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Chapter Four

Finance and Contracting in

Agriculture Value Chains

Soybeans grown under contract

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4.1 Investment Payback from Warehouse Establishment and Upgrading1

farming, grading systems, contracting, commodity exchanges, alternative dispute settlement (usually through arbitration by trade peers), hedging devices (through exchanges or over-the-counter), and market information systems.

However, apart from the important role of supporting the growth of these “support sectors” within the value chain the warehouse receipt system, or warehouse inventory credit, has been seen to achieve two important purposes. Firstly as a facilitator of credit delivery for inventory or products held

1 Author: Christian Baine, Coronet Consult Limited

Section 1 Why Invest in the Warehouse Receipt System (WRS)?

Warehouse receipt systems (WRS) can be described as part of a framework of ‘modern market institutions’, that countries like Uganda can adopt in different combinations and permutations according to circumstances, to develop their agriculture and render markets more efficient and effective in delivering benefits to consumers and producers.

Warehouse receipt systems normally work alongside various other institutions and business arrangements along the value chain, including: marketing cooperatives, contract

1000 MT warehouse Kisiita ACE, Western Uganda

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in storage; secondly as a means of improving the bargaining position of the depositor.

Facilitating credit delivery

a) Lenders can mitigate credit risk by using the stored commodity as collateral. This form of collateral is more readily available to rural farmers and is less difficult to liquidate than the more accepted fixed form of asset collateral. Quality risks, storage and the performance risk of the borrower are mitigated by the warehouse operator’s guarantee of delivery. The loss of value in the collateral is mitigated by monitoring movements in the market value as well as value discounting.

b) The system seeks to ease access to

commodity finance along the entire value chain with the receipts being used as collateral for loans. Farmers, farmer groups, traders and processors are able to stockpile needed inventories as well as defer sale at harvest when prices are very low. They can then use the receipts to finance household consumption needs as well as pay off production loans without having to sell the crop immediately. Farmers are therefore able to benefit from seasonal price increases, making production more rewarding and thereby attracting investment in productivity-enhancing inputs. Traders and processors also benefit from lower cost of inventory procurement, with the consumer ultimately benefiting from lower cost products during the lean season as a result of the reduced trade margins.

c) The value of collateral in properly

stored goods of standardised quality is more consistent and as has been

mentioned above, tends to appreciate after the harvest period. This makes it a better form of collateral for financiers who have historically discounted the value of immovable security located upcountry by up to 90%.

Improving marketing of agricultural commodities

i. In addition to providing a source of collateral and facilitating access to credit, warehouse receipts help to create awareness of standards for weights and measures and develop grading and other value-addition systems. A depositor who may be a farmer, farmer group, trader or exporter can take their commodity to a certified warehouse operated by a certified warehouse operator and obtain an independent confirmation of its quality and quantity.

ii. Warehouse receipts facilitate trading by making it possible for buyers to order without physical sampling of the commodities – i.e. allows “sight-unseen” trade to occur and to assure contract performance by guaranteeing delivery by the warehouse operator of commodities of known quality and quantity, from a stated location.

iii. Furthermore, the system not only makes it possible for farmers to bulk their produce in sizeable lots but, because documents are being used, it also enables information about these lots to be disseminated to larger buyers in the marketing chain and regional markets, at minimal cost, for a better price.

iv. With increased intra-seasonal stockpiling made possible and reduced

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cost-efficiency, quality commodities, timeliness and reliability of deliveries.

In 2008 WFP introduced its Purchase for Progress (P4P) program (see Box 1)2. Under this initiative WFP intends to leverage its demand in innovative ways to support the development of agricultural markets and small-holder farmers’ engagement in these markets. The P4P program is based on three critical components: a) WFP’s demand, b) supply side support through partners and c) learning and sharing. On the supply side, WFP usually buys food through large competitive tenders to traders. Through P4P, WFP is testing new procurement alternatives more suited to small-scale farmers who are, after all, the principal producers.

However, small-holder farmers face two major problems: the lack of proper stores and – partly because of this – poor quality grain. The WFP hopes that with the warehouse receipts system, the farmers will get to store and sell quality grain to WFP, through direct purchases or tendering, as well as sell to other big buyers at a premium. In this regard WFP is working closely with “modern market processes” like the WRS and the operations of the Uganda Commodity Exchange (UCE). The role of the UCE is to maximise throughput by means of sensitisation programs targeted at warehouse operators, producers and traders.

post-harvest losses due to more efficient storage, there will be upward pressure on harvest season prices, while out-of-season prices will decline. The overall reduction in seasonal price variability is expected to improve the prospects of value-added investments in agriculture.

In Uganda the benefits of the warehouse receipt system (WRS) have also been recognised as a platform for the interaction of various institutional innovations, notably grading, contracting and exchange trading. As such, significant investment and regulatory support policies have and are being actively pursued to deepen WRS applications along all levels of the commodity value chain. The Uganda Commodity Exchange (UCE), the private sector body mandated by law to regulate the warehouse receipt system, is the main driver of this process.

The World Food Program (WFP) the world’s largest humanitarian agency and major food buyer in Uganda, has also been instrumental in guiding the policy development process of the warehouse receipt system. The WFP objective in Uganda during the 2010/2011 season is to increase its local procurement of grain from 200,000MT to 400,000MT. In order to meet this objective local procurement for WFP’s food assistance programs requires

2 See also Wamala, Lydia “New WFP Initiative: Purchase for Progress” pp 86-87 in Agricultural Finance Yearbook 2008, BoU/PMA, Kampala

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Box 1 Purchase for Progress (P4P) Program

A Five Year Program 2008-2012Initial Budget: US$ 76 millionTo pilot systems of purchasing from farmers in 21 countriesOptions are:

Enhancing and expanding competitive tendering practices (for example reducing tender sizes, waiving bag markings or performance bonds, and purchasing ex-warehouse, commodity exchanges)

Purchasing directly from local entities (i.e. farmers’ associations) to support local livelihoods

Contracting in smallholder areas to reduce risk and create greater certainty for farmers in their planning (i.e. forward contracting, WRS programs and partnerships with micro-credit and insurance schemes)

Developing pro-smallholder processing opportunities

Annual purchases: 40,000 MT of commodities purchased in first year and increasingthereafter.

Source: WFP personal communication and website

1.

2.

3.

4.

The P4P program is already being applied in certified warehouses in Jinja and Masindi, operated by a private individual and a farmer group respectively. Smallholder farmers are encouraged and sometimes facilitated to deposit their produce at these warehouses and receive a warehouse receipt for about 60 percent of the market value. The receipt can be exchanged for cash at a participating financial institution. The final balance is paid once the commodities are sold.

Significant gains have already been achieved. During the two years between 2008 and 2010 bumper harvests have increased the supply of grain by more than 40 percent. A throughput of over 4,000MT has already been achieved through these warehouses. While bumper harvests have had the anticipated effect of depressing prices and discouraging

bigger throughput, the P4P program under the WRS should be able to streamline these distortions.

WFP, however, is a relief agency whose mandate does not extend to providing long-term food security solutions. The responsibility for ensuring that food is produced, graded, marketed and delivered remains a matter for the various players along the supply chain. Through its P4P program however WFP has chosen to support the development of a vibrant and cost effective WRS. In collaboration with the UCE, WFP through the P4P is supporting the establishment of well equipped licensed warehouses where small-holder farmers can aggregate, clean and bag their produce ready for delivery to regional markets.

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The Jinja and Masindi warehouses have capacities of 2,100 and 1,200 metric tons respectively. Another seven to be located regionally are being upgraded and will be equipped and leased to qualifying private and/or farmer group enterprises. However, these warehouses being equipped by WFP are quite expensive to construct and equip and are intended to be collection centres for grain in the regions where they will be located.

According to the Chief Warehouse Examiner at the Uganda Commodity Exchange, “rural investments in warehouses of capacity less than 2,000 metric tons may not be economically viable for operating a warehouse receipt system.” This is because the cost of $1m or so for construction/updating and equipping them cannot be recouped from storage fees. According to the UCE, in order for a rural warehouse to operate a WRS an annual stock throughput of at least 2,000 metric tonnes is required to ensure economies of scale.

The WRS warehouses certified by UCE will therefore have to be served by “feeder” stores. WFP and the UCE are encouraging investments by private individuals and farmer associations to set up smaller rural “satellite” warehouses of 100-300 metric tonne capacity where individual farmers can aggregate the grain into viable lots (5MT) for delivery to these WRS stores. There is however concern that the grain delivered by farmers may not meet the strict quality standards required under the P4P program. Indeed some contracts with farmer groups have been cancelled because of failure to meet these standards. The main activity at these warehouses therefore will essentially cover post-harvest handling of the grain to ensure that it meets the preliminary quality standards, such as moisture content, before it is picked up by WFP.

UCE currently licenses warehouses for coffee, paddy rice, beans and maize and where applications are made for any of these commodities at any location they are considered, provided they meet the licensing conditions. These conditions include many aspects, including but not limited to: site location, access, security, condition of road, electricity, water, repair condition of the buildings, availability of processing areas, latrines/toilets, fire protection and fighting systems and equipment, processing equipment, grading equipment. Also important are: financial considerations, reputation of the organisation and/or directors, calibre of the staff and their knowledge and experience with grain handling and storage, computers, etc.

