Report No. 48774-ZM Zambia Commercial Value Chains in Zambian Agriculture: Do Smallholders Benefit? June 2009 Agriculture and Rural Development (AFTAR) Sustainable Development Department Country Department AFCS2 Africa Region Document of the World Bank us United States US$ U S dollar VTAZ Virginia Tobacco Association of Zambia YIELD Yield Improvementthrough Empowerment, Learning, and Discipline ZACOPA Zambia Cotton Outgrower Pre-financiers Association ZAMSEM Zambia Agriculture Spatial EquilibriumModel ZCGA Zambia Cotton Ginners Association ZLTC zsc Zambia LeafTobacco Company Zambia Sugar Company ZNFU Zambia National Farmers'Union Vice President: Obiageli Katryn Ezekwesili Country Director: Michael Baxter Country Manager: Kapil Kapoor Sector Manager: KarenMcConnell Brooks Task Team Leader: Anke Reichhuber ... 111 CONTENTS Abbreviationsand acronyms ........................................................................................... .. 11 Acknowledgements ......................................................................................................... .. vi1 ExecutiveSummary ....................................................................................................... viii ... 1. Introduction ............................................................................................................... 1 2. Agriculture inZambia ............................................................................................... 2 3. Approach and Methodology ................................................................................... 10 4. BenefitsGoingto Smallholders .............................................................................. 15 5. Increasingthe BenefitsGeneratedby SelectedValue Chains ............................. 26 6. Conclusions and Recommendations ....................................................................... 33 References......................................................................................................................... 36 Annex A: The CottonValue Chain ................................................................................ 37 Table A.l: Ginningcompanies operatingin Zambia as of2005/06 ............................ 39 Annex B: The BurleyTobacco Value Chain ................................................................. 44 Annex C: The Sugar Value Chain .................................................................................. 51 Annex D: The Domestic HorticultureValue Chain ..................................................... 59 iv TABLES Table 1 Farmers' access to extension services. by serviceprovider ....................................... 5 Table 2 Detailsof farm budgetsfor four smallholder commercialcrops. Zambia ................ 14 Table 3 Estimatedgin-gate parityprices for Zambian lint .................................................... 16 Table 4 Competitivenessof cotton. tobacco, and sugar (US$/MT) at low kwachavalue ............................................................................................................ 16 Table 5 Competitiveness of cotton, tobacco, and sugar (US$/MT) at medium kwachavalue ............................................................................................................ 17 Table 6 Competitiveness ofcotton, tobacco, and sugar (US$/MT)at high kwachavalue ............................................................................................................ 17 Table 7 Chainorganizationfor study commodities ............................................................... 18 Table 8 Value chain institutionsfor study commodities ....................................................... 20 Table 9 Legislationandregulations pertainingto study commodities .................................. 22 Table 10 Benefitsto smallholdersparticipatinginthe cotton, sugar, andtobacco value chains ........................................................................................................................ 22 Table 11 Benefitsto smallholdersparticipatinginthe domestic horticulturevalue chain ......23 Table 12 Earningsandemployment for each value chain studiedandfor export horticulture ............................................................................................................... 25 Table 13 Selectedincomeandtrade indicators for policiesto enhancefarm productivity .............................................................................................................. 28 Table 14 Selectedregionalincome indicators for policiesto enhance farm productivity .............................................................................................................. 29 Table 15 Selectedincomeandtrade indicatorsfor policiesto strengthenvalue chains ........................................................................................................................ 32 Table 16 Selectedregionalincome indicators for policiesto strengthenvalue ........................................................................................................................ Table A.1 chains 32 GinningcompaniesoperatinginZambia as of 2005/06 ........................................... 40 Table A.2 Farm-levelbenefitsfor cottonoutgrowers at three yield levels ............................... 41 Table A.3 ........................................................ Table B.1 Cottonvalue chain costsundermediumyields 43 Tobacco outgrowers inEasternProvince, 2006/07 .................................................. Table B.2 Impactoftobacco side-sellingon Alliance One's investment in Zambia ................45 Table B.3 Farm-levelbenefits for Burleytobacco outgrowers at threeyield levels .................4647 Table B.4 Burleytobacco value chain costs under mediumyields ........................................... 