A new approach to development and investment
When farmer-allied intermediaries are the linchpins of their respective supply chains, they can fuel better economic development and nutritional outcomes.
But the intermediaries can’t get there entirely on their own. To play this role at scale, they depend on an enabling ecosystem. In the case of dairy, the Indian government laid critical groundwork for sector development. In Kenya, the prevalence of digital technology and relative availability of capital are key. Secure “demand sinks” provided by corporate buyers selling packaged consumer products to growing markets in Nigeria and other African countries have made it possible for cereal intermediaries to achieve commercial viability.
Our thesis is that to transform a smallholder-based agricultural supply chain—that is, to encourage its industrialization and commercialization; to make it more farmer allied, profitable and sustainable—requires a new approach informed by these ecosystems.
That approach should be three things.
- Value chain specific: Each value chain has different biological and economic characteristics. Programs, interventions and funding must be tailored for the unique dynamics of the relevant commodity value chain.
- Intermediary anchored: Farmer-allied intermediaries serve as a key leverage point, controlling the financial and material flows within a value chain. They are the route to market for smallholder farmers and often the most efficient and effective channel by which productivity-improving supports can reach the farmers. Intermediaries can also facilitate the growth of agricultural input companies by encouraging the use of their products. The profitable scaling of these intermediaries propels the broader development of the value chain, and any investment or development program should prioritize it.
- Aligned and coordinated: Accelerating the growth of these intermediaries will require a range of capital—including grants, debt and equity—and other supports, such as farmer training and organization. The broader ecosystem will also have to develop through supportive government policies, the creation of industry associations, building out open repositories of shared data and other activities. For maximum impact, there must be alignment and coordination on the outcomes targeted, the actors involved, and the programs and financing instruments deployed.
The ultimate goals are those we have written about earlier—namely, enhanced farmer livelihoods, more resilient food systems, better nutritional outcomes and greater socioeconomic development. An ecosystem of scaled, profitable, competitive, and farmer-allied intermediaries and supporting enterprises will get us there.
To date, some of the most successful efforts at building this kind of ecosystem have involved export-oriented high-margin cash crops. The East Africa Coffee Initiative (EACI) and the ComCashew program show how systems orientation can improve farmer livelihoods and add economic value beyond the farm gate. They also illustrate the significant value of large-scale sector development programs with long horizons as well as the need for philanthropic and patient capital.
EACI’s express goal is to improve the livelihoods of smallholder coffee farmers. With approximately $65 million in funding from the Bill & Melinda Gates Foundation, EACI, led by TechnoServe, helped farmers in Ethiopia, Kenya, Rwanda and Tanzania organize into cooperatives and set up and run low-cost wet mills to process green coffee beans. TechnoServe offered training and enhanced access to financing, and it linked coffee growers and processors to 20 global coffee roasters, including Starbucks. Before EACI’s launch in 2008, East African coffee production represented approximately 4% of global supply and was growing at less than 1% a year. Today, the four countries that EACI worked with supply 6.4% of global coffee, part of a rebound of regional coffee production that EACI helped support, and these four countries account for more than half of production on the continent, up from 34% in 2008. Over time, the program reached approximately 270,000 smallholder farmers who enjoyed an average increase in productivity of 38% and a jump in income of between 13% and 62%.
Similar results can be found in western Africa and Mozambique, where ComCashew has significantly increased investment in cashew processors. With almost $90 million in funding over a period of 12 years from the Bill & Melinda Gates Foundation, Germany’s Federal Ministry for Economic Cooperation and Development, and others, ComCashew has helped processors deepen links to farmers through loyalty packages that include training; access to information, inputs and warehousing; certification and traceability systems; and financing. By increasing domestic drying, shelling, roasting and sorting by quality, ComCashew has retained profits locally that historically went to offshore processors in India and Vietnam.
Important systemic improvements include ComCashew’s introduction of a guarantee facility that spreads banks’ risk in lending to processors as well as the education of financing providers about processor needs and the economics required to encourage more lending. ComCashew worked with industry boards and governments on crop supports from marketing to favorable regulation. Since its launch, raw cashew nut production has grown approximately 10% per year across the five countries targeted—namely, Ghana, Benin, Burkina Faso, Côte d’Ivoire and Mozambique—and now accounts for a third of global supply. In the process, ComCashew has reached more than 500,000 smallholder farmers, generally doubling their net income and helping create more than 130,000 new cashew processing jobs.