Section 2Financial Analysis of a Maize Operation at a Typical Rural Satellite Warehouse

Clearly the value of any analysis on the profitability of an investment depends upon the quality of the assumptions used. The way to deal with this problem is to progressively refine one’s assumptions in the light of observations in the field, so as to increasingly approximate reality. This analysis makes a start in that direction.

We have established that the minimum investment requirements for a rural satellite warehouse are as detailed under Table 1 on the next page.

The analysis that is summarized in Tables 2 and 2(a) looks at a receipt, storage and delivery operation, at a warehouse vis-à-vis the alternative where the farmers sell maize to traders immediately after drying.

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2.1 Assumptions

Rather than consider the operation in an early pilot phase, this appraisal looks at the feasibility of a mature operation where time and effort have already been devoted to getting the farmers organised so as to bulk

up substantial volumes, and where initial teething problems have been addressed. Table 2 shows the assumptions, Table 2 (a) shows estimated profit and loss at various levels of throughput.

Table 1 Costs of Establishing a Rural Satellite Warehouse

Item Number Cost (USD)

Source: Uganda Commodity Exchange, December 2010

Construction (including drying slabs)

Weighing scaleSampling spears

Moisture meters

Shellers

Alarm and fire system

Total

35,000

4,000500

2,000

1,500

2,500

45,500

24

1

1

1

The assumptions cover the effective capacity of the warehouse, the level of throughput, the investment cost of setting up the warehouse, financing, the increase in price attributable to bulking and quality improvements, and the costs the farmer incurs in obtaining a price premium.

The normal dimensions of a satellite warehouse are 100 ft x 32.5 ft x 14.3 ft, and if the grain were stacked wall to wall and up to a height of 10 ft, the capacity would be about 500 tonnes. Of course, allowing for gangways and space to manoeuvre, the effective capacity for long-term storage would probably be less than 400 tonnes.

These warehouses are expected to be used for very short-term storage, typically for less than a week’s duration. Hence stacking density is much less and a large amount of space must be kept free for grain to be moved in and out of the store; effective storage capacity at any one time is likely to be less

than 100 tonnes. Assuming optimistically that the stock can be turned over five times in a season the maximum throughput over the two grain seasons in one year would be 1,000 tonnes.

While we have assumed that the maximum throughput is 1,000 tonnes for two seasons, it may be difficult to put much more than 500 tonnes through the warehouse in a season. We have therefore assumed four alternative levels of annual throughput: 100, 200, 500 and 1,000 tonnes of grain per annum.

An assumption has also been made that with a mature operation the warehouse will operate for a period of four months during one season. A gross figure of US$ 800 per month will be collected to cover warehouse rental, fumigation, amortisation of pallets, spraying and any other indirect warehouse costs.

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It is assumed that financing can be obtained on the terms offered by participating banks, i.e. 2% for the time the maize stays at the warehouse. However, given the speed of turnover at the collection centres one may expect farmers not to require financing, so the financing option should be treated as the exception to the rule.

Farmers undoubtedly incur increased costs in producing higher quality grain to qualify

Table 2 Assumptions for the Profitability Analysis set out in Table 2 (a)

Assumptions Cost

Rate of exchange

Price at which farmers sell maize prior to participating in the WRS

Average cost of gunny bag

Weight of bag for maize to WFP

Freight cost for moving bags to WRS warehouse

Cost of offloading and stacking

Cost of loading out of warehouse

Capacity of warehouse

Storage charges (all costs incl. rental, pest control, etc)

Period during which warehousing services are provided

Proportion of valuation for bank financing

Cost of financing

Increased revenue from participating in WRS scheme (minimum)

Increased revenue from participating in WRS scheme (maximum)

Alternative assumptions re. throughput

UGX 2,200 per US$

UGX 240 per Kg

UGX 560 per bag

50 kg

UGX 20 per bag

UGX 5 per bag

UGX 2 per bag

500 metric tons

US$ 800 per month

8 months

60%

2% per month (or part thereof)

UGX 60 per Kg

UGX 90 per Kg

100 tons of Maize

200 tons of Maize

500 tons of Maize

1,000 tons of Maize

for the WRS. They must harvest the grain at the correct time, handle it with greater care, and dry it to the required level. We have used the UCE recommended warehouse costs for Masindi in our estimates.

According to data received from the pilot in Masindi we have determined a minimum margin of UGX 60 per kg, and a maximum of UGX 90 per kg, though the true figure varies and remains a matter for speculation.

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Table 2 (a) Profitability Analysis

Profitability – Assuming Maximum Revenue and alternative throughputs (figures in UGX)

Throughput in metric tons

Contribution per kg

Fixed cost per kg

Profit / loss

Profit / loss without financing

Throughput in metric tons

Contribution per kg

Fixed cost per kg

Profit / loss

Profit / loss without financing

Assuming maximum revenue

Profit / loss

Profit / loss without financing

Assuming minimum revenue

Profit / loss

Profit / loss without financing

100

50

70

-20

-17

200

50

35

15

18

500

50

14

36

39

1000

50

7

43

46

100

20

70

-50

-47

-20

-17

-50

-47

200

20

35

-15

-12

15

18

-15

-12

500

20

14

6

9

36

39

6

9

1000

20

7

13

16

43

46

13

16

Profitability – Assuming Minimum Revenue and alternative throughputs (figures in UGX)

Profit & Loss Matrix

Section 3Findings and Implications

With the higher margin (UGX 90 per kg), farmer groups earn profits from 200 tonne throughput, but with the lower margin, they can only make a nominal profit at the 500 tonne per season level. This finding re-emphasises what the promoters of the WRS already know, that success depends on getting farmers to bulk substantial volumes

of grain so that they can cover the fixed costs of the operation.

The increase in profitability between a 500 and 1,000 tonne operation is much less than between the 200 and 500 tonne operation, showing that returns to scale diminish as the scale of the operation increases. If

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throughput is 500 tonnes per season, farmer groups who do not use bank financing earn profits of between UGX 9 and 39 per kg.

Table 2 (a) shows that at a throughput of 500MT per season, the fixed costs per kg of grain are UGX 14. This also suggests that the warehouse is able to charge enough storage fees to recover the investment. At the equivalent of $800 per month or UGX 8 per kg per month (over the four month season) the warehouse operator should be able to recoup, from storage fees, within 5 years, the $45,000 investment required to construct and equip the warehouse.

The analysis suggests that the WRS operation at satellite warehouses is potentially profitable for farmers. Apart from this it helps them better understand the market and tailor their product to WRS specifications accordingly. However, some of the assumptions are tenuous, and it is difficult to know how farmers themselves perceive and value the various financial costs and benefits involved. It is probably worth continuing trials, with a view to ascertaining how farmers behave in practice. If there is a very vigorous adoption curve, and the operation quickly reaches the 500 tonne per season threshold, it will be strong evidence that farmers place a high value on the benefits obtained.

However, this conclusion will only hold if farmers are charged a realistic fee to recoup the investment costs involved. Otherwise a vigorous adoption curve may simply reflect a response to subsidies available under the P4P or other Government/donor incentives.

Section 4 Organisational and Policy Measures to Improve the System in Uganda

An important aspect of the viability and integrity of the system at the rural warehouse is its organisational structure and management. While it is true that the organisational structure of any enterprise ultimately depends on its size and in this particular case the degree of control required, a warehouse operation for WRS usage has particular personnel requirements. In addition to key management staff (details may vary according to the operators’ strategy, financial and organisation structure) the operator must also have the technical staff (including weighers, samplers, graders and storage/inventory controllers) not only to assure the quality of the grain but also its integrity during its tenor in the storage facility.

The UCE is actively spearheading reforms and formulating policy to Government and the donor community as well as engaging stakeholders like WFP to increase WRS investment and awareness in the grain sector. Private sector investment and participation are being stimulated through awareness campaigns at both meso and micro levels.

At meso level, UCE is working with donors including WFP, EU and others to increase stock throughput by setting up warehouses in nine regional centres in the country. Bids have already been sent out for qualifying operators to run fully equipped warehouses

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on a model basis. The ones in Gulu and Soroti are already operational.

Plans have been finalised with NGOs like Action Against Hunger (ACF) to establish satellite warehouses of between 200 – 500 metric tonne capacities in rural areas of northern Uganda.

At the micro level, UCE and WFP are undertaking awareness campaigns in the catchment areas around these regional warehouses to sensitise farmers as to how the WRS operates and what benefits can be expected.

Templates on warehouse management, WRS regulations have also been developed for banks, insurance companies and other interested stakeholders, to encourage them to buy into the system.

