Vertical Coordination and Foreign Direct Investment :
A comparative study of the dairy chains in
Bulgaria, Poland, and Slovakia
Liesbeth Dries
Centre for Agricultural and Food Economics &
Research Group on Food Policy, Transition and Development (PRG-Leuven)
Katholieke Universiteit Leuven, Belgium
Version: September 2004
Paper prepared for The World Bank (ECSSD) project “Dynamics of Vertical Coordination in ECA Agrifood Chains: Implications for Policy and Bank Operations” (EW-P084034-ESW-BB)
TABLE OF CONTENTS
EXECUTIVE SUMMARY ii
Introduction 1
Dairy processing companies 2
POLAND 2
SLOVAKIA 3
BULGARIA 3
GENERAL 4
Quality policy dairy companies 5
POLAND 5
SLOVAKIA 6
BULGARIA 7
GENERAL 8
Investment assistance to suppliers 9
POLAND 9
SLOVAKIA 9
BULGARIA 10
GENERAL 11
Impact at the farm level 12
POLAND 12
SLOVAKIA 13
BULGARIA 13
GENERAL 14
General conclusions 14
References 15
EXECUTIVE SUMMARY
The goal of the present study is to combine insights from interviews at different levels in the dairy supply chain with analysis of survey data (in the countries where such data are available), and information from existing studies to provide an analysis and documentation of the changes that have occurred in the vertical coordination of the dairy supply chain, and its effects on the various agents in the chain.
The study will focus on three countries: Poland, Slovakia and Bulgaria. These countries represent an interesting mix with respect to several relevant issues. Poland is the main dairy producing country in CEE, while Bulgaria and Slovakia are only small players on the dairy market. Both Poland and Slovakia have joined the EU in 2004 and are therefore more advanced in the EU integration process than Bulgaria. In terms of farm structure, the Polish and Bulgarian dairy sector consists mainly of small-scale household production. In contrast, the Slovakian dairy sector is dominated by large-scale farming enterprises. Similarly, the processing sector is much more fragmented in Poland and Bulgaria than it is in Slovakia.
Interviews were conducted with dairy processing companies in each of the three countries. The dairy companies were selected to provide variety in size (processing capacity), ownership structure (private, cooperative), and degree of foreign ownership. In line with the different dairy farm structures we find that dairy companies in Poland mainly source from small-scale individual farms, that dairies in Slovakia source almost exclusively from large-scale farming enterprises and that dairy companies in Bulgaria source both from small-scale and large-scale milk producers.
Improving milk quality has been a crucial aspect of the dairy companies’ policies. In all three countries, dairy companies are paying price premiums to farmers that are able to deliver high quality milk. Due to the small-scale dairy operations in Poland even under Communism, the initial situation was more problematic in Poland with respect to milk quality than in the other countries where the large-scale cooperative farms had the necessary institutions in place to ensure at least a minimum degree of milk quality.
Foreign investors in the dairy sector have played an important role by setting an example strategy for improving quality: making investments, introducing new quality tests etc. However, besides new policies introduced by foreign investors, export strategies of local and foreign firms may have an important impact on the average quality of milk supplies as well. Dairy companies in all three countries have indicated that the acquisition of an EU export license had a significant impact on their milk quality policy. Finally, government regulations have also played an important role.
In all three countries dairy companies are offering assistance programs to their suppliers. Assistance is provided most often under the form of facilitating access to inputs and investment credit (mainly for dairy-specific investments) as well as the provision of extension services. Often these types of assistance are complemented with the provision of a bank loan guarantee for farmers that are applying for a bank loan.
Access to these assistance programs is in some cases limited to large-scale producers, delivering best quality milk and in the best financial position (in other words, the most ‘valuable’ suppliers for the dairy).
While the share of dairy companies that are offering assistance to their suppliers has increased in all three countries, the content of the programs may have changed over time. For example, support is shifted from suppliers that want to buy a cooling tank to buying new cows (because most of suppliers have bought a cooling tank with aid from the dairy in previous years). Similarly, while extension services in earlier years may have been focused mainly on improving hygiene conditions during the milking process, these days, farmers are for example being informed about upgrading the genetic material of their herd.