49 Table C 1 . Farm-levelbenefits from sugarcaneproducedby outgrowers at three yield levels ................................................................................................................ 55 Table C.2 ......................................... Table D.1 Sugar value chaincosts undermediumyields (113 tha) 58 Farmerbenefits from domestic horticulture:two examples 62 Table D.2 Value chain costs for watermelon farmer andtrader ................................................ ..................................... 64 Table D.3 Value chaincosts for tomato farmer sellingto assemblershadersinMain MarsalaB Market,Ndola ......................................................................................... 65 FIGURES Figure 1 Tobacco production(tons ofunprocesedleaf). Zambia. 1989-2008 ....................... 6 Figure2 Stages ofthe value chain ........................................................................................ 11 Figure3 Incomedistributionalongthe cotton, tobacco, and sugar value chains ..................26 FigureA.l Structure ofthe cottonindustryin Zambia ............................................................. 39 FigureA.2 Farm-levelcostsand returns for cottonfarmers obtainingmediumyields in an outgrower scheme .......................................................................................... 41 FigureA.3 Cost of processingand distributingcottonfrom outgrower schemes ..................... 43 V FigureB.1 Tobacco procurement channels. Zambia ................................................................ 45 FigureB.2 Farm-levelcosts for smallholder Burleytobacco productionat mediumyield level ......................................................................................................................... 49 FigureB.3 Processingand distributioncosts for smallholder Burleytobacco grown in Zambia and processedinMalawi ........................................................................... 48 FigureC.l Productionof sugarcane inZambia, 2006/07 ......................................................... 52 FigureC.2 Supply chain for sugar underZambia Sugar Company .......................................... 54 FigureC.3 Farm-levelcosts for smallholder sugarcaneproductionunder medium yields ....................................................................................................................... 56 FigureC.4 Processingcosts for sugarcane from smallholder farms ......................................... 58 FigureD 1 . Simplifiedsupply chain map ofLusaka's fresh fruit andvegetable system ..................................................................................................................... 60 FigureD.2 Farm-levelcosts for smallholder tomato production .............................................. 62 FigureD.3 Farm-levelcosts for smallholder watermelon productionandtrade ....................... 63 FigureD.4 Wholesaler costs and benefits from tomato sales ................................................... 63 FigureD.5 Costs andbenefits for an assembler sellingtomatoesthrough acommission agent ........................................................................................................................ 64 MAPS Map 1 Zambia's roadnetwork. 2003 ............................................................................................. 3 BOXES Box 1 Farmers' and firms' reasons for side-tradingand its costs ............................................... 30 vi ACKNOWLEDGEMENTS This analysis of Zambia's agriculturalvalue chains was carried out by the World Bank and a team of consultants. The World Bank task team included Anke Reichhuber (AFTAR), PaavoEliste(AFTAR), Meseret Kebede(AFTAR), andSipiwe Janet Chihame (AFCC2). The consultant team included Tim Purcell, Rudy van Gent, Stuart Higgins, AlessandroAlasia, JohnKeyser, andKelly Cassaday.Extensivefieldwork assistancewas provided by Vernon Simbotwe and Irvine Mudenda. We are grateful to the Ministry of Agriculture and Cooperativesand especiallyto the manykey informantswho generously gavetheir time to answer our questions. The World Bank also would liketo acknowledge the excellentcollaborationwithAgriculturalConsultativeForuminLusaka. This report has benefitedfrom the efforts of peer reviewers Kees van der Meer (ARD) and Jacomina de Regt (AFTSD) as well as excellent comments from Martien van Nieuwkoop (AFTAR), Kapil Kapoor (AFMZM), Stephen Mink (AFTSN), and Sergiy Zorya (AFTAR). Thanks are also due to the members of the country team, who participatedin the presentationof an earlier version of this report in Lusaka in August 2008. Michael Baxter (AFCC2), Frank Byamugisha (AFTAR), and Karen McConnell Brooks (AFTAR) supported the study and ensured that resources were available for its implementation. The team also acknowledgesfinancial supportfrom the Trust Fundfor ESSD(TFESSD). vii EXECUTIVE SUMMARY 1. The commercialkation of small-scale agricultureis an important element in Zambia's strategy for equitableeconomic growth, but doubts persist about whether Zambian smallholders truly benefit from participating in value chains for commercialcrops. The common perception is that other participants inthe value chain, such as middlemen, traders, and processors reap a greater share o f the returns and that smallholders are being exploited. Another frequent assumption i s that smallholders have to sacrifice the production o f food crops to participate in the production o f commercial crops. 