More recently, the Ethiopian Agribusiness Accelerator Platform (EAAP) was created by the Ethiopian Agricultural Transformation Agency, a strategy- and delivery-oriented government agency charged with accelerating the growth and transformation of Ethiopia’s agriculture sector. EAAP’s mission is to build sustainable, competitive agricultural value chains by catalyzing agribusiness entrepreneurs who link the country’s smallholder farmers to markets.
It started with honey and wax, and over the past two to three years, EAAP has incubated more than half a dozen smaller, early-stage processors. It has also accelerated the growth of larger, export-focused processors; facilitated the setup of contract farming schemes; and created a supporting ecosystem of banking partners, quality-testing labs and input suppliers. After systematically identifying bottlenecks in the honey value chain, it has worked to coordinate the actors and types of capital needed to address them (see Figure 1).
How the Ethiopian Agribusiness Accelerator Platform (EAAP) is transforming the Ethiopian honey industry
Since late 2017, the EAAP has mobilized approximately $20 million in funding for investment in the honey value chain. It has worked directly with 21 honey processors, 6 of which are owned by women, and, on average, it has quadrupled the revenue of these businesses. The platform has now reached more than 6,500 farmers. For those farmers who have received modern inputs, income has increased 87%.
Closing the financing gap for intermediaries
Insufficient access to capital is the biggest obstacle to African agricultural intermediaries’ growth. This is true across all forms of financing. As stated in our introduction, there is a significant debt financing gap, estimated at $80 billion a year, for agricultural SMEs in sub-Saharan Africa. In addition, current levels of impact-oriented equity investment are also inadequate: An estimated $440 million was invested in agricultural SMEs between 2013 and mid-2018, of which roughly $80 million went to intermediaries in the “missing middle,” where farmer-allied intermediaries, including some we have profiled, most often fall.
“Finding small and medium-sized enterprises is not hard; we get daily requests for support. But the majority of the time, they don’t meet our criteria, primarily due to poor management, bookkeeping and a lack of track record.”
Three reasons for this investing shortfall became clear when we interviewed nearly 50 agribusiness investors, most impact-oriented, about the challenges of agriculture investing in Africa.
- Lack of investable pipeline: Many small agricultural enterprises are informal businesses and lack the foundational criteria investors require. This includes clean financial statements, management talent, a track record and clear, achievable growth aspirations. When investors screen for intent and behavior that allies with smallholder farmers, the pipeline further narrows. Incubator and accelerator programs that have emerged in recent years to build early-stage enterprises tend to focus predominantly on tech businesses, attracted by their promise of higher returns and scale.
- High firm-level risk: Investment risk is high partly because these intermediaries lack financial and management capacity and partly because they are often illiquid with only limited exit options.
- Unattractive financial returns due to system limitations: Intermediaries can struggle to secure enough high-quality supply from smallholder farmers at affordable prices within their required time frames. The local policy environment is often unstable: Price controls shift, new tariff policies are established, and unexpected taxes are levied. In addition, transportation, energy and irrigation infrastructures are not always sufficient.
“There is huge demand in places like Nigeria and Ghana for their own food production and food processing. But the problem is that 9 times out of 10, they’re not even able to secure the raw inputs they need.”
The returns on African agricultural investment are chronically disappointing (see Figure 2). Among investors seeking market returns, more than 60% report returns lower than the 15% net internal rate of return expected. Even among investors comfortable with returns below market, typically impact oriented, more than 20% report not being able to return their principal.
For investors in African agriculture, returns lag expectations
Portfolios focused on early-stage or seed investments have a particularly tough time. Almost half report losses or recovering their principal only. At the same time, there are no investment home runs sizable enough to make up for those losses. This leaves impact-oriented funds effectively shrinking, unable to return their principal. One way to begin to address this is by diversifying portfolios by geography, crop, business type and life stage to allow them the capital to support early-stage businesses. They will also have to adjust their return expectations accordingly.
