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2.6. Contracts with suppliers and retailers

2.6.1. Securing raw materials
2.6.2. Agreements with retailers and other sellers

2.6.1. Securing raw materials

Many small scale processors buy fruits and vegetables daily from their nearest public market. Although this is simple and straightforward, it creates a number of problems for a business: for example, the processors have little control over the price charged by traders each day and because of the large seasonal price fluctuations that characterise these raw materials, this makes financial planning and control over cashflow more difficult (Section 2.3.4). The processor is also unable to schedule the raw materials in the quantities required and it is common for production to fail to meet a target because there are simply not enough fruits and vegetables for sale on a particular day. Additionally, the processor has no control over the way fruits and vegetables are handled during harvest and transport to the markets and therefore no influence over the quality of the raw materials that are available (see also Section 2.7.2).

To address these problems, a processor can arrange contracts with either traders or farmers, in an attempt to have greater control over the amount of raw materials available for processing each day and their quality and price. This is not a common arrangement at present in most developing countries, possibly because commercial food processing is a relatively recent activity and there is no history of collaboration and formal contracts. However, where this has been done, there are benefits to both processor and suppliers, provided that the arrangements are made honourably and there is mutual trust. The benefits to farmers are a guaranteed price for their crop, based on a sliding scale of quality and a guaranteed market when it is harvested.

However, the traders who tour an area to buy crops provide a number of benefits to farmers that processors should not ignore when arranging contracts: for example the traders frequently buy the whole crop, regardless of quality and either sort it themselves for different markets or sell it on to wholesalers who do the sorting. From the farmers' perspective, they receive payment at the farm, without having to worry about marketing their crop or disposal of substandard items. Although farmers have a 'guaranteed' market by selling to traders, they have virtually no control over the prices offered and can be exploited, particularly at the peak of a growing season when there is an over-supply of a particular crop.

Traders also provide a number of other services that farmers may find difficult to obtain elsewhere: traders may be the only realistic source of farming tools and other inputs such as seeds; they are also a source of immediate informal credit, which farmers may require to buy inputs or for other needs such as funerals and weddings. Although the interest payments on such loans may be much higher than those charged on commercial loans, farmers often have no access to banks or other lenders and in practice have no choice. In many countries, large numbers of farmers are permanently indebted to traders for their lifetimes and are only released from the debt by sale of land.

When processors begin to negotiate contracts with farmers, they should therefore be aware that farmers may be unwilling to break the existing arrangements with traders, either because of genuine fears that they will lose the services provided or because they are indebted to traders and have no ability to make other arrangements. The local power of traders should not be under-estimated and may range from a refusal to offer further loans to farmers, a threat not to buy the crop again if sales are made directly to processors, a demand that farmers repay loans immediately and in extreme cases, physical violence.

Despite the problems described above, there are possibilities for processors to agree contracts to supply fruits and vegetables of a specified variety and quality with individual farmers or with groups of farmers who may be working cooperatively.

Typically a specification would include the variety to be grown, the degree of maturity at harvest, freedom from infection etc. The price paid for the crop is agreed in advance and may be set between the mid-season lowest point and the pre- and post-season high points. Alternatively a sliding scale of prices is agreed, based on one or more easily measurable characteristics such as minimum size or agreed colour range, with an independent person being present to confirm the agreement in case of later disputes. The agreement may also specify the minimum or maximum amount that will be bought. In a formal contract, these agreement are written down and signed by both parties, although such formal contracts are rare in most developing countries.

Figure 48. - Traders are important buyers of fruit and vegetables

Processors should also consider the other forms of assistance that could be offered to farmers. For example, in some other larger scale processing such as tea and coffee production, processors offer training and an extension service to address problems with the crop as they arise throughout the growing season. Although this may be beyond the resources of small scale processors, more limited types of assistance may include purchasing tools, fertilizer or other requirements in bulk with the savings being passed on to farmers. Alternatively, part-payment for the crop can be made in advance so that farmers can buy inputs without the need for credit and the consequent indebtedness.

The advantages to the processor are greater control over the quality of raw materials and the varieties that are planted, some control over the amounts supplied and an advance indication of likely raw material costs which assists in both financial control and production planning (Sections 2.3.4 and 2.7.1). The advantage to the farmer is the security of having a guaranteed market for the crop at a known price, together with any other incentives that may be offered by processors.