2. If these perceptions are true, the implications for Zambia's economy and growth strategy are serious. Zambia's rural economy is dominated by smallholder agriculture, and the Zambian economy as a whole i s sustained significantly by agriculture and agroprocessing, which account for more than 40 percent of GDP and contribute about 12 percent o f export earnings. Agriculture employs about 67 percent o f the labor force and supplies raw materials to agribusinesses, which account for some 84 percent o f manufacturingvalue-added inthe country. 3. Today about 300,000 smallholdersare linkedto agribusinesses through more or less vertically integratedvalue chains. Most o f these smallholders work as contract farmers, especially for cotton, Burley tobacco, and sugarcane processors. In return for assuring their supplies o f raw produce, these agribusinesses provide farmers with varying amounts o f inputs and services, including not only marketing services but crop management knowledge and skills. 4. An unbiased assessment of the benefits and costs of smallholders' participation in Zambia's value chains would help to determine whether it is worthwhile to support their participation.Perceptions o f exploitation underminetrust and cooperation among value chain participants, preventing them from pursuing market opportunities. A persistent negative attitude towards the private sector also reduces the commitment to reforms that would increase investmentsand raise growth rates. 5. This study addresses those concerns. It provides an evidence-based analysis of specific benefitsand constraintsassociatedwith smallholders'integrationinto the commercial value chains for cotton, Burley tobacco, sugar, and domestic horticulturalcrops. These particular value chains were selected for the analysis because o f the numbers o f smallholders involved and the contrasting links between small-scale farmers and agribusiness. Cotton and tobacco are the two main commercial crops grown by smallholders. Sugar provides an example o f extremely close collaboration between smallholders and agribusiness within a vertically integrated value chain. In contrast, the value chain for .domestically marketed horticultural crops encompasses the largest number of smallholders, buttheir links to agribusiness are quite weak. 6. Smallholders-contraryto common perceptions-benefit considerably from increased participation in value chains, The conclusion that smallholders are among ... Vlll the major beneficiaries in commercial value chains is based on the costs and profits accruing to individual participants at each segment of the value chains and the nonmonetary benefits received by smallholders. 7. Under all yield assumptions, smallholder farmers exhibit healthy returns on their participationin these value chains. Returns to family labor are positive for all four chains (see tables). Sugarcane farmers earn exceptionally high returns to family labor, probably because of the good local growing conditions, the industry's general profitability, and the way that smallholders are organized under the outgrower scheme. Returns to family labor for cotton, tobacco, and horticulture are also very good, considering that the wage rate for rural casual labor is about US$1.20 per day and that smallholders rarelyhave the opportunity to sell their labor at the full wage rate every day of the year. IBenefitsto smallholders participatingin Zambia's cotton, sugar, and tobacco value chains Valuechain I Indicator I Benefitsat low I Benefits at I Benefitsat highI Cotton I Returnto family labor I 0.65 1.71 2.77 (US$/d) Burley Returnto family labor 0.68 2.44 3.32 tobacco (US$/d) Sugar Returnto family labor 134 183 204 (US$/d) Tomato production Watermelon production and trade Returnto family labor(US$d) 1.94 5.99 8. Zambia is a competitiveproducerof cottonand tobacco for export.Evenso, a sensitivity analysis using different exchange rates suggests that although the profitability of cotton and tobacco is generally robust, the trade advantage could evaporate if the . Zambian kwacha appreciates significantly (that is, to levels higher than K 3,500 : US$l.O). In the sugar industry, as trade rules change, profit margins may have to be reducedto improve international competitiveness. 9. Farmersdo not haveto abandonfood crop productionto participateinvalue chains for commercial crops. No trade-off exists between cash crops and food crops. Despite the enduring notion to the contrary, farmers seem well aware that maize can be grown in rotation with cotton, tobacco, and horticultural crops, depending on levels of soil moisture and rainfall, which in Zambia are usually sufficient. Most smallholders in the farming systems examined for this study practiced suchrotations. Insome instances, inputs supplied to produce commercial crops, especially fertilizer, are beneficial for subsequent food crops. Commercial crops also provide much-needed cash to invest in humanandphysical capital. ix . 10. The nonmonetary benefits that smallholders gain from value chains are critical, not only for the success of the value chains but for maintaining farmers' knowledgeand skills. Sugar producers-who are in a highly managed relationship with the monopsonist Zambia Sugar Company-receive the highest level o f nonmonetary benefits, but the cotton and tobacco industries also invest heavily in supplying extension services and inputs to the smallholders in their outgrower schemes. Dunavant, the main cotton company inZambia, has initiated a successful extension program aimed at raising farmers' yields. The cost o f managing these schemes represents 8 percent o f the costs of cotton processors and 14 percent o f the costs of tobacco processors. In contrast, smallholders growing horticultural crops for the domestic market receive no services, owing to their weak links with agribusiness. 