The farm survey shows that assistance programs have a significant positive impact on on-farm investments. The reason why loans come from dairies or from banks is determined by the type of investment rather than farm characteristics. Dairy loans are used almost uniquely for investments in enlarging and upgrading the livestock herd and cooling tanks.
Evidence suggests that foreign investment has played a more important role early on in transition as an initiator of change and institutional innovation.
A key issue is how opening of the dairy sector to foreign competition and increased quality requirements has affected the survival and growth of dairy farms. We do not find support for the hypothesis that these forces drive local companies, in particular the smallest, out of business. From the Polish farm survey we find that 87% of households in the sample continued delivering to dairies despite radical restructuring of the dairies and tightened quality demands. Moreover, some of those who stopped delivering might have stopped anyhow: the average age of those who stopped producing is 56 years, compared to 45 years for the entire sample. As a consequence, the size distribution changed, but only gradually. The share of farms in the 4-12 cow category has reduced significantly with about the same amount upgrading to a larger size as falling back to smaller, presumably subsistence farms producing solely for home consumption.
However, the Bulgarian survey evidence shows that the direct impact of assistance programs on on-farm investments may be limited if access to these assistance programs is restricted to large-scale farms. This may lead to an important conclusion. In countries where the initial size distribution is more equal (either only small farms like in Poland, or only large farms like in Slovakia), farmers are more likely to have access to assistance programs of the dairy that they deliver to. However, in a country like Bulgaria, where the initial size distribution includes a large number of very small dairy farms (less than five cows per household) but a reasonable number of large-scale farms (former state or collective farms), dairy companies are more likely to invest their resources in maintaining the large-scale supply base than in upgrading the small-scale sector.
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Introduction
Studies find that foreign firms facilitate the adoption of new technologies and can solve contract enforcement problems (Key and Runsten, 1999; Gow and Swinnen, 1998). Yet most studies conclude that the impact on local suppliers is mostly negative, in particular for small suppliers in developing countries (Dolan and Humphrey, 2000; Weatherspoon and Reardon, 2002). The latter often cannot comply with the higher standards and grading requirements for the supplied products (Farina and Reardon, 2000; Henson et al., 2000; Reardon et al., 1999). Moreover, foreign investors prefer to deal with a few large suppliers to minimise transaction costs, forcing consolidation of the supplier base and hence separating many small suppliers from their traditional outlets (Runsten and Key, 1996; Holloway et al., 2000; Winters, 2000). Reardon and Berdegué (2002) show, in the case of retail investors in Latin America, how this process can lead to the rapid exclusion of thousands of small suppliers.
A major problem in transition countries is the breakdown of exchange systems and contract enforcement mechanisms (Blanchard, 1999; Konings and Walsh, 1999). Private institutional innovations have solved these problems in some countries (Johnson et al., 1999; McMillan and Woodruff, 1999). Case studies suggest that foreign investors have played an important role in this process through vertical coordination throughout the supply chain (Foster, 1999; Gow et al., 2000). At least in some cases such FDI-induced vertical coordination has contributed to improved access to finance and inputs, and productivity growth of suppliers (Gow and Swinnen, 2001).
The current paper presents evidence of vertical coordination and the role played by foreign investors in three Central and Eastern European countries: Bulgaria, Poland, and Slovakia.
These countries represent an interesting mix. With its 12 million ton of milk in 2003, Poland is by far the most important dairy producing CEE country. Slovakia and Bulgaria both produced about one tenth of this amount: 1.1 and 1.2 million ton respectively (FAO, 2004). Both Poland and Slovakia have joined the EU in May 2004, meaning that the process of EU integration has already proceeded further in these countries than it has in Bulgaria (expected to join the EU in 2007).
Furthermore, the three countries present an interesting mix with respect to the structure of their dairy farms. Both in Poland and in Bulgaria, the dairy sector consists of mainly small-scale household production as more than 85% of all milk producers have a herd size of less than 5 cows (see table 1). A high share of their production is used for self-consumption and the remainder is often sold to dairies through village collection points. The situation is completely different in Slovakia. A 1999 representative survey (ACE) shows that only 10% of family farms have dairy cows and more than half of the milk produced in these farms is used for self-consumption. On the other hand, 81% of farming enterprises have dairy cows and 100% of this milk production is sold (of which, 87% directly to a dairy processing company).