References

Coulter, J.P and Shepherd, A.W. (1995) Inventory Credit; An Approach to Developing Agricultural Markets. FAO Agricultural Services Bulletin No 120. 105pp FAO Rome

Coulter, J. (2007) Farmer Groups Enterprises and the Marketing of Staple Food

Commodities in Africa. CAPRi Working Paper 72. IFPRI Washington, DC

Coulter Jonathan (2009) Review of Warehouse Receipt System and Inventory Credit Initiatives in Eastern & Southern Africa pp 8

Onumah, G.E. and Temu (2008) Reducing Marketing Constraints and Enhancing the Producer Incomes through Warehouse Receipt Systems: Cases from Coffee and Cotton Subsectors in Tanzania. Report prepared for CTA/AFD-supported study visit on WRS and Agricultural Commodity Exchanges, 5-19 October 2008

Stringfellow, R., Coulter, J., Hussain, A., T. and Mckone, C. (1997) Improving the Access of Smallholders to Agricultural Services in Sub-Saharan Africa. Small Enterprise Development vol.8, No 3 p35-41

Tschirley, D. (2008) “WFP’s Purchase for Progress (P4P): Comments for discussion on design and M&E”. Presentation at World Food Program, Rome, Monday 30 June, 2008.

WFP (2006) “Policy Issues” Agenda Item 5, Food Procurement in Developing Countries

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4.2 Contract Farming in Uganda: Past Attempts, Current Operations and Future Prospects1

Section 1

What is Contract Farming?Contract farming, also called “farming forward contract”, refers to a market linkage mechanism whereby a producer or producer group of a specified agricultural commodity sells that commodity into a predetermined market, under a written agreement, in advance of production. In other words the buying and selling of the commodity in question is under a pre-production contractual guarantee.

In ideal circumstances, the contractual agreement specifies key attributes to be achieved, including but not limited to:

a. The quantity to be supplied by the contracting producer;

1 Author: Asaph Besigye, Inspired Associates

b. The quality parameters of the commodity to be supplied;

c. The price, either fixed or floor, at which the commodity will be bought by the contracting buyer when it is supplied;

d. The latest date or time on which the buyer will take delivery of the commodity;

e. The delivery point at which the commodity will be passed on by the seller to the buyer.

However, often some of these attributes are not clearly spelt out in the contract. For example, a review of past and existing farming contract cases in Uganda reveals

Barley fields supervision by KACOFA in Eastern Uganda

contracting on such bases as acreage to be planted, despite the potential variation in yield from such acreage and/or unspecified delivery point and time in which the seller must perform.

The contracting buyer may be a seller of the commodity into the local or international market; a processor of that commodity such as a rice miller, coffee huller, dairy processor, tea processor, beer brewer, sugar manufacturer or cotton ginner; a commodity bulker such as a farmer cooperative or a producers’ association or an NGO/international agency that may be engaged in such activities as providing bulk relief food supplies e.g. World Food Programme, Red Cross, Oxfam, etc. Other contracting buyers for agricultural commodities may include supermarkets, big restaurants, hotels and public institutions such as schools, hospitals, police and prisons.

Contract farming is normally intended to achieve specific principal benefits to the main contracting parties as follows.

To the seller (producer or producer group), the intended benefits include:

a) Guaranteed market with a reliable buyer;

b) Guaranteed price (at least minimum) and guaranteed realizable income;

c) Lower marketing costs and thus better returns;

d) Better planning for production and other long term on-farm and off-farm investments;

e) Ability to borrow for production and to save;

f) Enhanced opportunity to specialize in specific farming enterprises;

g) Realizing better quality;

h) In the case of contracting by farmer groups, realizing a stronger group through enhanced loyalty of the members and increased membership.

To the buyer, the intended benefits include:

a) Reliable and stable supply of the commodity either for raw material or commodity sale, bulking or distribution;

b) Reliable quality for better processing out-turn or market acceptability;

c) Predictable price, thus managing commodity price volatility;

d) Lower procurement costs;

e) Optimum utilization of existing capacity of facilities;

f) Better relationships with own buyers or clients.

Beyond the principal parties, contract farming has potential benefits for third parties e.g. lenders whose lending comfort to otherwise unbankable clients, especially smallholder producers, is enhanced by the strength of the contract. Moreover, certainty of volume and timing of cash flows facilitates structured trade financing mechanisms that allow the buyer to pay the supplier directly through the lender. This helps manage both risk and cost in lending to agribusinesses.

Additional benefits to lenders include increased access to low cost offsetting liabilities that accrue from the savings on the sellers’ accounts and also the opportunity to bank the buyers and other actors within the value chain, including input suppliers, intermediate traders and transporters.

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For the above benefits to be realized and thus for a win-win situation to obtain, the principal contracting parties must fully perform their respective obligations under the contract, in addition to having readiness to mutually vary the terms to accommodate the changing economic realities as these unfold. When contracting parties fail to meet their obligations, the arrangement can degenerate into confrontation that may involve costly litigation and or arbitration, harassment, commodity wastage and lost market for either one or both parties.

Section 2

Risks and Risk Mitigation in Contract FarmingContract farming per se is not a panacea for production and marketing maladies associated with agricultural production in particular and agribusinesses in general. There are risks involved.

Buyer’s risks

For the buyer the risks, which can result in financial losses, include:

1) No delivery or under-delivery by the seller. This can be due to side-selling or production losses. Side-selling might be prompted by a market price at harvest that is higher than the contracted price. It can also be due to a desire to avoid repayment obligations on loans that are a part of the contract. Again, it might be due to pressing needs for money, ahead of the scheduled time for payment under the contract. The last instance can give rise to the sale of an immature crop. Production losses can be due to unfavourable weather, outbreak of pests and diseases that cannot be controlled with technology available to

the farmer, floods, hailstorms, and even a deliberate act by the farmers not to carry out normal crop husbandry practices.

2) Poor quality of the commodity supplied;

3) Late delivery by the seller.

Seller’s risks

1) Failure by the buyer to take delivery (either in part or in full) of the contracted commodity within the contracted time;

2) Failure by the buyer to pay (either in part or in full) the contracted volume delivered.

Risks to third parties

As for the third party such as a lender, the risk is non-recovery of credit as a result of failure by the principal contracting parties to fully honour their contractual obligations. Even when they do, there can be failure by the buyer to remit the contract proceeds through the lender. The bank or other lending party can thus lose the ability to easily and fully recover the credit.

Risk mitigation

Mitigating buyer’s risk can be through mechanisms instituted by both the buyer and seller. The easiest risk mitigation measures are non-performance penalties such as fines and blacklisting of defaulting suppliers for future contracting opportunities, and withholding incentives provided by the buyer such as provision of inputs or extension and other services. These are however often difficult to implement especially in the case of smallholder producers and also in the case of production failure that is occasioned by circumstances beyond the farmers’ control.

Often ignored is the role of the seller in mitigating non-performance risk, especially

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for contracting by producer groups. The contracting producer group needs to institute contract enforcement mechanisms to compel its members to perform, once the group has entered into contract farming on behalf of its members. Such mechanisms include effective mobilization and monitoring of the members, group incentives for well-performing members and penalties for the errant ones (including those engaging in side selling or delivering less than committed volumes) and commitment by other members to contribute for the shortfall of their failing colleagues.

Along with these measures there is often a need for assisting in meeting a member’s emergency financing needs. Measures might include: group savings and loan schemes, and mediation with third parties. Once these mutually reinforcing measures by the buyer and seller are well thought out and carefully implemented, the buyer risk can be reasonably mitigated.

Mitigating seller’s risk: the risk here is that the contracting buyer will not take delivery of the commodity, will not pay or will delay to pay for the delivered commodity. Here the only plausible mitigation measure is litigation. However, this option raises two critical issues that are of concern to those promoting contract farming as a means for increasing the flow of finance to agribusinesses.

1. The capacity of farmers and farmer groups to understand, negotiate and sign contracts that can stand the tough test of the legal process. Usually buyers prepare the contracts and they do so in such a way that they protect themselves at the expense of the farmers. The sellers normally have nothing or little to offer in drafting the contract. More than this, they often do not even comprehend

contracts. That is why in many instances the farmers get stuck with the contracted commodity when the buyers shy away from taking delivery or why they endure painful delays in receiving payments from the buyers for the delivered commodity.

2. The legal enforcement of contracts in Uganda. The legal system appears to be generally weak in enforcing farming contracts vis-à-vis other commercial contracts. The general stance has always been to “advise” the parties to sort themselves out. However, contracts serve a purpose. It makes no sense for a buyer to lose a contracted commodity to a competitor, when that competitor fully knows that the product was contracted to the first buyer. Similarly it makes no sense for a seller to remain stuck with the contracted commodity, with the buyer being permitted to source product from other farmers, at will.

Section 3

Past Contract Farming Attempts in UgandaThere are a number of past contract farming attempts in Uganda, with differing levels of success and failure. Some of them have been abandoned and others (to be discussed in the next section) are on-going. Prominent commodities in which contract farming had been engaged and was successful to a reasonable degree are:

a) Tea production and processing with contracted out growers providing additional leaf tea to supplement factory plantation output;

b) Sugar cane production by sugar cane outgrowers for the three sugar cane factories (Kakira, SCOUL and Kinyara);

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c) Barley production in Kapchorwa for Kenya Malting Company on behalf of East African Breweries;

d) Tobacco growing for BAT and Continental Leaf Tobacco;

e) Rice production for Tilda;

f) Sorghum growing for Nile Breweries, and

g) Dairy production for the Dairy Corporation (currently Sameer Agricultural).