11. Targeted public investments in developing value chains and outgrower schemes would greatly support the government's strategy for equitable growth and agricultural diversification through smallholders' greater participation in commercial agriculture. The levels o f monetary and nonmonetary benefits that smallholders receive from participating in commercial value chains indicate that Zambia has a major opportunity to move forward with this strategy. 12. Moving forward will require a number of steps by the public and private sector to further develop value chains, improve their performance, and sustain and increasethe benefitsgoingto farmers: Effective coordination among value chain participants depends on private sector initiatives, but the public sector can contribute by maintaining a transparent and stable policy environment, supporting effective regulation to promote competition, supporting better access to market and price information, and actively promoting market linkages. A significant step in this direction would be to complete and enact revisions to the Markets Act and Cotton Act. The trading environment, market transparency, and value chain coordination are all likely to improve as a result. Coordination along the tobacco chain could be improved by a careful review of the responsibilities, capacity, and funding o f the Tobacco Board and Tobacco Association, with the aim o f providing better services to the sector. Without public and private sector alliances for effective contract enforcement, outgrower schemes will not be sustainable. Weak contract enforcement i s the single most important constraint for almost all o f Zambia's commercially oriented smallholders and the value chains in which they participate. Side-selling and side- buyingthreaten the profitability o fthe entire value chains for cotton and tobacco. It is critical that all stakeholders work together to solve this problem. Any solution will require efforts from all chain participants and the public sector. The Government o f Zambia needs to ensure that commercial disputes in rural areas can be resolved effectively in a timely and affordable fashion. A better local system must be developed for sanctioning contract-breakers. It i s also essential to increase smallholders' awareness o f the consequences o f side-selling. Aside from public efforts to improve contract enforcement, cotton and tobacco firms can alter their X contracting procedures to ensure that sanctions are necessary only in rare cases. For example, firms can invest in management information systems to monitor farmers more effectively, ensure that contracts are worded to increase informed consent among all parties (especially farmers) with respect to their rights and obligations, and improve coordination among all stakeholders through the institutions that have been created for this purpose. Public-private partnerships in extension could improve the performance of value chains and increase benepts going to smallholders. Private efforts to transfer knowledge and skills to smallholders have been effective and offer lessons for future efforts to strengthenvalue chains. Considerable returns could be gained from public- private partnerships to support extension in particular value chains. For example, a one-off training for all 300,000 cotton and tobacco farmers inbetter farming practices and improved technologies would cost US$6.13 million. Real farm income benefits across the board would be US$7.2 million per year. Even if these benefits should prove transient and evaporate after five years, the internal rate of return on this extension effort would be 112 percent-which i s a significant return on any investment infarm productivity. Public investments in developing value chains will dijfer over the near and long term. Inthe near term, the public sector should focus on strengtheningvalue chains as indicated above. Inthe medium to longer term, investments in transport, energy, and telecommunications should be targeted at the rural areas with the highest potential for agricultural growth. Such investments are widely recognized as essential for generating new economic opportunities in agriculture and agribusiness, facilitating value chain development, and increasing the number of smallholders who participate invalue chains. xi 1. INTRODUCTION Agriculture and agroprocessing are important in Zambia's economy, representing more than 40 percent of gross domestic product (GDP) and contributing about 12 percent of national export earnings. Agriculture employs some 67 percent of the labor force and supplies raw materials to agricultural industries, which account for some 84 percent of manufacturing value-added inthe country. Smallholder agriculture dominates the rural economy. It provides livelihoods for the overwhelming majority of rural households. The commercialization of smallholder agriculture is an important element of Zambia's strategy to increase economic growth in an equitable mannerand diversify smallholder agriculture. For many years, the government supportedagriculture by providingfarmers with services such as extension, credit, and market outlets, but the government withdrew from these activities following the reforms of the 1990s. Since then the private sector has driven changes in agricultural production patterns, technology adoption, and the mix of enterprises, with some impressive results. Between 1990 and 1994, agricultural exports doubled from US$30 million to US$61 million; by 