The processing sector is much more fragmented in Poland and Bulgaria than it is in Slovakia. For example, in Bulgaria, 95% of all dairy processing units are classified as so-called mandras (mini-dairies) with a capacity of less than 10 ton/day (FAO, 2000a). This in contrast to Slovakia where the ten largest dairy companies hold about 60% of the market (table 2)
It seems that there has been a larger inflow of foreign direct investments in countries (sectors) where the processing capacity and supply base have been more concentrated. By 2003, 77% of the milk purchased in Slovakia was processed by foreign owned dairy companies (Agra Europe, April 2003). Table 2 shows that the 22 main dairy processing companies in Slovakia together held about 97% market share in the beginning of 2003. In contrast, while foreign dairy companies have invested both in Bulgaria and in Poland, the combined market share held by foreign investors in these two markets is only limited (less than 10%).
The political and macroeconomic situation in a country is a crucial aspect of the attractiveness of that country for foreign investors. Table 2 shows that most of the foreign investments in the dairy sector in Slovakia, with the exception of the entry of Meggle in 1993, have taken place since 2000. This seems to be relatively late when we compare to Poland where a major inflow of foreign investors in the sector occurred already in the mid 1990s. The sudden attractiveness of Slovakia can at least partly be attributed to a shift in the political environment in the previous years. In the mid ‘90s Slovakia appeared to be moving towards authoritarian politics. The country was even singled among the 10 CEE applicants for EU membership as the only country that had failed to meet the political criteria for EU entry. The 1998 elections ended the totalitarian regime of Meciar and the new government moved quickly to implement the EU’s demands, hence creating a more stable investment climate.
The data used in this paper are the result of interviews that were conducted in the three countries between July 2001 and March 2003. The next section presents evidence of changes that have occurred and policies that are implemented at the level of the dairy processing companies. The last section summarises the impact of these changes and policies at the farm level.
Dairy processing companies
POLAND
Table 3 summarises information on the selected dairy companies. The six Polish companies were selected in the north-eastern region of Warminsko-Mazurskie and provide an interesting mix. Four are medium size companies (50-70 million liters of milk) with one large (420 million liters) and one small (2.5 million liters). Three are cooperatives, two private, and one a joint venture of a cooperative and a private company. In terms of foreign investment, two are majority foreign owned, and two have important links to foreign companies.
- ‘Mlekpol’ is one of the largest dairy cooperatives in Poland and currently receives milk from 14000 dairy farmers. It produces a wide variety of products.
- ‘Mleczarnia’, in contrast, is a small domestically owned private company. Its main production consists of yogurts. ‘Mleczarnia’ sells its products to local shops in the region.
- ‘Kurpie’ is a middle sized domestic cooperative. In 2000, Hochland (German, French) opened a dairy production plant next to the dairy cooperative. ‘Kurpie’ is the sole supplier of cheese to Hochland, who produce secondary level processed cheeses.
- ‘Mazowsze’ is also a middle sized Polish dairy cooperative. Since 1993 they started supplying pasteurized milk to Kraft, who had bought the cooperative’s debts from the bank and thus acquired part of the cooperative’s buildings. In 1998, Kraft was bought by Bel (French). Bel still buys milk from ‘Mazowsze’.
- ‘ICC Paslek’ was founded in 1994 when Land O’ Lakes (USA) entered into a 50-50 joint venture with the local dairy cooperative in Paslek. Through consecutive capital injections, Land O’ Lakes currently has a 70% ownership share in ‘ICC Paslek’.
- ‘Warmia Dairy’ started also as a joint venture between a foreign investor (Hoogwegt, Netherlands) and a local dairy cooperative in 1995. Since 1997 Hoogwegt has acquired 100% ownership.
SLOVAKIA
The six Slovakian dairy companies are located in West and Central Slovakia. Three are medium size companies (25-42 million litres per year) and three are large companies (75-155 million litres per year). Four dairies are majority foreign owned, two are domestically owned companies.