“If I go into the seed space [in Africa agriculture], I’m going to lose money … and there’s no single business that will blow it out of the park and carry the portfolio. … In the venture stage, at best, we’d preserve capital, probably worse. … In our growth portfolio, we’re looking at businesses that want to expand. There we’re looking at making, after costs, 3% to 5% across a portfolio.”
Innovations in financial instruments, such as the use of venture debt—that is, uncollateralized lending to early-stage companies that have already raised equity investment—and other revenue-sharing mechanisms, can partially address these challenges. But impact investors generally have less capacity or incentive to solve broader system issues on their own. Those that do undertake activities to address system bottlenecks will inevitably be taking on costs that compromise their returns.
Debt financing available to agricultural intermediaries is also limited, hurt by the high transaction costs of lending to small enterprises as well as inherent firm-level and systemic risks. In research conducted by Dalberg, eastern Africa’s local banks cite “high risk” and “high cost to serve” as the two biggest barriers to lending to agricultural SMEs. Loans to companies selling within domestic markets rather than those selling to export markets, such as coffee or cocoa producers, were 2.5 times more likely to default. Smaller loans carry the same servicing costs as larger loans but have a 94% higher risk of default. And even where loans are available, they often carry such high interest rates as to be unaffordable to a small enterprise, or they contain payment terms that don’t match actual enterprise cash flow.
Innovations in impact lending—including forms of short-term accounts receivable financing that use buyer commitments for collateral—have expanded the debt available, with members of the Council on Smallholder Agricultural Finance, for example, extending 35% more credit annually to sub-Saharan African agricultural enterprises since 2013. Innovations, however, have been largely confined to a limited amount of dollar-denominated, short-term trade financing for export-oriented cash crops such as coffee and cocoa.
Closing the large and persistent capital gap faced by the agricultural intermediaries of sub-Saharan Africa can only be done through a combination of four activities.
Governments need to play a more active role in catalyzing local bank lending to agricultural intermediaries. They can start by addressing some of the challenges banks face—for instance, strengthening credit reporting and payments systems (including electronic systems), subsidizing transaction costs, and improving contract enforcement. One example from Mexico, Sistema de Estímulos a la Banca, subsidizes the administrative and screening costs for small borrowers.
Government-subsidized insurance or credit guarantees to agricultural intermediaries (similar to those Rwanda’s Business Development Fund offers) can reduce systemic risks such as crop failure or new government policies. To overcome a lack of collateral, governments can support new lending systems, such as factoring or leasing, and the use of flexible forms of collateral, such as warehouse receipts, something the government of India legalized in 2007. Other options include modernizing insolvency regimes and expanding the lending system to include nonbanks, agent banking and digital banking.
Finally, governments can lend directly through state-owned banks or support other banks’ efforts to develop their capacity. Strong policy mandates can also have a powerful effect. One example: The Indian government requirement that commercial banks lend at least 18% of their adjusted net bank credit to agriculture has significantly benefited the Indian dairy sector.
Significantly greater amounts of philanthropic capital are needed. Philanthropic capital can help address upstream constraints, build capacity of agricultural intermediaries, and unlock commercial lending and equity by offloading systemic risks. These grants can help farmer-allied intermediaries support the organization and training of smallholder farmers, improving the reliability and quality of supply. They also make it possible for intermediaries to get the technical assistance (financial, managerial, operational) they need to scale. Also, grants in the form of credit guarantees or first-loss vehicles can effectively reduce the risk of lending to or investing in these intermediaries, thereby facilitating greater capital flows. Grant matching by governments and others can unlock still greater amounts of philanthropic capital.
In recent years, there has been an unfortunate decline in philanthropic capital for large-scale initiatives with longer time horizons that support intermediaries and value chain transformation. In 2007, 30% of all agriculture grants from the Bill & Melinda Gates Foundation were large grants exceeding $20 million, but by 2018, that had fallen to just 4%, according to Bain & Company analysis. Hopefully, the trend will swing back.
Significantly greater amounts of truly patient capital are needed. More highly risk-tolerant, truly patient capital is needed to support the growth of early-stage agricultural enterprises, particularly farmer-allied intermediaries that are building and validating their business models.
Because of the moderated financial return expectations and longer horizon for payback—7 to 10 years vs. the 3 to 5 years typical with commercial capital—patient capital can be critical for intermediaries in the missing middle, enabling them to adapt and grow their repeatable model. This should help the enterprises become more attractive to investors over time, unlocking further equity investing and commercial lending from traditional sources. Perhaps most importantly, this type of capital should be explicitly focused on supporting businesses that are in turn supporting smallholder farmers.