2006, they had reached US$300 million. Zambia's main agricultural exports are cotton, tobacco, and sugar, which together represent about two-thirdof agricultural exports. Between2000 and 2006, cotton exports grew at an average rate of 31 percent, tobacco exports grew by 29 percent, and sugar exports grew by 19 percent. Today about 300,000 smallholders are linked to agribusinessesthrough value chains that are more or less vertically integrated, depending on the crop. The majority of these smallholders participate in contract farming schemes for tobacco, cotton, and sugar; under these schemes, farmers receive inputs and market their output through the agribusiness. They also learn new farming techniques and management skills. Inreturn, agribusinesses secure raw produce for their value-adding activities. Many of the current arrangements are very similar to the relationships smallholders had with the government inthepast. Yet Zambians are concernedthat these arrangements may not benefit all participants and that the benefits may not be distributed fairly along the value chains. It is commonly asserted that smallholders do not benefit from participating in value chains because middlemen inthe value chains, such as traders and processors, obtain higher returns than farmers, which is perceived as unfair. This assertion echoes the widespread perception that earlier economic reforms benefited mainly foreigners and left Zambians increasingly poor. These concerns are important for many reasons, not the least of which is that smallholders and other stakeholders will be reluctant to participate in value chains without a clear, unbiased assessment of the expected gains. Frequent complaints about exploitation and a high level of mistrust prevent stakeholders from working together effectively to take advantage o f market opportunities. Persistent negative attitudes towards the private sector reduce the commitment to reforms that might otherwise increaseinvestmentsandraise growth rates. 1 This study therefore asks: "DOZambian smallholdersbenefitfrom greater participation in value chains?" It provides an evidence-based analysis of the benefits and constraints associated with smallholders' integration into specific commercial value chains. The study also investigates whether the benefits of participating in these value chains can be increased for smallholders and provides corresponding policy and investment recommendations. The cotton, Burley tobacco, sugar, and domestic horticulture value chains were selected for the analysis because of the numbers of smallholders involved and the contrasting linkages between small-scale farmers and agribusiness. Cotton and tobacco are the two main commercial crops grown by smallholders. Sugar provides an interesting example of extremely close collaboration between smallholders and agribusiness within a vertically integrated value chain. In contrast, domestic horticulture includes the largest number o f smallholders, but their links to agribusinessare very weak. A participatory approach was adopted for this study. In March 2007, a stakeholder workshop, hosted by the Agricultural Consultative Forum (ACF) and opened by the Ministry of Agriculture and Cooperatives (MACO), launched the study and provided a forum for discussing its design. In October 2007, ACF hosted a second workshop to verify and discuss preliminary results after the field research. The workshop made it possible to address common misperceptions of recent developments in cotton and tobacco, gain input from agribusinessesto compile full data sets on costs and margins for each value chain, and develop concrete proposals for interventions to improve the performance o f eachvalue chain. The following chapter reviews the salient features ofZambian agriculture for the crops in question and provides an introduction to each value chain. Chapter 3 describes the methodology. Results are presented in Chapters 4 and 5, followed by conclusions in Chapter 6. Commodity-specific results are containedinthe Annexes. 2. AGRICULTURE INZAMBIA Zambia is a landlocked country endowed with abundant natural resources for agriculture. Although 58 percent of the land in Zambia (75 million hectares) is classified as having medium to high potential for agriculture, only about 14 percent of arable land is cultivated. About 40 percent of cultivated area is planted to maize, the dominant crop, which accounts for about 40 percent of agricultural GDP. Maize, with cassava, accounts for about 75 percent of Zambia's crop production. Zambia has a center-periphery structure. Southern, Central, Lusaka, Eastern, and Copperbelt Provinces, with their core urban markets (Ndola, Kabwe, Lusaka, and Livingstone), are Zambia's agricultural heartland. These provinces yield about 80 percent of domestic food production and a large share of Zambia's major agricultural export crops, particularly cotton, tobacco, and sugar. These provinces are crossed by the main transport corridors and are consequently better connected and serviced by private operators (Map 1). 