In these incidences the buyers had a high degree of commitment and thus honoured the contracts as they considered the producers as a necessary and indispensable source of raw materials for their processing operations. Similarly, the producers had limited or no opportunity for side- selling as any attempt to do so would make the transaction not only technically unfeasible but also economically unviable. For example, it would not make sense to engage in side-selling of leaf tea from Kayonza in South Western Uganda to processors in Igara or Fort Portal, or to move sugar cane grown for Kinyara in Masindi to sell it to Kakira Sugar Factory in Jinja. Sugar, tea and milk share the characteristic that processing must take place quickly in order to avoid spoilage.

The cases of contract farming that have not been successful, or only partially so, include contract sunflower growing for Mukwano Industries that was initiated in 2001 in Northern Uganda, involving more than 20,000 smallholder farmers. Due to uncontrollable side-selling of the crop by the producers, prompted by the massive milling competition in the region and the limited flexibility of the buyer to adjust the contract price to match the reality in the market, Mukwano had to abandon the idea of contracting production and engaged in

open market buying like other competitors. Other cases in this category include contract farming for seed multiplication by seed companies such as Farm Care Inputs Centre (FICA) and Victoria Seeds, in areas such as Masindi and Kasese; horticultural crops such as chilies for exporters in the Mubuku Irrigation Scheme in Kasese from 2000 to 2003.

In the above cases failure in the respective contracting mechanisms is attributed to a number of factors. In the case of seed multiplication, the volatility of grain prices impacted on the performance of both buyers and producers. In instances when the grain prices were higher than price for seed, the producers sold seed as grain. Also, when the demand for seed was low as a result of depressed prices for grain, the uptake of seed crop by the processors was low. As for horticultural crops, the failure in contract production is associated with the volatility in both the international prices of the crop and foreign currency exchange rates.

The lessons that can be learned from the above cases include:

1) There is need for maximum buyer commitment to honour the contract, to invest substantially not only in processing capacity, but also in building up a core of reliable and consistent suppliers;

2) Limited opportunities for side-selling are a key prerequisite for successful contract farming initiatives;

3) Commodities that are susceptible to frequent price volatility are not easy to handle in contract farming;

4) Contracting with a strong farmers’ group that can enforce compliance by its smallholder members in order to honour the contract, as in the case of KACOFA 2, is very important.

2 Kapchorwa Commercial Farmers Association

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Section 4

Present Operations in Contract FarmingThe specific examples (by and large not an exhaustive list) of major on-going contract farming operations are discussed in the following paragraphs.

Sugar production

All sugar processors in Uganda engage in own plantation production but also contract sugar cane outgrowers to augment their own production in order to maximize their processing capacities and meet their market demand. These contract farming operations have so far been successful, though with a few gaps (for financing purposes) such as contracting on the basis of acreage planted and not on volume harvested and delivered. The number of contract out-growers and acreage increases year after year. For example, currently Kinyara Sugar Factory has 4,000 registered sugar cane outgrowers who are farming 9,000 ha. It is estimated that the average return on working capital investment by sugar cane outgrowers, i.e. ignoring the cost of own land, is about 95 percent which is capable of sustaining commercial financing. The success factors for contract farming in the sugar sector include buyer loyalty and full commitment to honour contracts, no opportunity for side selling, well organized producer associations and access to structured trade financing opportunities enabled by the contract.

Tea production

As in the case of sugar, most tea processors have their own tea plantations but also engage in outgrower contracts with thousands of smallholder tea growers. Such contract operations exist in Kayonza, Kyamuhunga, Igara, Mabale, Kyenjojo, Hoima and other

tea growing areas. These operations are very successful owing to high levels of commitment by the buyer processors and the limited opportunities for side selling of leaf tea by the growers. Moreover, incremental working capital costs on established tea gardens are relatively low and tea prices have been relatively stable. In recent times farmers have been realizing annual rates of return on crop investments that exceed 100 percent. This means that they can access commercial financing, as has been the case for Kayonza tea growers, highlighted in the Agricultural Finance Year Book 2008.

Barley

For the past five years farmers in Sebei region have engaged in contract farming of malting barley for East African Breweries Uganda operations. This mechanism has been very successful and is not only continuing but is also expanding. Again the factors for success are: no side-selling opportunities accessible by farmers, high level of commitment to the contract by the buyer and, existence of a strong and commercially-oriented farmers’ group. Again the average returns to the farmers, though data have not been accessed for the purposes of this article, are estimated to be reasonably high.

Tobacco

BAT engages in contract farming with farmers for its entire tobacco processing requirements. Most of its growers are in Bunyoro and West Nile. Also Continental Tobacco (Uganda) Ltd., e.g. in Kibaale District, contracts growers for its raw material requirements. Though in the past there have been problems of side-selling by the growers and also controversies over price and non-purchase by the buyers, the contract farming mechanism for tobacco is still surviving3. The future success of this mechanism appears to depend on how

3 At the time of writing there are allegations, reported in the press, that farmers sponsored by one tobacco company are being persuaded by another company, with a similar name, to sell their leaf to them. If proven, this would be in contravention of the Tobacco Control and Marketing Regulations 1996. In order to curb this malpractice MTTI is centrally licensing tobacco companies and also monitors their buying practices to ensure there is maximum adherence to the contracts.

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quickly the contracting controversies are resolved, as they emerge, and also on the continuous alignment of the value cost ratio of tobacco vis-à-vis that of other competing crops such as sunflower, maize, sugar cane and rice.

Sorghum

SAB Millers has been engaging in contract farming in several places in Uganda for Epuripur sorghum for its raw material requirements, for one of its product lines. The contracting is on a seasonal basis and has been fairly successful. However, there are reports of a number of challenges that often increase the buyer’s risk. These include poor quality seed, birds that invade the crop prior to harvest and side-selling to buyers from Kenya and Sudan. These problems notwithstanding, the contracting mechanism has the opportunity to succeed as the buyer has firm commitment to honour the contract and the final product has a steady market. Thus the challenge is basically the buyer risk. For example farmers in Kisiita in Kibale could not realize the contracted volume for the first 2010 growing season, though the buyer still took delivery of what was produced. Typically, with good yields, farmers are realizing a seasonal return on gross margin (crop cycle) investment of up to 80 percent.

Coffee

The Kaweri Coffee model in Mubende and Mityana is possibly the only contract farming activity for this crop 4. This model is flexible, as the buyer allows sellers to offer the crop to alternative buyers, if the latter can offer better prices.

Dairy

Milk processors, particularly Sameer Agriculture and Livestock Ltd., have

4 See Article 3.2, by Ezra Munyambonera, of UCDA, in the Agricultural Finance Yearbook 2009, especially pp. 79-81, for more details on contracting by the NKG Kaweri Coffee Estate.

contracts with dairy cooperatives, on behalf of their dairy farmer members, for raw milk supplies. The contract mechanism appears to be working fairly well, albeit there is some farmer discomfort with a contract price that is typically blamed on the near monopoly processing operation by Sameer, which controls over 80 percent of the dairy processing capacity in Uganda.

Seeds

As discussed earlier, this sub-sector, though still involving contract farming, has challenges. Its future success depends on the commitment by the buyers and sellers to resolve the mentioned challenges through exercising greater flexibility.

Section 5

Future Prospects for Contract Farming in UgandaThe combined effects of steady economic growth realized in Uganda over the last two and half decades and the proactive policy environment that focuses on increasing value addition for agricultural commodities, in addition to the ever growing regional demand for food stuffs, provides clear avenues for expanded contract farming operations in Uganda.

Much of Uganda has the comparative advantage of two rain seasons and constant good climate throughout the year. These factors favour sustainable contract agricultural production. Further, expanded agro-based processing is gaining sufficient momentum, with the following examples: dairy, poultry products, cotton ginning, fruit juices, beer production, baking and confectionery, high protein foods such as soya and millet, etc.

Beyond these, the demand for relief food in the region is still high, and relief suppliers are re-engineering their procurement strategies. An example is the Purchase for Progress (P4P) of WFP5. These ought to provide additional opportunities for contract farming operations. In addition, there are increasing numbers of big supermarkets, restaurants and fast food centres that have, to a large degree, changed the buying and dining landscape in Uganda. This development provides another avenue for exploring further contract farming options for poultry and crops like Irish potatoes, vegetables and fruits.

Further opportunities for contracting are created by the increasing demand for high quality agricultural raw products. The key policy areas for attention that should help to propel contract farming mechanisms in Uganda include enacting or amending contract enforcement laws (particularly addressing contract farming with smallholders) to avoid the current system of resorting to awkward stratagems such as involving the police and politicians in what is essentially a civil matter.

Other policy initiatives to steer contract farming may include those that target expansion and strengthening of farmer groups or cooperatives, stimulating investment in on-farm and off-farm infrastructure, particularly storage, and increasing availability and accessibility to better quality inputs, breeds and extension.

