In rural Uganda, helicopters and armored vehicles regularly drop hundreds of thousands of dollars in cash for coffee farmers in remote areas. In rural Ghana, it is not unusual for small cocoa buyers to stuff $20,000 in cash in a plastic bag every week and disburse it from their motorbikes. These scenarios are played out regularly in rural farming communities throughout Africa.
Smallholder households, estimated at about 500 million globally in low- and middle-income countries, are the largest segment by livelihood of those living under $2 a day. Traditionally excluded from formal financial services, digital financial services represent an opportunity to deepen financial inclusion amongst this segment. One avenue to facilitating this is to digitize the agriculture value chains that some smallholders are a part of. Although just 7% of smallholders are in tight agriculture value chains, digitizing these holds significant benefits for the buyers that smallholders are dependent on, creating a strong incentive that doesn’t exist for non-commercial smallholders or those in loose value chains.
A value chain is the range of steps and related actors necessary for an agriculture product to move from the farm to the final customers. Value-chain finance includes any or all of the financial services that flow to and/or through the chain to address the needs and constraints of its participants in accessing finance or procuring products. Although there is enormous variety depending on the particular crop and geographic location, generally agriculture value chains include the following actors:
- Input providers supplying raw materials such as seeds, fertilizer and pesticides;
- Farmers who manage the production of the agricultural product (often called producers or smallholders);
- Associations and cooperatives who often organize many individual smallholder farmers into groups to negotiate better prices with buyers and provide extension services;
- Buyers who purchase the agriculture product and sometimes undertake the processing, packaging and marketing of the final products as well;
- Customers who ultimately consume the products.
In reality, agriculture value chains are often quite complex. For example, one actor can play more than one role such as when buyers become input providers when the farmers they work with don’t have a reliable supply of inputs. In many cases, buyers also supply loans for these inputs. Middlemen often confuse the picture by buying at farm gate from individual smallholders and selling in bulk to the more established buying companies. They often take a huge share of the profit and offer low prices to cash-strapped farmers.
Key benefit for buyers: reducing costs of dealing with cash
The key benefits for buyers of agricultural products to digitize value chains are to lower the costs of withdrawing, transporting, and securing cash and distributing payments – either to farmers directly or via associations or cooperatives. Agriculture value chains are often characterized by a small number of buyers paying a large number of farmers spread out over a vast geographic area - and working through a complex network of middlemen and traders. A review of the expenses of several domestic cotton and coffee companies in rural Uganda by the mobile money issuer SmartMoney revealed that the businesses were spending about 10% of their annual operating budget on covering losses - from theft or fraud - and expenses related to insuring, securing, and transporting cash.
Another, often overlooked, benefit of digitization is the increase in trust from farmers when transactions are completed rapidly. After months of high investment in seeds and fertilizer with no return, farmers (often in debt at this point) are desperate to be paid immediately when their crops are ready. Digitization avoids the anxieties created while farmers wait to receive their funds – and reduces the temptation for them to sell crops too early for a lower price just to get cash in hand. Also, having historic electronic data on farmers could help more progressive companies make better decisions on who to lend to and eventually lead to access to digital credit.
Examples on the ground
Given the benefits to buyers, it may be surprising that there are not many examples at scale of businesses successfully digitizing payments to farmers. One exception is the Colombia Coffee Growers Federation which issued ATM cards to 82% of its out-growers (farmers who are contracted to produce for a specific buyer) between 2007 and 2013. As BTCA has documented, this helped the company reduce its disbursement costs by up to 79% compared to cash, a saving of $15.5 million.
However, most of the examples are still much smaller. Multiflower, a seed and cuttings exporter based in Arusha, Tanzania, works with 3500 outgrowers and has close to $1 million in annual revenue. Multiflower embarked on a proof of concept pilot in 2013 where they issued loans totaling $6,000 to 200 farmers and paid $67,000 to 300 farmers via M-Pesa. Apart from affording each farmer with an additional and simple method for accessing credit, the switch from cash to digital payment also resulted in an average saving of $10.75 in transport costs and 8 hours per payment per farmer. Over the duration of the pilot, participating farmers saved a total of approximately 6,000 hours because they didn’t have to travel to collect their payments. They could then use this additional time for other productive uses. Farmers were also spared the insecurity of traveling back home with large amounts of cash on hand and were able to benefit from a secure mechanism for saving.
Given the positive evidence from these early examples, why are we not seeing more examples at scale? There are many challenges but perhaps predominant among these is the lack of a mobile money ecosystem in rural areas, even in countries with the most developed digital financial service ecosystems. This gives farmers little incentive to switch from cash to digital payments. In order for digital value chains to work, the proper incentives need to be in place for all parties. In the next blog, we’ll take a look at the value proposition for farmers.