However, this type of arrangement can only operate successfully when both processors and farmers honour their side of the agreement. In the author's experience, there have been a number of occasions when these forms of agreement have been tried, but have failed because one party breaks their part of the contract. Typically, this can be farmers who sell part of their crop to traders at each end of the season, when the price is higher than that offered by the processor. The expected volume of crop is not then available to the processor and planned production capacity cannot be achieved, seriously damaging both sales and cashflow. Alternatively, the processor delays payment to farmers, resulting in the need for them to take another loan and greater indebtedness. The processor may also fail to buy the agreed amount of crop and farmers are left to find alternative markets without the option of supplying traders who may refuse to buy it or may offer an insignificant price.

A slightly different approach is that in which a processor takes a greater degree of control over production of the crop and specifies the types of fruit or vegetable to be grown, supplies seeds and other inputs, even including labour. In effect farmers are paid by the processor for the use of their land. Although this involves greater organisational complexity and higher operating costs for the processor, the benefits of an assured supply of raw materials having the correct qualities for processing may outweigh the disadvantages, particularly in situations where the demand for a crop outstrips the supply.

A further development of the approach is for the processor to rent or buy land and set up a separate operation to supply the processing unit. This often happens 'in reverse' when an existing farmer diversifies into processing but retains the farm. In either case the processor hires the labour and supplies all inputs needed to operate the farm. The bulk of the produce supplies the processing unit with any excess being sold in local markets or to traders.

2.6.2. Agreements with retailers and other sellers

Decisions by processors on how to sell their products, and to whom, are part of the marketing strategy for each individual product (Section 2.8.2) and these decisions may therefore be different for each product in a range. For example a jam manufacturer may make one range that is sold to wealthy urban consumers and another that is sold to bakers as an ingredient in doughnuts and cakes. Whatever type of sale is envisaged, it is necessary for processors to understand the market in which they operate and know the way in which products move through the market and gain value. A typical 'route map' for sales of fruit and vegetable products is shown in Figure 49.

As each seller requires a profit of between 10% and 25% for handling, stocking or transporting the foods, it is clear from Figure 49 that the less direct routes from producer to consumer result in substantial increases in the unit cost of the product. Other points to note on the route map are that a lower producer's profit may be necessary when supplying wholesalers that have control over a large part of the market, distributors add a higher percentage than other groups to account for the high transport charges in most developing countries and street traders and kiosk owners usually have the lowest profit of any group.

The simplest form of selling is directly to customers from the processing unit and this method also results in the lowest cost for consumers. Direct selling is common with bakery products, which have a short shelf life and are generally better preferred when straight from the oven, but is less common with fruit and vegetable products. Exceptions include sale of pickles and chutneys from bulk containers into customers' own pots, a small 'factory shop' selling packs of product at the front of the processing unit and sales of fresh, un-pasteurised juices in cafes or tea rooms that are adjacent to the production unit and may also be owned by the processor.

In these cases, provision has to be made in both the design and layout of the premises to accommodate customers and to have staff available to sell the product. In order to maintain control over hygiene, pilferage and health and safety, it is essential that customers are not allowed into the processing area.

Delivery of goods directly to retailers is feasible if the processing unit is located within a reasonably short radius of a sufficient number. However, the costs of distribution are met by the processor and a higher price should be charged to cover this, although it can still be cheaper for retailers than buying from a wholesaler.

Although the above methods are feasible when the production unit is centrally located, in many instances processing is carried out near to a rural area to reduce the cost of transporting raw materials. In this situation, it is more common for either processors to deliver products to one or more wholesalers, or for wholesalers to collect goods from the production unit. The relative advantages and limitations of transporting either raw materials to a production site or alternatively transporting products to a market should be carefully considered when choosing the site of a processing unit during a feasibility study (see also Section 2.5.2). Particular consideration is needed when glass jars or bottles are to be transported on rural roads, because of the potentially high losses of both empty packaging on the way to the unit and filled product on the way to wholesalers or retailers.

Figure 49. - Examples of sales routes from a processor to the final consumers (percentage figures are profit at each stage, prices are unit sale price to each group)

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