Finally, licensing of buyers for commodities such as tobacco, if rigorously monitored, should strengthen the contracting process. Attempts to do something similar with cotton, through a zoning process, have met with problems, but some observers believe that a tighter control by the authorities could well be appropriate in order to facilitate genuine contract farming arrangements.

Section 6

ConclusionContract farming arrangements help financiers with two key ingredients for financing operations:

I. Information as to whether the project is likely to be economically viable and capable of generating a reasonable rate of return on the investment, permitting loan obligations to be met;

II. Management of some key risks in farm production, especially market risk. When the contract also involves extension advice and access to agro-chemicals, then some basic production risks are also managed as a result of the contract.

Where commitment to the contract by both principal contracting parties is successfully achieved, and recovery of buyer credit is facilitated, then the contract farming mechanism proves its worth as a means to broadening and deepening financial services to agriculture.

The information given in this article serves to build on the previous accounts of successful commercial financing pilots by Centenary Bank and Kyamuhunga SACCO in Kayonza and Bushenyi, elaborated in the 2008 and 2009 Agricultural Finance Yearbooks. It is hoped that further replication, with other commodities or in other locations in Uganda, can result in increased opportunities to access finance for agriculture.

What remains critically important is the appropriate structuring of financial products by financial institutions to take advantage of opportunities provided by contract farming mechanisms.There is clearly scope for the authorities to strengthen their involvement in contract farming, and to intervene through licensing and monitoring of buyers.

5 See Article 6.1 by Dr. Bernard Bashaasha in the Agricultural Finance Yearbook 2009, pp 140-143

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4.3 Investment in an Integrated Contract Farming System: The Case of the Mango Value Chain in Eastern Uganda1

1 Author: Richard Wangwe

Section 1Fruit Sector in Uganda

This document reviews production, marketing and processing by smallholders and traders along the mango value chain in Eastern Uganda It also examines the opportunities for investment and the potential role of financial institutions along the same value chain.

The horticultural industry in Uganda is an underdeveloped and underutilized sector of the country’s economy. Of the 19 million hectares available for agriculture (which accounts for 39 percent of GDP and 85 percent of export earnings), the total area allocated to fruits and vegetables

is estimated to be less than 1 percent. In 2004, the total value of exported fresh fruit was US$1.4m, $850,000 of which was from bananas, with only $200,000 of processed fruit exports, the vast majority of which were dried fruit.

Uganda’s climate is a key determinant of crop production success but also a constraint to the range of crops that can be grown commercially. However, the consistently warm weather plus reliable rainfall makes the land suitable for cultivation of many tropical and sub-tropical fruits.

Mangoes of the kind produced in Eastern Uganda

Historically, most production of fruits in Uganda has been utilized for local consumption. Smallholder farmers dominate the market, producing the vast majority of fruits and vegetables available locally. Weak market linkages and undeveloped producer organizations have led to sub-standard quality and insufficient supply of fruits for both the fresh market and for processing.

Thus far, the fruit processing industry in Uganda has been mainly limited to extraction of fruit juice sold on the local market. However, processors import fruit juices in order to meet a demand that outstrips local supply. This suggests that there is an opportunity to develop the domestic supply market2. For example, Britania Allied Industries Ltd, Uganda’s largest juice producer, sources mangoes from domestic suppliers but still imported close to $3 million of mango concentrate between May 2008 and May 2009, due to

inadequate local supply. As of 2005, most of the company’s production (80 percent) was sold locally, while the remaining 20 percent was exported, primarily to neighboring countries such as Kenya, Tanzania, and Rwanda.

Uganda’s climate allows production of different varieties of mango in almost all regions of the country. According to the Ugandan Investment Authority (UIA), mangoes are grown throughout the North and Northeastern regions. Production is also seasonal in nature. In 2005, Uganda is estimated to have produced around 47,000 MT of mangoes. The local variety Kakule accounts for much of the area and production.3 Less common varieties include Sena, Khaki, and Tommy Atkins. Improved varieties currently account for only 4 percent of production in the Eastern Province project area. Figure 1 sets out production data, by variety.

Figure 1: Production of Local and Improved Varieties

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2 Supported by statements from the Ugandan Investment Authority

3 According to the Britania agronomist, Kakule is a “lookalike” of Haden and Irwin varieties. Size and taste specification requirements still to be confirmed

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Section 2 TechnoServe’s Role in Optimizing the Mango Supply Value Chain

TechnoServe (TNS) is implementing a programme in Eastern Uganda under the theme of Increasing Farmer Incomes from Fruit in East Africa through Integrated Interventions in Production and Processing.

This is a four-year pilot program that will demonstrate the ability of African smallholder men and women farmers to increase their incomes at least two-fold by becoming long-term sustainable suppliers of mango and passion fruit, both for sale on the fresh market and for processing. The program’s aim is to improve smallholder farmer incomes through productivity improvements, development of farmer-based organizations, and creation of market linkages.

The participation of the Coca Cola Company in this initiative creates a

compelling pull factor and serves to lower risk for all participants along the chain, especially processors, as the purchase guarantees offered by Coca Cola will help processors access any financing necessary to meet quality and quantity standards. Coca Cola is forecasting strong growth in the juice market in Africa, with overall juice sales in the region expected to increase substantially.

The ability of smallholder farmers to take advantage of such opportunities depends initially on getting farmers organized into organized farmer groups (Producer Business Groups – PBGs).

TNS is supporting farmers in PBGs to:

• Access training packages aimed atimproving productivity for both mango and passion fruits.

• Improve varietal mix, in collaborationwith certified nurseries.

• Establish commercial relationshipsdirectly with wholesalers of fresh produce

Pallisa Kumi Budaka Bukedea Soroti

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Figure 2: Marketed Production per District

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and processors, eliminating middlemen and directly increasing farmer incomes.

The programme has been successfully launched in the districts of Pallisa, Budaka, Kumi, Bukedea, Soroti, Mbale, Sironko and Manafwa. Since the launch of this programme, the districts mentioned have further been split to other smaller districts, but for purposes of this article we shall stick to the original districts.

TechnoServe will create value through streamlining the supply chain (eliminating middlemen to maximize farmer returns) for fresh and processed fruit supply, as well as creating market linkages to provide sales opportunities for fruit produced in excess of fresh market needs and fruit that is below fresh market sale grades.

To make a real difference to smallholder farmers engaging in fruit production, the entire value chain must be addressed. Figure 3 on the next page serves as a summary

Section 3 The Situation prior to TechnoServe Support in the Mango Value Chain in Eastern Uganda

Marketing system

The functional organization of the value chain is: sapling/seedlings production by nursery farms, mango production by the farmers, collection and transport of mango by the middlemen/consolidators, and distribution in the consumption markets by the wholesale traders and retailers. The main marketing channel for supply of mango

from production area to the consumption markets is: farmer/middlemen– wholesale trader – retailer – consumer. On a small scale there are a few institutional suppliers who supply institutions (hotels, supermarkets, upscale schools/institutions etc.); and farmers with improved varieties of mangoes who supply directly to the final consumer.

Harvesting and assembly

As for any other fruits, the middlemen/consolidators are the main assembling agents in the case of mango. These traders conduct visits to individual farmers, at maturity, and enter into contracts by fixing lump-sum amounts for the purchase of all or some of the production, after selecting the trees on the farm. They also pay some advance money.

The middlemen/consolidators usually have their fixed trading partners, the wholesale traders, in the consuming market centers (Nakasero, Nakawa, Owino and Kalerwe etc). The wholesale traders, to a limited extent, finance middlemen for expenses in contracting the farmers, including payment of advance money to the mango tree owners. This limited financing by the wholesale trader is for reserving the supplies. The financing is free of interest.

Packaging

The most popular containers used for packing mangoes are sacks. In some instances, especially with the improved sorted varieties of mango, wooden or paper boxes are used. Mango leaves are used as lining material in the boxes.

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Marketing costs and margins

Mango from the area is supplied to the distant consuming markets in Kampala and the neighboring areas on buses and on trucks. Due to the bulky nature of the fruit, middlemen prefer to use trucks. Farmers’ share in the wholesale price is negligible and improvements are only possible for farmers who can organize and take the mangoes to the main markets in Kampala. Given that there is no system of group marketing, most farmers are left with no option but to accept the best bargain they can make with the pre-harvest contractors.

