Core Supply Chain Investment as Launching Platform for Outlier Farm Engerprises-Part I

Case Studies

Dec 16, 2009 — Neil Boyle

Getting outlier farmers, as opposed to core farmers, up to capacity and scale is a central aim of combating rural poverty and food security in many parts of the world. Outlier farmers require steady and reliable support over long periods of time during which much can and will go wrong. The good part is that outlier operations are where the large returns are because that is where the economies of scale and scope are located. Outlier farmers are contract farmers for a strategic supply chain (SSCI) investor who serves as the entrepreneur for a supply chain operation. His goal is to operate the supply chain efficaciously and to reap the benefits of his labor and capital. The bad part is that outlier farmers are not easy to manage or provide with long term financing.  The alternative of plantation farming is socially undesirable and contract farmers own their capital and labor and thus have powerful incentives to be autonomous and their relations with the investor is at  best vulnerable to disturbances. In contrast, core farmers are employed labor and their relations with the investor is hierarchical and easier to manage.  Core farmers are a key part of the core operations of the supply chain. Core operations are where the security is, which is the investor’s own capital and labor on land owned and financed by him.  Core operations are similar to the  security of a mini plantation with employed labor, but without the associated social costs of a large scale plantation. Core returns are therefore limited to the scale of the core operation.  Total returns, however, can be high because of the economies gained from outlier farming. Hence, outlier farming is on the critical path to success of the overall operation and this means getting outlier farmer contracts right — not an easy task; here’s why.

The private sector is not geared to nurturing SMEs.  Private firms are geared to short time horizons and unforgiving investment hurdles. Wise and patient capital are needed: wise capital to avoid both the financial hazards of debt and equity financing and the moral hazaards of fraud and embezzelment that are incurred in the absence of credible commitement; and patient capital to enable the performance of long term debt maturities that are needed to grow the appropriate scale for SMEs to be sustainable. [A]TCE tells us that contracts are inseparable from the projects they reflect, so getting contract design and implementation right is essential to getting projects to work correctly.  This involves spotting how to read where the hazardous incentives are located and how to mitigate them through proper contract design. It further tells us that comprehensive contracting is unworkable where contingencies are identified beforehand and expost hazards are ignored. Parties need to act with foresight. Thus knowing the problems they will encounter ex-ante, a farsighted SSC investor acts to insert superior institutions and mechanisms into the economic organization of the project by means of  the contract to mitigate the hazardous incentives as they arise expost.  Traditional analysis is silent on many of the issues dicussed here.

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