2 0 0 Map 1: Zambia's road network, 2003 Source: National Road FundAgency; available at: Iitt~://www.nrfa.org.zm/index.html According to the Crop Forecast Survey 2007/08, 1,145,829 smallholder households grow crops inZambia. Of these, 96 percent are classified as small-scale farmers (with holdings of 5 hectares or less); the rest are medium-scalefarmers (withholdings of 5-20 hectares). From 2000 to, 2008, the proportion of small-scale to medium-scale holdings did not change significantly. Zambia also has about 1,500 large-scalecommercial farmers. The 1.1 million smallholders are very heterogeneous. About one-quarter consist of very poor, vulnerable households suffering chronic food insecurity and requiring long-term social protection. A second group includes very poor households with the potential to achieve sustainable livelihoods; these households market small surpluses in years with reasonablerainfall. About one-third of the small-scale farmers are commercially oriented. They are generally better educated than the other smallholders, possess more labor and land per capita, allocate a larger share of labor and land to cash crop production, and generally live inthe agricultural heartland. Commercially oriented smallholders face considerable constraints, including the low productivity of their production models and factors that limit the profitability of the commodities they produce, including financing costs, poor access to credit, poor transport infrastructure, a weak regulatory environment, and exchange rate volatility. 3 Zambia experienced unprecedented exchange rate appreciation during most o f 2005 and the first half o f 2006. Duringthis period, the exchange rate for the Zambian kwacha (K) relative to the US dollar (US$)appreciated from around K 5,000 :US$l.OO at the start o f 2005 to K 2,800 :US$l.OO inApril 2006. The appreciating kwacha was widely regarded as having reduced the competitiveness o f several important export industries, including tobacco and cotton, since labor and other domestic costs still had to be paid at the same kwacha prices, but exports earned less local currency in foreign markets. The reduced value o f agricultural exports was partly offset by a reduction inthe costs o f some inputs that were imported or quoted in foreign exchange. For each particular enterprise, the overall effect o f the revaluation on competitiveness depended on the timing of input purchases and crop procurement as well as the extent to which the enterprise was dependent upon kwacha-based expenses. Many smallholders are also affected by poor access to extension services. Agricultural services are provided through MACO, donor-funded projects, nongovernmental organizations, churches, and the private sector. The quality and availability o f extension provided by M A C O has greatly declined since reforms were introduced in 1991,largely because o f budget cuts. Although MACO extension workers are based in the villages, farmers report that they do not provide any extension services to enhance production, do not serve as good models inthe community, or do not visit farmers as they did inthe past. Insome cases, extension workers ask farmers to buy fuel to visit their fields-an expense beyond the means o f most farmers. For the most part, farmers have abandoned efforts to obtain extension services from the government. Data from a survey conducted by INESOR (2005) show that about 77 percent o f farmers interviewed never had access to government extension services (Table I). 4 Table 1: Farmers' access to extension services, by service provider IService provider 1 Very I Often IRarelyI Never I NA I Government agricultural extensionofficer 5.3 7.4 10.6 76.7 Private extensionofficer 2.3 33.0 37.5 27.3 Governmentveterinaryofficer 1.3 88.0 10.7 Private veterinary officer 86.6 11.4 A general framework for smallholder commercialization is provided by the Zambia Smallholder Agriculture Commercialization Strategy (SACS) (World Bank 2006), which contends that smallholder agriculture has the potential to increase economic growth and reduce poverty in Zambia, primarily because land i s plentiful and production costs are low. Even so, the SACS emphasizes the need to be realistic about smallholders' potential to increase their commercial orientation in the short and medium term. Smallholders differ greatly in their access to the assets required for commercialization, such as land and labor, human and social capital, and physical and financial assets. Nor can most smallholders independently capture the economic opportunities associated with better access to global value chains. Stronger linkages must be established between smallholders and agribusiness if smallholders are to take advantage o f such opportunities. The SACS recognizes the role of outgrower (contract farming) schemes in commercializing smallholder agriculture but sees little scope for expanding them, because most commercially viable smallholders in high-potential agricultural areas have already joined such schemes. In the longer term, new economic opportunities and value chains are most likely to be developed through investments in transport, energy, and telecommunications targeted to rural areas with the highest potential for agricultural growth. COTTON Cotton is produced almost entirely by small-scale farmers and contributes significantly to agricultural GDP (about 20 percent) and employment. In 2005, every third smallholder household in Zambia sold seed cotton ("seed cotton" refers to the harvested cotton bolls that have not yet been ginned to separate the cotton lint from the seeds). These households produced a gross value of exports o f US$71.8 million (in 2006), which accounted for 32 percent o f the value o f Zambia's main agricultural exports. Average yields, at about 800 kilograms per hectare, are considerably below yields o f 1,200 kilograms per hectare or more achieved by smallholders elsewhere in Africa and only 20 percent o f the potential yields of the varieties used. Because the government has taken a very strong stance against genetically modified organisms, farmers do not grow Btcotton andother genetically modifiedvarieties. 