Marketing information

The crop and market information systems in the region appear to be driven more by hearsay and rumours than by fact. In the absence of realistic projections of crop size, competitive market conditions, harvest schedules and packing shed activity, growers base their harvesting decisions on speculation as to potential moves in distant markets, rather than on factual market appraisals

Figure 3: The Mango Value Chain Marketing Costs and Margins

Production and harvesting

Post-harvest distribution Processing Trade /

wholesale distribution

Description/Issue

Value Levers

Key enablers

• Smallholders are fragmented and lack market access

• Market weaknesses (e.g. inefficient distribution systems) between wholesalers and consumer markets

• Local processors often lack capacity to outsource sufficient quantities of high premium fruits

• Rural-urban wholesalers and brokers negotiate with smallholders through chain of opportunistic traders

• Improve marketable yield reducing post harvest loss

• Introduce fruit grading process (e.g.A for premium grade products B. for lower tier quality)

• Diversify production mix ( e.g. vary % of production dedicated to fresh fruit versus processed)

• Develop additional more efficient wholesale markets also for fresh produce by leveraging ongoing efforts (e.g. by Gatsby Trust, Rockefeller Foundation) and empowering individual entrepreneurs (e.g. independent groceries such as Zucchini)

• Introduce new lines depending on CAPEX Investment

• Optimize overall capacity utilization considering seasonality -reduces supply gluts, stabilizes prices

• Improve quality

• Reduce delay time (e.g. transport time from small holder farm to processing plant)

• Reduce intermediate linkages (e.g. brokers, opportunistic traders)

Technoserve

• Producer Business Groups (PBGs) to provide economies of scale

• Financing options required for new processing facilities, new lines, labor costs

• PBGs to negotiate directly with processing plants

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Processing

There are two agro-processing industries Britania and Reco industries; Britania is the current leading juice processor while Reco Industries produces mango-based products such as jams, pickles, as well as juice.

Britania produces fruit juice as an end-product. It is based in Kampala and currently has a majority share of the Ugandan market. The company has a distribution network across Uganda (e.g. Jinja, Mbale, Lira, Mbarara, Masaka, Arua), and also exports juice to Kenya, Tanzania, and Rwanda.

Britania’s capacity utilization and sourcing decisions are also impacted by a limited local supply.4 As noted above, most of the puree used in Britania’s current mango juice production is sourced from imported concentrate, with the company claiming to import close to $3m of mango concentrate

each year. While Britania has indicated that importing concentrate for juice production is expensive, the current inconsistencies in quality and quantity of the local raw fruit and puree supply create significant barriers to reliance on this source. The company has indicated a desire to increase its percent of fresh pulp used (ideally to completely replace imported concentrate) in its juices, as local supply challenges are overcome.

Section 4 Current Constraints Along The Value Chain Negatively Impacting Smallholders

The domestic fruit value chains in Uganda are plagued by various inefficiencies driven by structural failures such as weak producer organizations and weak/non-existent market linkages, as well as lack of access to

4 While Britania also indicated inventory storage space is limited and that this restricts current capacity utilization, expansion efforts are currently underway.

Processed mango juice.

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inputs, inability to control disease and pests and weak post-harvest handling. This results in sub-optimal production and low income for smallholder producers. Smallholders are tapped, unable to benefit from the emerging market opportunity, as they cannot produce fruits of sufficient quantities and of the right quality. With low volume sales, at low prices, they cannot invest in their land and production processes, leading again to low yields and quality.

Additionally, informal sub-value chain relationships (such as between farmer and broker, broker and wholesalers, wholesalers and retailers) dominate the fruit value chain. These relationships tend to be weak, transactional and short-term in nature, thus unreliable and unsustainable, leading to low farm gate prices and significant value leakages.

Poor marketing infrastructure coupled with long distances makes it difficult for processors to procure from smallholder farmers. They opt instead to import fruit concentrate from destinations such as India and South Africa. Poor access to rural areas is further exacerbated by insufficient farmer organization and no recognised collection centres.

During harvest season farmers are typically unable to market all their fruits, leading to high post-harvest losses, while processors cannot procure enough quantities for their factories due to weak market linkages and poor quality of produce. As a result, the income opportunites for smallholder men and women farmers in the existing fruit value chain are limited.

TechnoServe in the first year of its programme, has begun creating value through streamlining the value chain (eliminating middlemen to maximise

farmer returns) for frech and processed fruit supply, as well as creating market linkages to provide sales opportunties for fruit produced in excess of frech market needs and fruit that is below fresh market sale-grades.

As at December 2010, over 100 producer business groups have been formed and these have been directly linked to markets in Kampla and Britania, the leading fresh fruit processing plant in Kampala.

The TechnoServe programme is in its initial years in adddressing issues in both the fresh and processed fruit value chains. It is not enough to address only one of these markets as both make an important contribution to farmer income. Farmers will typically receive higher prices for produce that go the fresh market, a source of income TechnoServe wants to perpetuate and support by allowing farmers’ to capture more value in the process. The processing market, while generally offering a lower price for fruit, is able to absorb additional volume, especially that not meeting the quality standards of the freash market. The creation of market linkages with processors will help capture more of the peak harvest revenues by offsetting fresh market saturation of mango during harvest periods.

Section 5 Involvement of Financial Services

The above activities require both up-front investment and involve higher on-going costs to be borne by farmers, middlemen/brokers, wholesalers and processors. Hence there is a need for better access to capital, either by building on existing relationships

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or by forging new relationships with financial institutions.

With limited access to financial services, a significant demand for short-term credit, and predominant trade financing provided by chain actors for whom financing is not their core business, there may be interesting opportunities for financial institutions to offer services to various actors within the mango value chain. To do so would require an excellent understanding of chain dynamics, including costs, revenues and risk, in order to design appropriate financial

Chain Actor Potential Role of Finance

Growers

Middlemen and wholesalers

Processing

Upgrading Opportunity

• Transition from sale to middlemen to domestic markets and processors. While many small growers are already indirectly selling to domestic markets, they don’t necessarily receive the price benefits as a result of engaging in financing contracts with the middle men or other intermediaries that limit negotiating power.

• Transition from conventional farming methods where the mango is left to grow naturally to modern improved to mango production crop husbandry, which can provide 30 to 40% increased revenue.

• Increased productivity (via training in modern crop husbandry, pruning, disease and pest control, irrigation/drainage, genetic grafting to improve cross-pollination, etc.)

• Third-party financing from a financial institution.

• Third-party financing of modern crop husbandry conversion, but should be provided once a solid technical package for crop husbandry is developed.

• Third-party financing may play a role, but only upon research to understand return on investment specific to the mango growing regions of eastern Uganda, as well as rigorous research on determining factors for improved productivity.

• Third-party financing to growers based on information from middlemen and wholesalers for short-term credit (initially) and possibly for longer term loans over time.

• Pass financing opportunities to third party financial institutions, thereby focus energies on suitable bulking activity, but still ensure fruit supply required by buyers.

• Establish a processing plant in the region that would take advantage of lower quality fruit, and generate an industrial market channel for this highly perishable product.

• Investment capital financing for Processing Plant development

A summary of upgrading and financing opportunities.

services for the sector.

Significant involvement of financial institutions in the fruit sub-sector is yet to be developed. In a real sense this is a “work in progress”. It is hoped that future editions of the Yearbook will describe in detail how the financial sector has entered into business relationships with those in fruit value chains, for mutual benefit.

In the meantime one can note the current situation, involving informal intermediaries (middlemen) and wholesalers.

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These can be described as being parts of the existing trade credit network. a) Intermediary Financing: Informal intermediaries (often referred

to as “middlemen”) purchase crops from small producers in advance, paying cash and offering prices below what growers could likely attain selling directly to wholesalers. Although they sometimes have a negative reputation (often deserved) these intermediaries do take on certain costs and risks and do offer liquidity to growers, albeit often at a high price.

b) Wholesalers/Bulking Agent Financing Some wholesalers and processors provide

pre-harvest advances to their trusted suppliers, in return for a commitment to deliver the crop to the processing plants, on either a firm or consignment basis. Some processors start the season with advances, then deduct the value of the advances against deliveries during the course of the season.

Given the potential benefits of formal, third-party financial services highlighted above there is need to understand the potential for expansion of services from such actors. Different financial institutions require different approaches, depending on their institutional capacity, organizational culture, and experience in agriculture. Basic capacity, commitment, interest, capital, and a predisposition to learn through controlled experimentation are “table stakes” for trying a new approach to agricultural finance. For instance, non-viable, struggling institutions, or those without a firm commitment, should not be encouraged to embark on such an initiative.

Needless to say there is good potential for designing and providing financial services to various parts of the chain in order to improve its overall competitiveness and simultaneously allow growers to align themselves with value chain actors that most suit their long-term interests.

This is especially the case for formal financial institutions capable of establishing and managing mutually beneficial alliances with commercial actors in order to understand the business, provide an additional source of external liquidity, taking advantage wherever possible of useful information to measure and manage risk, and leverage repayment channels to reduce both risk and transaction costs for clients and financial institutions alike.

The Table on the left serves as a summary of upgrading and financing opportunities.

References:

AFIRMA Project (2008) Ataulfo Mango Value Chain in Chiapas, Mexico, MicroReport No. 110 July 2008, DAI for USAID

UIA (2009) Investment Potential in Mango Farming Uganda Investment Authority October 2009. Kampala

FAO (2009) Value Chain Analysis: A Case Study of Mangoes in Kenya Sugar and Beverages Group, Raw Materials, Tropical and Horticultural Products Service, Commodities and Trade Division. FAO, Rome

AMA (2010) Mini Mango Baseline in Eastern Uganda Agribusiness Management Associates (U) Ltd. Kampala

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4.4 Meeting the Market for Fish: Aquaculture Investments in Uganda1

1 Author: Jimmy Pule

Section 1 The Markets for Ugandan Fish

Introduction

The fish sector in Uganda is one of the most important natural resources in Uganda, offering employment to over 2 million people directly and indirectly. Moreover, fish exports are one of the biggest foreign income earners – second only to coffee.

