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Dr Gift Mugano

Value chain finance is a smart way of mobilising resources for productivity enhancement. And, rightly so, the Governor of the Reserve Bank of Zimbabwe (RBZ) in his recent monetary policy indicated that the central bank is working on operationising value chain finance models. This was quite spot on considering that the recent Confederation of Zimbabwe Industries (CZI) congress was centred on value chain finance.The RBZ governor attended the CZI congress. The reference by the Central Bank Governor that he will focus on operationising value chain finance models is quite humbling. He is actually implementing one of the CZI’s congress resolution. This is sweet music into our ears. On this one, I will take my hat off for him!

The term “value chain finance” refers to the flows of funds to and among the various links within a value chain. It relates to any or all of the financial services, products and support services flowing to and/or through a value chain to address the needs and constraints of those involved in that chain, be it to obtain financing, or to secure sales, procure products, reduce risk and/or improve efficiency within the chain. It refers to both internal and external forms of finance:

Internal value chain finance is financing that takes place within the value chain, such as when a supplier provides credit to a farmer or when a lead firm advances funds to a market intermediary;

External value chain finance is financing from outside the chain made possible by value chain relationships and mechanisms; for example, when a bank issues a loan to a farmer based on a contract with a trusted buyer or a warehouse receipt from a recognised storage facility.

Value chain finance offers an opportunity to expand financing for agriculture, improve efficiency and repayments in financing, and strengthen or consolidate linkages among participants in value chains. It can improve quality and efficiency in financing say agricultural chains by:

Identifying the financing needed to strengthen the chain;

Tailoring financial products to suit the needs of the participants in the chain;

Reducing financial transaction costs through the direct discounting of loan payments at the time of product sale; and

Using value chain linkages and knowledge of the chain to mitigate risks to the chain and its partners.

Value chain finance models

The models can be characterised by the main driver of the VC and the rationale for promoting the chain. Four main models are used in value chain financing, that is, producer driven, buyer driven, facilitator driven and integrated value chain models.

Producers’ driven model

Producers driven model works on the rationale of reaping the economies of scale and bargaining power for higher price. Since small-scale producers are always at the receiving end in the marketing system, it is in their interest to join hands with other farmers to market the bulk quantity. This model invariably leads to the formation of some kind of producers’ association (co-operative or producers’ company), where the association becomes the driver for VC promotion and its development. The association provides technical assistance,marketing, inputs and linkage to finance.

This is the situation in seed manufacturing companies where companies like Seed Co and Panner support seed growers with technical assistance,marketing and inputs.

Buyer driven model

The buyers’ interest to procure a certain flow of product is the basic foundation of the buyer driven model of a value chain. Finance is used to get the commitment of the producers to sell the required quantity and quality of the agricultural commodity at the appropriate time, in an affordable cost price. This is achieved through developing suitable contracts between buyer and seller.

Contract farming is the most common buyer driven VC model in agriculture commodities. However, contract farming is also plagued with a serious problem of side-selling by farmers, if the prices in the alternative market shoot up drastically. Besides, the farmers are dependent on a single buyer who may later on become monopolistic or may lose the interest in the relationship with the farmers. It is therefore important to develop a legal framework which protect both the interests of the farmer and the contractor.

In Costa Rica, Hortifruti, an institutional buyer that consolidates products from many different small-scale farmers who are its suppliers and sells the bulked produce to supermarkets is one such buyer driven model which provides an example of a complex set of financing mechanisms that work together to support a value chain. The agreements between the lead firm, that is, Hortifruti,farmers and processors enable them to access finance from banking institutions such as BAC San José.

Hortifruti also directly provides financing and/or guarantees in other value chains as:

Bank financing for rice growers: Hortifruti guarantees purchase of crop under contract; contracts provide assurance to BAC San José bank for financing of rice growers;

BAC San José Bank: Finances 60 

percent of production costs; requires no collateral pledge but requires crop insurance coverage;

Suppliers: Provide in-kind financing of 35 percent of the production costs in the form of farm inputs.

Processor: Upon receipt and payment of rice, debits the farmers’ accounts to pay first the bank and suppliers, with part of the sales proceeds of the crop.

