What is a value chain?
A value chain is often defined as sequence of value-adding activities in a supply chain – from production to consumption, through processing and commercialization. Value chains in agriculture can be thought of as a “farm to fork” set of processes and flows – from the inputs to production to processing, marketing and the consumer. Each segment of a chain has one or more backward and forward linkages. A chain is only as strong as its weakest link and hence the stronger the links, the more secure is the flow of products and services within chain. It is important to note that the benefit of value chain finance goes beyond that of the financial flows within the chain. Yes, it is about finance with agriculture and agribusiness within a chain but also about aligning and structuring finance with the chain or because of it. Simply being a part of a secure market chain makes one a better credit risk.
What is “financing along the value chain?”
For centuries traders have provided finance to farmers for harvest, inputs or other needs such as emergencies. Many of the traders in turn receive finance from millers and processors who in turn may be financed from wholesalers or exporters who are farther “up” the chain from production to marketing. We all understand how trade finance typically works. But we also want to note that there are many entry points and many factors involved.
Agricultural Value Chains (AVCs) have become very important in determining countries’ trade competitiveness in a globalized world. In Africa, where agriculture is the backbone in many economies, they are important not only in enhancing export competitiveness, but also in developing sustainable agricultural systems, alleviating poverty and promoting financial inclusion, especially of the rural poor.
Products typically flow from stage to stage along a chain in one direction, while financial resources mostly flow in another. Funds can also flow into the chain at any stage. Chains operate within a complex environment of policies, regulations, institutions and support services. Achieving chain competitiveness is thus no simple task: it requires operational efficiency in each of its segments, coordination of transactions among chain actors and insertion within a supportive business environment. Finance and agribusiness today often go far beyond simple linkages and has often moved into integrated systems. Large agribusinesses may integrate credit and other financial services directly or indirectly at many or all of the steps in the value chain. Directly they can provide funding upstream or downstream in the chain, at whatever level in the farm-to-fork continuum. Indirectly they do so in two manners. First, they can facilitate or intermediate funding from a third party to the client or company in the chain, such as when an export company helps arrange funding for the companies or producers it buys from or sells to. Alternatively, the mere fact of being within a value chain is often sufficient for the chain actor to obtain funding from financial organizations.
Value chain finance is built not only upon physical linkages but also knowledge integration. Innovations in technology have made value chain finance what it is today. Access to market information is available for buying and selling with the ticking of an SMS on a cell phone. Smart cards, internet access and others let us communicate with each other – banks, farmers, agribusinesses and suppliers. As we will learn in this conference, there are many exciting innovations in this area. There are also many innovations in the products and services as we will discuss. For example, there are new ways for product-linked finance which uses the commodity as collateral.
A key to success in finance is to “know the business and the client.” Those who know the business the best are those persons and companies directly involved in the value chain. Having and using that knowledge of the chain, they can understand the risks and work to mitigate them much easier than a traditional banker who works with all types of businesses and clients. For this reason, some business groups have formed conglomerates which provide both formal banking and a range of agribusiness services to serve the value chain. The logic is to increase efficiency, ensure tighter control and accountability within the supply chains, and consequently increase profits. While this creates greater competition for other financial service providers, it can also create opportunities for collaboration and partnership.
There are many bankers here. Traditional loan risk assessment is still important. But we now give more emphasis to the market, to competitiveness and to the cash flow. We give less to the collateral, hence a big benefit for the poor. We also move from a supply driven offer of products and services to one based on the client and business. Good loan structuring can increase one’s credit capacity without increasing risk. This is facilitated by the new and improved technologies and products. Not all of these fit the small farmer – many risk management tools, for example, are more practical for agro-industries and wholesalers, but can stabilize prices and reduce risks for all producers and bankers. Risk mitigation tools can help stabilize income and hence improve borrowing access and conditions. Crop and/or weather insurance provide an income stream to those insured in case of failure. Forward contracts provide an avenue sell a product for future delivery at a specified price. This not only reduces price risk but also the futures contract can be used as collateral upon which one can borrow money. This is being used by small farmers in India and a few other countries but direct widespread use will be difficult in many developing countries. However, if millers and wholesalers use forward contracts, they can offer farmers prices with less risk and ostensibly with a higher price due to the reduction in uncertainty. Furthermore, they can access funding more easily due to the security of such contracts, thus providing more capital and potentially more competition and higher prices to producers. Another key to note for small farmers is the access to technical assistance and training. Without it there is little hope for many to be competitive.