Official records show fish export earnings rising from just US$1.4m in the 1990 to US$143.6m in 2005. This figure has however declined to as low as US$87m in 2009, Returns for 2010 might be even lower. Data from January to June 2010 show a meagre US$25m.

A fish farm in Western Uganda.

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The main cause of this huge nose dive is fish stock depletion due to rampant illegal and indiscriminate fishing coupled with uncontrolled and unregulated access to fishing areas i.e. more and more capture fishing, leading to supply limitations, so that the demand far exceeds supply.

This article responds to the resulting market opportunity by outlining some key features of farming fish - aquaculture. The article does not purport to be a technical manual on fish farming. Rather it sets out to summarize some of the key facts needed by investors, large and small, and their financiers. It also includes a useful list of references.

Export markets: the role of processors

Processing for export takes place in 15 licensed fish processing factories in Uganda,

each with a processing capacity of over 30 tons per day. These factories process Nile perch from capture fisheries, with one also processing Nile tilapia. Processed fish is mainly sold to Europe, Middle East and to some niche markets within the region (Rwanda, Congo, and Sudan), and in some supermarkets within Uganda.

Fish products are exported on a weekly basis to the European and Middle East markets. Some clients pre-finance their orders, while others pay on receipt of product.

Despite the vigorous export market for their products, fish processors still face a number of challenges:

a) High dependency on capture fisheries, coupled with supply problems caused by over-exploitation of the Nile perch stocks;

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Domestic fish markets

There is a large domestic market potential for tilapia and catfish. In the Lake Victoria Basin area alone there are some 58 fish markets and of these, ten are in Kampala.

Other fish markets, outside the Lake Victoria Basin, are widely distributed and include those in Gulu, Lira, Kitgum, West Nile (Arua, Nebbi, Moyo, Adjumani, Yumbe, Koboko, and Maracha/Terego). Markets in these and similar rural centres offer fish at prices ranging upwards from UGX 6000/kg for fresh tilapia and UGX 6500/kg for the smoked product.

Section 2 Turning to Aquaculture

The strong market demand for Ugandan fish and fish products prompts attention to measures to raise production to take advantage of the opportunities presented. Given the constraints to capture fisheries in the major lakes and rivers, this focuses attention on aquaculture.

Table 1: Uganda’s Informal Cross-border Fish Exports

b) Unregulated, uncontrolled and unreported capture, sale and processing of immature Nile perch;

c) High operational costs (electricity is one of the high cost necessities for the processing factories);

d) Competition in the export markets from the Far East.

Regional fish markets

Regional fish exports have significantly contributed to Uganda’s economic growth and to the livelihoods of many Ugandans. There are several regional markets with very competitive prices for fish and fish products. These markets’ total earnings in 2006 are as shown in table below (some of these data are rough estimates).

The main constraints in regional fish marketing include: scarce fish supply, rudimentary processing technology, inadequate trade information, stringent regulations and unclear policies governing the trade.

Country of destination Value UGX (million) Value US $ (million)

DRC

Kenya

Rwanda

Sudan

Tanzania

Totals

10,408

10,675

89

345

27

21,544

35,863

23,866

134

1,616

59

61,638

19.4

13

0.072

0.876

0.032

33.38

Quantity (tonnes)

Source: UBOS 2006

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The Uganda Bureau of Statistics estimates that in 2006 aquaculture production was slightly over 32,000 tonnes, having grown from 5,000 tonnes in 2004 and 11,000 tonnes in 20052. However, Government statistics on this subject are considered to be somewhat inaccurate.

MAAIF has identified over 31 districts as suitable for fisheries and aquaculture development, based on both natural and socio-economic factors. Districts located around Uganda’s major water systems including Lake Victoria Crescent, Lake Kyoga basin, River Nile catchments, Edward complex and the Koki lakes offer suitable sites for aquaculture.

Cultured species

Nile tilapia (Oreochromis niloticus) was until recently the most farmed species. Their main characteristics include: fast growth, good taste and easy production of fish seeds.

The African catfish (Clarias gariepinus), has recently overtaken Nile tilapia as the most popular species for aquaculture in Uganda. It is fast growing and literally feeds on anything organic at household level. This species is found in all waters of Uganda; especially those linked to swamps, and has been a target of a good segment of the fishing community. It currently contributes an estimated sixty percent of aquaculture production in Uganda.

Carp have been farmed in the past. Other species reared but with little market value include Tilapia zilli, Oreochromis leucostica and the giant river prawn (Macrobrochium rosenburgii).

Systems of culture

Pond culture is the most common system in the country. Another form of fish culture, cage

culture (production of aquatic organisms by confining them in a cage within a body of water, which could be a pond, a river, or an estuary), is only starting to be discussed -especially by emerging commercial fish farmers. More detail on these two systems is given in Sections 3 and 4.

Categories of fish farmers in Uganda

Subsistence fish farmers comprise 60 percent by number of Ugandans practising aquaculture. They have pond areas ranging anywhere from 50m2 to 200m2, have little or no technical input or management Their fish feed on natural foods in ponds with little growth. Production is purely for home consumption.

Progressive fish farmers emerged from the subsistence farmers. They produce fish for income and for household protein. These have ponds averaging 500m2 in area.

Commercial fish farmers use formulated fish feeds and have semi-intensive or intensive production systems. They number about 200 (number widely disputed) and contribute nearly 20 to 30 percent of active pond surface. This group emerged in the last 2-3 years with support from the Government’s strategic interventions for the promotion of fish exports. Typically they export mainly quality fish seeds and some table fish, regionally, e.g. to Democratic Republic of Congo, Kenya and Rwanda.

Culture systems

Culture refers to the manner in which fish are allowed to grow in the ponds.

i) Monoculture where a farmer rears only one type of fish e.g. tilapia alone, or catfish alone; this has several advantages:

2 Statistical Abstract, 2007 Uganda Bureau of Statistics

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• Easy to feed andmanage since onlyone type of fish is grown;

• Easytodetermineageandsexoffish;• Easytoharvest;• Fishgrowat the same rate, attaining

desired size at the same time.

Disadvantages are:

• Asingleparasiteordiseasemaywipeout all the fish in a pond;

• Typically individual fish have a lowharvest weight (which can be addressed by having same-sex stocking).

ii) Polyculture where a farmer rears two or more types of fish at same time in one pond e.g tilapia-catfish. If managed well, the different fish feed on different foods and do not compete with each other for nutrients. Fish reared in polyculture systems are more resistant to diseases.

Feed: Local manufacture

Quality fish feed is essential for satisfactory production, both in ponds and cages. Unfortunately, the availability of feeds of the required quality has been a problem for a long time. Recently, however, the USAID/LEAD project paid for the importation of equipment for the manufacture of high quality sinking feed. Expanded local production of suitable fish feed can now be expected.

Hatcheries

Good quality seed are a pre-requisite for successful aquaculture. There are several hatcheries in Uganda, producing mainly tilapia and catfish fry and fingerlings. These hatcheries produce in total 20 million units, yet the demand is believed to be in the range of 600 million units. A major challenge of

most hatcheries has been the high cost of specialized feed, imported from Israel.

Processors

It is estimated that out of the total fish landed, 60 percent is marketed fresh and 20 percent is processed locally (smoking, salting, frying and sun drying). Fresh fish is often processed into various products depending on market demands.

Assistance with financing and related services

There have been several attempts by the Government of Uganda, through international agencies, to encourage the development of commercial aquaculture. The major development partner has been USAID, through a number of projects – as outlined below:

• SPEED provided a basis for credit toagriculture, including aquaculture.

• SCOPE helped organize and createawareness of the aquaculture opportunities.

•COMPETEassistedinthedevelopmentofa marketing strategy.

• FISH provided the technical frameworkand trained the people. It provided critical input to develop the models for profitable operation of commercial feed, hatchery, pond and cage businesses.

• LEAD is making the proven models ofcommercial aquaculture available on a national scale, and is providing the technical and other support necessary to assure the models are being implemented correctly. It has, in addition, supported

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some feed industries (Ugachick, Source of Nile and Kahoora Enterprises Limited).

Section 3Pond Aquaculture

Location and construction

A pond is a shallow section where water is enclosed. It can be earthen, concrete or plastic lined. Earthen ponds are good, cheap to construct and their bottom allows growth of natural food for fish. Selecting a suitable location and design/construction call for expert advice, with attention to such factors as the need to be able to drain the pond readily (assisted by a gentle-sloping site), the type of soil and a plentiful supply of good quality water.

Pond liming

Liming is the application of calcium compounds in a pond. Liming enhances pond productivity and helps with sanitation.

Pond fertilization

The objective is to maintain a good crop of micro-organisms to ensure high growth and survival of fish. The plankton protozoa, rotifers, crustaceans and cladocera are food for fry and fingerlings3.

Feeding

Fish feed on natural foods in the pond, but growth is fully attained if supplementary feeds (manufactured quality feeds) are given. Cost of quality feeds is a major expense in aquaculture production. Feeds and proper feed management can result in a profitable enterprise. Poor feeding management can

result in diseases, slow growth, environmental degradation and poor harvests.