5 All smallholders producing cotton are linked to the cotton value chain under outgrower arrangements. As noted, the basic principle of outgrower schemes is that a private company provides farhers with inputs (seed, chemicals) and technical support in exchange for their output (seed cotton). The company also provides marketing services, including pickingand packaging material andtransport logistics. The main cotton company in Zambia, Dunavant, initiated the YIELD program (Yield Improvement through Empowerment, Learning, and Discipline) to improve average yields (Dunavant 2005,2007). The program focuses on the "five basic nonnegotiables" o f cotton production: (i)early and proper land preparation, (ii) timely planting, (iii) correct and properly spaced plant population, (iv) keeping the crop weed free, and (v) wise pest management. The program uses proven and advanced extension and training methods to create a critical mass of smallholders who can sustainably improve cotton yields, earn higher incomes, andthus continue to profit despite declining world prices for cotton lint. A one-year pi1,oto f the YIELD program in2004/05 indicated that farmers could improve cotton yields by more than 100 percent. With such training, the majority of "traditional" fanners, who obtain seed cotton yields of slightly less than 600 kilograms per hectare, could shift into the "better" and then "committed" farmer categories and continue growing cotton because of the profits (van Gent 2007). BURLEY TOBACCO Zambia's agroecological conditions are well suited to tobacco production. Not surprisingly, Zambia has a strong tradition in tobacco exports. Tobacco was grown successfully before independence and continued to be a mainstay of agricultural exports and rural employment until the mid-1980s. Tobacco exports then declined-falling to less than US$5 million in 1995-and Zimbabwe and, to a lesser degree, Malawi became the region's dominant producers. Since the mid-1 9 9 0 ~when considerable efforts were ~ madeto promote tobacco production, Zambia has seen a significant revival of the crop. Tobacco production has grown rapidly in recent years, especially between 2001 and 2004. Figure 1 shows production trends for the two major types of tobacco grown in Zambia, Virginia and Burley.' Key informants indicated that sharp increases in the 2002/03 and 2003/04 production seasons coincided with the arrival of farmers from Zimbabwe, butproduction now seems to have stabilized. Burley tobacco i s the second largest smallholder crop inZambia; national average yields are 0.95 metric tons per hectare. As with cotton, tobacco farmers are linked to agribusiness through contract farming. The estimated number of smallholders growing Burley tobacco dropped from 20,000 in 2005/06 to around 9,000 in 2006/07. Low prices in 2005/06, resulting from the appreciating kwacha, caused substantial numbers of smallholders to abandontobacco. Production fell to 22,200 tons in2006/07 (see section 4 'The sector's rapid expansion is not fully captured inthe statistics available at the time of the study, which presentedsubstantial discrepancies. Despite uncertainties about actual production levels, it is nevertheless clear that total tobacco production peaked in2004/05. 6 for a discussion of the impacts of exchange rate movements on competitiveness). Following the production shortfall of 2006/07, prices rebounded. Total production for 2007/08 was forecast to increase slightly, to 26,850 tons. Figure 1: Tobacco production(tons of unprocessedleaf), Zambia, 1989-2008 25,000 20,000 15,000 10,000 5,000 0 1989/90 1994/95 1999100 2004105 Crop Year Source: Based on unpublisheddate fTom the Central StatisticalOffice (CSO), Zambia, 1989-2004 andZambiaLeaf2005-08 (forecast) SUGARCANE Certain areas of Zambia are ideally suited for sugarcane production, and by world standards Zambia enjoys very high sugarcane yields. An important element of sugarcane production is that yields vary over the years as the crop regenerates.Yields canbe as high as 170 tons per hectare in the initial years but drop over the longer term (10 years) to an average of 105-1 10tons per hectare. The sugar industry has been one of Zambia's most successful nontraditional export sectors. Sugar exports stood at around US$25 million annually in the mid-1990s but nearly doubled invalue over the subsequent decade to generate almost US$45.million in gross export revenues annually (about 4 percent of total merchandise exports) (Keyser and van Gent 2007). In 2009, Zambian sugar's preferential access to the European Union (EU) market will end. As price protection and volume restrictions are lifted, Zambia's pricing structure will 7 change. Although growth inZambia's sugar industry was constrained by the EU quotas, the new trade policy permits Zambia to export a maximum of 250,000 tons of refined sugar (about 95 percento f its current production) to the EUfrom 2009 until at least 2015. This change represents a significant challenge for Zambia, not least because the new policy i s expected to reduce prices by 32.5 percent compared to the old protected price, but also becauseofthevast developmentopportunity itoffers. More than 80 percent of the sugarcane produced in Zambia comes from the Zambia Sugar Company's (ZSC) estate o f 10,500 hectaresat Nakambala. Cane is also suppliedto ZSC by the Kaleya Smallholder Outgrower Scheme (KASCOL), which is managed centrally as an extension of the ZSC estate. KASCOL was formed in 1980 to produce cane for sale to ZSC by involving and developing smallholder growers.2 KASCOL occupies 2,197 hectares-a core estate of 1,130hectares and 1,067 hectares leasedto 161 smallholders. The smallholders have an average of 6.5 hectares of cane each and receive an extensiverange