Farmer: Signs pledge to deliver crop to rice mill; thus becomes more creditworthy with BAC San José Bank.

Non-bank financing for rice and bean growers: Hortifruti guarantees purchase of crop under contract and (a) Provides assurance to BAC bank for financing of rice growers, and (b) Finances farmers directly, using company resources (30 percent of production cost); charges no interest (pays advance on purchase of the crop).

Facilitator driven models

The basis of the facilitator driven models is that development agencies (Government or non-government) have a social mandate and can provide the required support to promote value chains integrating small farmers and agro-enterprises.

TechnoServe is facilitating chain development in Malawi and Tanzania. TechnoServe, a not-for-profit development agency, demonstrates how an external agency, acting as a market developer,can facilitate the development of a chain through interventions at various levels. TechnoServe utilises various business models to enhance smallholder incomes through: processing business, supply business and out-grower models.

In Malawi, TechnoServe is facilitating the seed industry value chain in response to severe financing gaps in agribusiness in Southern Africa which is characterised by asset finance needs and working capital needs. The reasons for a lack of access to finance, especially by start-up businesses and early stage expansions have mainly been shortage of risk capital and poor business management capacity. TechnoServe developed the following three-pronged business model to address the needs in the seed chain:

Processing businesses — facilitating enhanced value addition and farmer linkages;

Input supply businesses — facilitating access to improved seeds, fertilisers and production technology; and

Farmer businesses — facilitating farmer integration into the seed production, processing and marketing chain through farmer organisation, training and outgrower contracts.

By addressing the whole chain, TechnoServe is able to secure a market for the young seed businesses and a more secure repayment of the financing.

In Tanzania, TechnoServe helped to create Kilicafe, an organisation that is now owned by 9 000 smallholder farmers. It works with local and international financial institutions to design financial products that serve those in the value chain. These products range from short-term input credit and sales pre-financing to multi-year loans used by farmers to invest in centralised processing facilities.

Credit is guaranteed through a variety of innovative ways, including private guarantee funds, warehouse receipts, forward sales to specialty coffee buyers. These included: Long-term financing for processing infrastructure, secured by fixed assets and marketing agreements.

Short-term financing for working capital, advance payments to farmers and agro-input credit, secured by guarantee funds, warehouse receipts, marketing agreements and price risk management.

Initially, the local banks did not understand the business model and its risk mitigation measures, and they did not also accept coffee as collateral. The financial arrangements built according to the value chain were only possible due to significant initial support from TechnoServe to both the banks and the clients; developing business plans,monitoring performance and providing operational assistance until credit worthiness is fully established.

Integrated Value

Chain (VC) model

The fourth business model is the integrated value chain model, which not only links the producers to other players in the chain,but also integrates many of these through ownership and/or formal contractual relationship.

Full vertical integration exercised by supermarkets is a classic example of this type of model. Other examples are integrated service models led either by a financial entity or by a facilitating agency.

Lessons which can be drawn from other countries on value chain finance are as follows:

First and foremost, agricultural value chain finance is not simply a single instrument or a defined “recipe” to follow. It involves systemic analysis of an entire value chain and the relationship amongst its actors and it competitiveness.

The approach enables lenders to better evaluate creditworthiness of individuals or groups of businesses within the chain through identifying risks and analysing the competitiveness of that chain.

A value chain finance approach is already used by some leading financial institutions that include sector analysis and market potential in their lending programmes. It focuses on the transactions throughout the chain which is quite dissimilar in approach to the majority of financial institutions which offer a relatively fixed set of loan products secured by the collateral of a specific borrower with little consideration given to the market system as a whole – value chain unlock finance.

Value chain finance can be “positive-sum”. The use of contractual agreements is increasingly important in modern value chains. The strength of these contracts and the commitment of the partners to abide by them is a key determining factor in the success of value chain financing.

Value chains work well in areas where there is potential to develop clusters for critical mass — for example tea/coffee estates.

Application of value chain finance instruments depends upon the enabling environment.

Dr Mugano is an Economic Advisor, Author and Expert in Trade and Competitiveness. He is a Research Associate of Nelson Mandela Metropolitan University. Feedback: +263 772 541 209 or [email protected]