Capital providers need to expand their use of blended financing instruments. Blended financing, which takes advantage of the role that different capital providers can play, is growing 25% a year globally, and 10% of those deals include an agricultural focus. This class of financing leverages philanthropic and patient capital to reduce risk and mobilize commercial capital investments, mostly in developing markets.
Some common instruments include concessionary fund structures, such as first-loss vehicles that blend higher and lower risk-tolerant capital from public and private sources; concessionary risk mitigation instruments, including political risk insurance and currency hedging by governments and DFIs intended to reduce the risk faced by other capital providers; and philanthropically funded technical assistance structures integrated into a broader investment portfolio, providing for advisory services to strengthen enterprise operations.
Capital providers must pursue the use of such blended financing mechanisms more aggressively when lending to or investing in early-stage agricultural intermediaries given the inherent systemic risks and firm-level challenges.
Underlying all this is one fundamental reality: If they want to have a significant impact on smallholder farmers, all funders and investors need to adjust their expectations both for financial returns and the time horizon over which they can be paid back or exit the investment. This is especially true when it comes to investing in early-stage, farmer-allied intermediaries in lower-margin value chains. This is the trade-off of backing farmer-allied intermediaries—namely, lower returns in exchange for greater impact transforming African smallholder agriculture.
Three models of intermediary-anchored collaboration
The complex systemic challenges of transforming smallholder agriculture require collaborative action.
The ever-increasing list of collaborative efforts to date is encouraging (see Figure 3). Still, there are limitations with current efforts. Some focus on just one or two levers to effect change and lack an integrated approach across all system challenges. Others have too broad a focus, spanning too many countries or too many crop value chains. Insufficient capital or a lack of long-term commitment is a problem, too. So is a tendency to bring similar organizations together instead of mobilizing a broader group of actors across sectors that could offer important and complementary contributions. Misalignment of partner objectives can be an issue as well.
Existing collaborations address certain challenges but not all the elements required for African farmer-allied intermediaries to succeed
The greatest shortcoming of all, however, is the failure to focus explicitly on strengthening the role of high-potential, high-performing farmer-allied intermediaries as the crucial anchor of multistakeholder collaboration. The appropriate catalyst for these collaborative efforts will depend on specific value chain dynamics, including smallholder farmer productivity, crop quality, whether there is a critical mass of commercially viable intermediaries and a concentration of downstream buyers that can commit to significant purchase volumes at premium prices.
There are generally three viable intermediary-anchored models. Each requires coordinated effort by many stakeholders. The specific catalyst of change defines the model.
Model No. 1: Inclusive corporate supply chains with farmer-allied intermediaries
Value chain context: A large customer, typically a corporation, commits to buy from farmer-allied intermediaries. A strong economic and operational case exists for buying from smallholder farmers in order to ensure security of supply, volume and quality. The buyer is often willing to pay a premium to an intermediary (or directly to farmers) as an incentive for farmers to grow the crop and sell into their supply chain. This type of smallholder-focused supply chain model has perhaps been most successfully scaled in export-oriented cash crops, such as coffee. Examples in local supply chains, however, do exist and will likely become even more important going forward as companies look to serve the growing demand for food and beverages, such as beer and packaged cereals, in domestic African markets.
Typical catalysts: Corporate multinationals or family-owned businesses often working with an enterprise that aggregates, organizes and facilitates farmers’ access to inputs and markets.
Key elements/conditions of model: Requires sufficient potential margin for corporations to be willing to invest in the supply chain. The company will have to balance internal tension between procurement, which aims for the lowest unit cost possible for raw materials, and sustanability goals, including improving farmer livelihoods. The best solution is to establish a single point of accountability, a role responsible for balancing those goals and managing trade-offs. If the total cost of local procurement cannot be justified, corporations will move to other sources of supply, but when grants are available to offset the cost of the public good of training farmers, corporations are more likely to continue and grow these programs. Their efforts may not always involve large numbers of farmers, however, as the corporation is typically focused on optimizing specific asset utilization (for example, processing machinery) and may have access to other sources of supply, such as a large corporate-owned nucleus farm or large-scale commercial farms.
