used as an example above is applied to rice per hectare and per production cycle. If rice is grown twice a year, then the 100 kg./ha would be applied to each crop.

No production cycle in RuralInvest can be more than 12 months. For permanent crops, therefore, such as fruit trees, palms and coffee, which produce over a period of many years, as well as for livestock such as dairy cattle, the production cycle is usually best defined as 12 months, as costs are incurred continuously. With a twelve month production cycle, there can only be a single cycle per year. However, some continual production activities (for example a metal fabricator, or a clothing workshop) are best suited to the use of shorter production cycles, as their costs and income are most commonly expressed on a weekly or monthly basis (staff salaries, electricity, payment to suppliers, etc.). Thus you might have 12 cycles of one month each, or 52 cycles of one week.

For a hotel, the production cycle may be as short as one day, with up to 365 cycles per year (less if the hotel is shut down for a period every year). For a poultry operation, there may be 4 cycles of 12 weeks, with a four week break every year to permit an annual cleanup and disinfection.[3]

As for units of production, there is no absolute correct answer to how to define the production cycle; often several choices are possible. However it is best to choose the easiest alternative, and you must remember that the duration of the cycle times the number of cycles must add up to the total production period per year: an agroindustrial plant may have 7 one month cycles per year, for the remaining 5 months it is not in operation.

4.4.4 Sales Units

Sales units are simply the unit used in pricing the output. Thus they can be in kilos, passenger seats, hotel rooms (or beds), pairs of shoes, or cases of 12 jars. What is critical is that they relate to the unit of production defined earlier. Thus for rice, the sales unit may be tons, but they must be tons per hectare, if that is the production unit defined. A dairy herd might have litres of milk as its sales units, but these would be litres of milk per production unit (often per cow). Sometimes the two units will be the same - a juice plant may define both the production and sales unit as a 20 kg. drum of juice. Thus costs and income must both estimated for each 20 kg. drum.

4.5 Categorizing Costs

There are three principal types of costs to be considered in preparing a project profile:

Although detailed investigation of costs is not required - or even recommended - at the profile stage, it is important that an effort be made to assign all known costs as accurately as possible to each of these above categories. Where this is not done, the profile may not properly reflect the cost structure of the proposal, causing errors that may result in an apparently viable project being rejected, or a poor project being approved for further detailed analysis.

4.5.1 Investment Costs

The investment constitutes the heart of any project. An investment is a cost which once paid, will last for a number of years. Some investments will last many years - for example a well - while others, such as a computer, may be only good for 4 or 5 years. But all investments must last more than one year. By definition, a cost that recurs every year is not an investment, it is an operating cost (like purchasing fertiliser).

Land is a special type of investment. Unlike other types of investments, land usually does not lose value over time, and is considered to last indefinitely. As a result, while the average annual cost of a truck may be the cost of the truck divided by the number of years it runs, for land the average annual cost is usually assumed as zero; it can be used for many years and still has the same value. Buildings made of stone or other solid materials may also last a long time, but they must usually be maintained, and so will ahev an annual cost associated with them.

Not all investment is in the form of physical goods (buildings, machinery etc.), although these are typically the most frequent. One can also invest in less tangible items, such as training, design of packaging, or in accounting systems - but the same rule applies: each of these investments is a one-off expense that produces over a number of years.

Despite the above rule, it is not always easy to decide whether an item should be treated as an investment. The most common example is the cost of establishing or purchasing permanent crops or large livestock. While the establishment of each hectare of coffee, or purchase of each breeding cow, is clearly an investment, if it is intended to establish/purchase frequently during the project period (e.g. rehabilitation of 20 has of citrus undertaken on the basis of 4ha per year over 5 years), it may well be easier to treat them as an operating expense.

4.5.2 Production or Operating Costs

Investment costs are not the only type of costs facing a project. Once the investment is completed, the vast majority of projects (and all income generating activities) will have costs of operation or production. In the case of a local road, these may be no more than annual repair and maintenance, but for a dairy processing plant, these operating costs will include raw materials (milk), labour, other additives, packaging and electricity, to name only a few. Production or operating costs have the characteristic that they are recurring; that is they are incurred regularly, on a periodic basis that can be daily, monthly or at some other interval, but will be at least annually.

A second key characteristic of production or operating costs is that they arise directly from the use or functioning of the investment. They are directly affected by the scale of these activities (for this reason they are also sometimes referred to as direct costs). Thus, if the project operates at only one half of the level that it did in the previous year, the operating costs will also decline.

Labour is considered a production or operating cost if it is paid in relation to the scale of activity. Workers paid only when there are tasks to be done (e.g. harvesting, working on the production line in a plant) would therefore clearly be production costs. However, the salaries of any staff paid whether the project is running at full capacity, or nearly stopped (for example, the manager, or the mechanic in charge of the machines), would not be classified as a production cost, but rather as a general or overhead cost (see below).

It is not always easy to make the distinction between these two categories. For example, a vet who comes every month to examine the cattle in a dairy operation: is his or her payment classified as a production cost? The answer is that it depends on how the vet is paid. If it is per animal inspected, it is clearly a production cost. If, however, a vet is paid per visit (no matter how many animals there are), it would be a general or overhead cost (see below). A useful rule of thumb is that any cost that varies when the scale of operation changes by 20%, is a production cost.

4.5.3 General and Maintenance Costs

General and maintenance (or overhead) costs comprise the third category of costs faced by a project. These are costs that occur because the project exists, but which do not depend on the scale of operations. These might include office expenses, routine maintenance, local taxes, accounting services, or the cost of keeping a truck that performs a variety of jobs. Although they have to be paid on a regular basis (unlike investment costs) these costs often stay the same year after year, especially if inflation is not taken into account.

4.6 Environmental Sustainability

When preparing a project profile, it is not necessary to devote a lot of effort to considering environmental factors. However, it is important to be aware from the very beginning of the sort of factors that could lead to sustainability problems when full project preparation (Module 3) is undertaken.

Environmental sustainability deals with the impact of the proposed project on the natural resources and environment in the area of the project. If it is intended to use a small stream to irrigate a large area, the amount of water needed might be more than could be drawn from that source during the dry period of the year. As a result, the irrigation system could fail, or there could be insufficient drinking water available to communities downstream. Such a project would not be sustainable. Projects which result in the destruction of natural forests, mangrove swamps, wetlands or other natural areas are also likely to be unsustainable, as the impact of these changes may well damage the livelihoods of the communities in the area, and result in erosion and other damage to the environment.

It should also be remembered that many sources of financing for projects will not approve activities that lead to environmental damage, so although the project may seem very profitable, it will be impossible to obtain the required loans or grants to implement it.

There are projects that may cause environmental damage if poorly designed, but will not if the design is properly thought out. This often involves considering 'mitigation' measures that will reduce the environmental impact. An example might be a slaughterhouse producing much waste material, which would pollute the waters of the river into which the effluent is pumped. Here the inclusion of wastewater treatment tanks may permit the water to be purified before entering the river, and thus eliminate the problem.

[3] For those who are curious, the cost of the annual cleanup would probably be best treated not as a production cost but as an overhead. This difference is discussed in the following sections.

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