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3.3 Vertical Coordination and Value Chain Finance

The move toward value chains with increasingly stringent standards has led to changes in the organization of supply chains. Rather than being based on spot market transactions, value chains entail varying levels of vertical coordination at different nodes in the chains.[1] First, at the production level, contracting and vertical coordination has grown strongly in some of the high-value supply chains in Latin America, Asia, Europe, and Africa (Swinnen, 2007; World Bank, 2005). Part of these vertical coordination initiatives include the provision of, for example, finance, transportation, physical inputs, and quality control. However, investment loans and bank loan guarantees are also provided in several cases.

Rising food standards are increasingly associated with a shift toward even more extreme levels of vertical coordination in upstream processing and trading. Large exporters increasingly engage in fully vertically integrated estate production where wage laborers are hired to work on large-scale plantations.

Second, downstream vertical coordination is also increasing, which is apparent in vertical relationships between global retailing and food import companies and overseas suppliers. Most African fruit and vegetable exporters, for example, have ex-ante agreements with European importers before the start of the season. Some of these agreements are oral and do not include binding specifications in terms of prices or delivery dates. Yet, most large exporters increasingly engage in more binding contracts with buyers, including a (minimum) price, quantity, and timing of delivery. Some exporting firms even receive pre-financing from their overseas partners.

  • [1] A 2005 comparative study by the World Bank on Eastern Europe and Central Asia came to the conclusion that such vertical coordination programs were important in transition countries for several commodities, and growing (World Bank, 2005; Swinnen, 2006). The study concluded that, for example, in the dairy sector, extensive production contracts have developed between dairy processors and farms, including the provision of credit, investment loans, animal feed, extension services, bank loan guarantees, etc. In the sugar sector, marketing agreements are widespread, but also more extensive contracts, including also input provisions, investment loan assistance, etc. In both the dairy and sugar sectors, the extent of supplier assistance by processors also goes considerably beyond some of the trade credit and input assistance provided by agribusiness to farms in some developing countries. In cotton, cotton gins typically contract farms to supply seed cotton and provides them with a variety of inputs. This model, which is common in Central Asia, resembles that of the gin supply chain structure in developing countries, such as in Africa. However, the extent of contracting and supplier assistance seems to be more extensive in Central Asia, with credit, seeds, irrigation, fertilizer, etc., being provided by the gins. In fresh fruits and vegetables, the rapid growth of modern retail chains with high demands on quality and timeliness of delivery is changing the supply chains. New supplier contracting, which is developing rapidly as part of these retail investments, include farm assistance programs, which are more extensive than typically observed in Western markets. They resemble those in emerging economies, but appear more complex in several cases. Finally, in grains there is extensive and full vertical integration in Russia and Kazakhstan, where large agro-holdings and grain trading companies own several large grain farms in some of the best grain producing regions
 
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