- Coca-Cola Project Nurture (mango and passion fruit, Kenya and Uganda). Launched in 2010, Project Nurture was an $11.5 million partnership between Coca-Cola, TechnoServe and the Bill & Melinda Gates Foundation. It aimed to double the income of more than 50,000 smallholder mango and passion fruit farmers selling to Coca-Cola, which used the fruit in juices it produced and sold in Kenya and Uganda. Serving as the chief implementer of the program, TechnoServe advisers trained farmers, often using demonstration plots, on good agricultural practices, such as planting trees or vines, controlling pests and diseases, and soil management. By increasing the volume and quality of local farmers’ fruit, Coca-Cola reduced its costs, lead times and sourcing risks, while farmers’ net revenue increased by 142%.
- Anheuser-Busch InBev Nile Breweries Limited and Cervejas de Moçambique (sorghum and cassava, Uganda and Mozambique). In May 2016, Anheuser-Busch InBev (then SABMiller) began working with TechnoServe to source sorghum, barley and cassava from smallholder farmers in Uganda and Mozambique to be used in the development of two new local brands of beer, Ugandan Eagle and Mozambican Impala. These two new affordable beers experienced significant sales growth, more than 25,000 smallholder farmers enjoyed higher incomes, and local governments collected increased tax revenue.
- Nespresso Gigante Central Wet-Mill initiative (coffee, Colombia). To increase its supply of high-quality, sustainable Colombian coffee, Nespresso worked with TechnoServe to identify a farmer cooperative called the Asociación de Cafeteros el Desarrollo (ACD) to manage the operations of a central wet mill. In 2015, ACD and Acumen set up Gigante Central Wet-Mill, which they own together, with Acumen investing $460,000. ACD owns a majority of the company, empowering local farmers and minimizing the risk that they will drop out. Nespresso pays the mill premium prices for high-quality coffee and offers technical assistance administered by local coffee exporter SKN Caribecafe as well as TechnoServe. Since its opening, Gigante Central Wet-Mill has benefited almost 80 smallholder coffee farming households, increasing their incomes by about 35%.
Model No. 2: Investor acceleration of farmer-allied enterprises
Typical value chain context: Includes a relatively strong pipeline of investable enterprises in a more developed ecosystem, though many of these enterprises still struggle to attract commercial capital because of a combination of misaligned returns expectations and poor investor understanding of the relevant value chains.
Typical catalysts: Impact investors.
Key elements/conditions of model: Requires patient or blended capital and the provision of other support, such as access to talent and strategic, operational and technical advice to accelerate intermediaries’ growth trajectories and attract additional capital.
- Technical Assistance Facility of the African Agriculture Fund (TAF) (Nigeria, Malawi, Cameroon, Sierra Leone, Burkina Faso, Ethiopia, Zambia and others). Between 2011 and 2018, TAF, administered by TechnoServe, provided tailored assistance and expertise to agribusinesses that had received investments from the nearly $250 million African Agriculture Fund. That fund, backed by development finance institutions from Europe, Africa and North America as well as by private equity fund manager Phatisa, aimed to provide African agricultural companies with the capital they needed to expand, to increase the local availability of affordable food, and to benefit both farmers and consumers. Financed by the EU through the International Fund for Agricultural Development, TAF worked with 12 companies to design, strengthen and expand their farmer-allied business strategies, connecting them to the technical expertise needed to implement those plans.
All told, TAF helped more than 26,000 farmers, as well as entrepreneurs and consumers, and it increased smallholders’ net incomes by more than $1.3 million. One successful example is Norish Business in Ethiopia, a diversified food manufacturer specializing in fortified food and animal feed production. Norish is one of three manufacturers certified by the UN’s World Food Programme for the production of “super-cereal,” a highly nutritious corn-soya blend for young children six months old to two years old.
Supported by a TAF investment in 2015, Norish established a contract agreement with 11 local maize co-ops that supplied 2,500 metric tons of maize in the 2016 production year, approximately 30% of Norish’s requirements at the time. Also, 1,500 smallholder farmers received training on agronomic practices for maize and soybean production, and they were given improved hybrid maize and soy seeds. TAF subsidized the purchases so that farmers paid 50% of the cost of seeds at the beginning of the season and the remaining 50% upon harvest, increasing their cash flows throughout the year.