Costs involved in pond establishment and operation include:

•Land(ifhiredorbought)• Construction (technical services, tools

used, materials bought-PVC pipes, PVC bends etc)

•Limeandfertilizersused• Stocking(fingerlings,transportationetc)•Feeds•Labour(wages/salaries)•Salary of owner (equal to proportion of

time he/she spends on the pond)• Pondtoolsandequipment(wheelbarrows,

nets, slashers, fencing equipment)•Harvesting,processingandstorage.• Transportation to market, and actual

marketing•Taxesetc. 4

Pond culture of tilapia is more profitable than that of catfish. Taking capital cost into account, and assuming four ¼ acre ponds, the total capital investment would be in the range of UGX 12m. This would return a net profit of UGX 6m per annum, assuming the funds for the capital investment are borrowed at commercial rates, with amortization over ten years. 5

Section 4 Cage Aquaculture

Cage culture of fish is a method of raising fish in containers enclosed on all sides and bottom by materials that hold the fish in the cage, while permitting water exchange and waste removal into the surrounding water environment.

3 Rutaisire (2002). Training manual for resource persons in fish farming (unpublished)4 NAADS (2005). Productivity and Profitability Enhancement, Technical Manual Vol. 2.5 USAID LEAD (2009). Fisheries value chain assessment report

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A cage consists of a floating unit, a frame work that holds cages suspended in the water and a flexible mesh net suspended under it6. Cage design must take full account of operational needs (stocking, sampling, monitoring, removal of dead fish and harvesting, removal of accumulated wastes and threats from predation). The precise cage and systems design depend on the species farmed, the production system used and the site and scale of operation. Site selection and design make all the difference to economic viability.

Fish feeding

Fish must be fed daily and with good quality feed7.

Water quality considerations

Adequate water exchange brings in oxygen for the fish and removes fish wastes. Accumulated uneaten feeds and wastes consume oxygen during their decomposition; this can lower the amount of dissolved oxygen to critical levels, resulting in stress and the death of significant numbers of fish.

Fish production

Cage production in Uganda targets only tilapia and catfish. Attempts to culture Nile perch commercially have failed8. The weight of fish produced in cages depends on: fish species farmed, fingerling/stock health, stocking density, fish size at stocking, cage size, feed quality, feed application regimes, quality of monitoring and management practices, culture period and water quality. Onshore installations are needed for washing, processing, packaging and transport of the harvested fish.

Financing

Cage culture can produce attractive returns. A ten cage farm costs UGX 6.2m to construct but net returns to the farmer are over UGX 32m per year. This assumes that the selling price of fish is UGX 3500/kg and feeds at UGX 1000/kg. Experience has shown that the normal selling price is somewhat higher than UGX 3,500 per kg9.

Interest of banks to finance such investments

Facilitating successful entry into cage farming through finance and technical support remains a complex and difficult area. Across Africa there have been many failed projects10. However Stanbic Bank Uganda and other commercial banks have a range of loan products that can be used to finance such investments11.

Section 5Risks in Aquaculture, both in Ponds and Cages

Aquaculture has risks

Commercial aquaculture is still a relatively new type of enterprise in Uganda. Many associated risks are yet to be appreciated and appropriate management measures identified. The most common risks are:

a) water pollution and supply problems

b) feed inadequacy – especially vitamin deficiency

6 Use nylon nets, and use double netting where the outer one serves as a predator net protecting the inner one where fish are stocked.

7 Without high quality seed (fingerling) and feed, there is poor growth and low economic return.8 & 9 USAID / LEAD (2009). Fisheries Value Chain Assessment report10 FAO Regional Technical Expert Workshop on Cage Culture in Africa. Entebbe, Uganda, 20 –23 October 2004as re-

ported in FAO Fisheries Proceedings No. 6, 113 pp. Rome, FAO. 11 Personal communication from a Stanbic Bank manager.

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c) diseases (viral, bacterial, parasitic, fungal or nutritional)

d) predation and theft (birds, monitor lizards, man)

Control measures summary

Proper pond management practices (draining, liming, screening, feed quality) are the key to disease control in ponds. Predators and thieves can be deterred with fencing and guarding. Parasites such as gut nematodes, leeches and water lice are encouraged by poor water quality. Harmful invertebrates (water beetles, water bugs, dragon flies and back swimmers) feed on fish fry. These can be controlled by pond liming.

Water quality problems include: oxygen depletion due to a substantial degree of organic matter decomposition and/or pollution due to algal blooms. These reduce the amounts of dissolved oxygen in the water, resulting in stress and fish kills. It is essential to routinely monitor water quality parameters (dissolved oxygen, pH, transparency etc.) and fish health to detect early signs of trouble, so that appropriate control measures can be taken in time.

Management challenges for associated risks include: over-crowding, fish escapes due to flooding and damaged banks, inadequate water due to prolonged droughts etc.

Cage fishing on the shores of Lake Victoria in Eastern Uganda

121121

Section 6 Future Prospects

World wide the farming of fish is growing rapidly. Aquacultural production now accounts for more than 40 percent of the human consumption of fish and marine products. In just over 50 years total global aquaculture production grew from 640,000 tonnes in 1950 to nearly 60 million tonnes in 2004, valued at US $ 70.3 billion.

Uganda is well-favoured to participate in this expansion of aquaculture, both from the viewpoint of market demand (see Section 1) and natural endowment. Some 18 percent of the total area of the country is covered by fresh water, provided by lakes, rivers, swamps and streams that are also the basis of the country’s capture fishery.

The foundations for competitive feed and hatchery industries are in place though they are still small. The equipment and supplies necessary for aquaculture development are available in the country and models for profitable commercial aquaculture have been developed, tested and proven. Most importantly, trained local personnel and suitable training materials are available for use.

Government policy, as expressed in the National Fisheries Policy Statement No. 9 of 2004, states, “Aquaculture fish production will be increased so as to reduce the gap between fish supply and the increasing demand for food fish”.

The basic economic case for doing so is strong. Studies carried out by NaFIRRI-ARDC revealed that total costs of producing 1 kg of fish in aquaculture is Shs 3,381 for

tilapia in ponds, Shs 2,681 for tilapia in cages and Shs 2,457 for catfish in ponds.

This compares with a typical retail sales price of Shs 6,000 per kilo, fresh fish, ungutted equivalent. In some areas of Uganda, and in regional markets, sales prices are usually higher than this.

Section 7Useful References:

Section 1 Fish MarketsUganda Bureau of Statistics (2006) The Informal Cross Border Trade Survey Report Entebbe, Uganda 2006 p.37-44

USAID FISH (2006) “Fisheries Investment for Sustainable Harvest”. Proceedings of the Consultative Meeting of Fish Health Managements USAID LEAD (2009) Fisheries Value Chain Assessment Report Kampala

C.M. Dhatemwa (2010). “Regional Fisheries/Farmed Products, Market Study, East Africa” Unpublished.

LVEMP and LVFO, (2006).Regional Status Report on Lake Victoria Frame Surveys for 2000, 2002 and 2004: Kenya, Tanzania and Uganda. Jinja, Uganda.

Section 2Aquaculture in UgandaUganda Bureau of Statistics Statistical Abstract 2007 UBOS, Entebbe, Uganda

Pillay T.V.R. & N.M. Kutty (2005). Aquaculture Principles and Practice, 2nd Edition Blackwell, Oxford

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Section 3 Pond AquacultureNAADS (2005) An Introduction to Commercial Fish Farming. Aquaculture Technical Manual, Vol.1 NAADS, Kampala, Uganda

Rutaisire (2002). Training manual for resource persons in fish farming, Aquaculture Research and Development Centre, Kajjansi (unpublished)

NAADS (2005) Productivity and profitability enhancement, Technical Manual Vol 2 NAADS, Kampala, Uganda

Section 4 Cage AquacultureHalwart, Matthias, Doris Soto and J. Richard Arthur (Eds) Cage Aquaculture: Regional Reviews and Global Overview FAO Fisheries Technical Paper 498, FAO, Rome 2007 http://aquanic.org/systems/cages/documents/FAOcages.pdf

Halwart, Matthias and John F. Moehl (2006). Cage Aquaculture in Africa, FAO Regional Technical Expert workshop, 20-24 Oct 2004, Entebbe Uganda, FAO Rome

Section 5 Challenges in Ponds and CagesUSAID FISH (2006) “Fisheries Investment for Sustainable Harvest”. Paper presented at the Consultative Meeting of fish Health Managements, Kampala Uganda

Roberts R.A.J. (2007). Livestock and Aquaculture Insurance in Developing Countries. Food and Agriculture Organization of the United Nations (FAO), Rome

Section 6 Future ProspectsNARO, NaFIRRI-The Strategies for Marketing Farmed Fish (NaFIRRI-ARDC Technical Report, Kajjansi)

MAAIF (2010) Development Strategy and Investment Plan (DSIP), Kampala

MAAIF (2004). The National Fisheries Policy. Department of Fisheries Resources, Entebbe

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