- Acumen’s Resilient Agriculture Initiative (east and west Africa). Acumen has developed this initiative to invest more than $30 million in east and west African early-growth stage, innovative agribusinesses that enhance the productivity, incomes and climate resilience of smallholder farms. These include aggregator and digital platforms that bundle solutions of inputs, finance and technical assistance as well as innovative financial services that provide payment, credit and insurance solutions to farmers.
To mitigate the systemic risks inherent in smallholder agriculture, the initiative plans to use blended finance, including catalytic first-loss funding, to deploy equity and quasi-equity investments, with ticket sizes less than $3 million. The intent is to help early-stage agribusinesses bridge the funding gap between seed and angel investments (typically less than $1 million) and midmarket private equity funds with ticket sizes larger than $5 million. There will also be a dedicated technical assistance grant facility to help companies tackle critical operating challenges, including farmer training. This initiative is anticipated to reach 10 million members of smallholder farming families and 12 to 15 agribusinesses over the coming decade.
Model No. 3: Intermediary-anchored industry and sector development
Typical value chain context: India dairy, EACI, ComCashew and the EAAP are all good examples of this model. It applies where value chains have significant upstream productivity gaps, requiring substantial grant or public funding to create common benefits, such as the adoption of good agricultural practices and farmer organization.
Typical catalysts: Governments, foundations, multilaterals, corporate consortiums.
Key elements/conditions of model: Of the models we describe, this one requires the broadest coordination and alignment of multiple stakeholders in order to ensure that downstream demand matches upstream productivity and that the full value chain becomes as efficient as possible. Because they seek to invest in and create broad industry-wide benefits, governments often need to play a key role in these transformations. The size and duration of the investment required are typically much larger than those of the other, often more targeted models.
- HortInvest Rwanda (horticulture, Rwanda). HortInvest aims to professionalize Rwandan horticulture and increase its economic contribution by supporting the growth of agricultural SMEs, providing farmer and cooperative training on good agricultural practices, and increasing both domestic and export demand for specific crops by strengthening supply chains and the broader environment. It also aims to increase food and nutrition security for highly vulnerable households. The HortInvest project hopes to increase the incomes of at least 44,000 smallholder farmer households that grow fruits and vegetables across six districts in northwestern Rwanda from 2018 to 2021. The project has a budget of approximately $18 million from the Embassy of the Kingdom of the Netherlands in Rwanda, with an additional $5 million innovation and investment fund partly funded by private sector partners.
- Global Dairy Platform: Dairy Nourishes Africa (dairy, Africa). A consortium of dairy companies, scientific bodies and other partners, the Global Dairy Platform has collaborated precompetitively for more than a decade to increase the understanding and consumption of dairy as an integral part of a nutrient-rich diet and to advance the sector’s role in sustainable food production across the world (see Figure 4). The platform is launching the Dairy Nourishes Africa (DNA) initiative, a new kind of public-private partnership that utilizes a “whole value chain” approach, from grass to glass, leveraging the collective strength and expertise of the global dairy industry. DNA seeks to transform the African dairy industry by creating vibrant ecosystems of farmer-allied enterprises that improve nutrition (especially for children younger than five), enhance livelihoods, stimulate economic growth and ensure environmental sustainability.
The DNA initiative is specifically designed to strengthen local African enterprises and institutions, helping them to succeed. It will take an enterprise-centric and government-aligned approach coordinating across a range of stakeholders to grow consumer demand, drive dairy enterprises to their full potential, sustainably increase farmer production and create a supportive operating environment in which the dairy industry can thrive.
Initial pilots, expected to begin this year in Tanzania, aim to double smallholder farmer income and increase processed dairy sales by 150% in two years while accelerating the path of high-potential farmer-allied dairy processors toward profitable scale. The repeatable model will then be rolled out and adapted for other countries, possibly including Ethiopia, Kenya, Rwanda and Uganda.
Dairy Nourishes Africa’s strategic framework for ecosystem development
As these three models show, there is no single formula for collaboration centered on farmer-allied intermediaries. Different players can be instrumental, different crops involved, different geographies covered. The common thread is the farmer-allied intermediary.