of services. Because the smallholders lease their land from the estate, they cannot convert it to other uses, and there is limited opportunity for additional smallholders to participate in the scheme. The participating smallholders are no more than 30 kilometers from the ZSC processingplant at Nakambala. It is not normally viable to transport raw cane beyond this distance, because it must be delivered to the plant within 48 hours after cutting. The closest alternative factory is approximately 170 kilometers away, making ZSC the only option for cane growers in the Nakambala area. The only service provided by ZSC to KASCOL is irrigation, on the condition that the sugarcane is sold to them. The sugarcane outgrower example is particularly interesting because of its historical and production-specific circumstances. KASCOL, smallholder farmers, and ZSC are in a symbiotic relationship to which there is no real alternative. It is indicative of the attractiveness of the enterprise that only 4 of the 165 original farmers inthe scheme have left; none of these departures were voluntary. DOMESTICHORTICULTURE With elevations ranging from 1,200 to 1,800 meters and a southerly latitude, Zambia has good potential to grow high-quality horticultural crops (vegetables and fruits) for the domestic and export markets. Common vegetables grown for domestic markets are tomatoes, cabbages, rape, pumpkins,green beans, potatoes, onions, garlic, okra, eggplant, green maize, carrots, chilies, and spinach. Domestic produce is often seasonal owing to the general lack of irrigation. The average aggregate vegetable yield (FAOSTAT 2007) is slightly less than 7 tons per hectare. This value seems rather conservative compared to aggregate average vegetable yields for other countries and average yields for specific vegetable crops in Zambia. KASCOL holds a 99-year lease on the core estate and outgrower land. The smallholders sublease their landfor 14years, andthe sublease cannot be transferred. To avoid dividingthe leasedland, the headofthe outgrower householdmustmakea.willidentifyingonepersonwho will continue the tenancy. 8 Using the FAOSTAT average yield for all the provinces of Zambia, it is possible to generate an indicative value for the total area planted to vegetables and the average area planted to vegetables per household. The national average vegetable area per household i s about 0.1 he~tare.~ While much is known about the successes and failures of export horticulture in Zambia, much less is known about the performance of the domestic horticultural system. Yet domestic horticulture is much larger and involves many more people than the export sector. Compared to growing vegetables for export, growing vegetables for the domestic market offers far greater scope for smallholder participation. Smallholders already account for a considerable`share of vegetable producetraded inLusaka at Soweto Market and other domestic outlets. The study team generatedbaselineproduction, marketing, and consumption figures at the provincial level from a wide range of so~rces.~ This research suggests that nationwide approximately 500,000 smallholder households produce vegetables (primarily tomatoes, cabbage, rape, and onions), of which only 170,000 sell surplus production with a value exceeding US100 per year. Only about 16 percent of all farming households are estimated to be involved in vegetable sales, compared to about 70 percent in Kenya and 25 percent inMozambique. Zambia's national production is likely to be on the order of 450,000 tons. The marketed volume inZambia is estimated at around27 percent of total production, with a total value of approximately K 72,000 million in 2004. Urban and periurbanproduction is believed to be significant, as vegetable production is concentrated around urban areas or within 50-1 00 kilometers of the main processing and storage facilities. This pattern suggests that smallholders would respondquite substantially to new demand points for vegetables ifthey could be effectively linkedto them. These links could be especially important for fruit, muchofwhich likely now goes to waste for lack ofmarkets. Inthe Livingstone branch of Shoprite, the turnover for fruits and vegetables was claimed to be K 120 million per month, with an average daily turnover of K 4 million. Shoprite's policy is to obtain at least 60 percent of the products it sells from local sources. This policy applies to grocery items as a whole and might not apply to each item separately. If this policy were applied to fruits and vegetables, then just in the Livingstone store the yearly turnover of Zambian-sourced fruits and vegetables could be K 864 million (US$216,000). Assuming that each of the 18 Shoprite branches averages the same as the Livingstone branch, the potential turnover for domestically sourced fruits and vegetables would be US$4 millionper year, Hichaambwa and Tschirley (2006) identified 10 large farms around Lusaka supplying flesh produce, including Evergreen, Faro, CJ, Lilayi, Ellensdale, and Buya Bamba. They produce mostly tomatoes, onions, and cabbage. Most of the produce is sold in Soweto Market and at supermarkets. The areas cultivated rangeffom 4 to 500 hectares. 4 Most of the vegetable statistics presented inthis study correspond to the aggregate "vegetable" category andnot to individualvegetablecrops. Clearlythis is a compositeofnumerousvegetablecrops. 9 3. APPROACHAND METHODOLOGY This study takes several approaches to determining whether smallholders benefit from participating invalue chains and whether these benefits can be increased. The potential o f agricultural value chains to benefit smallholders depends to a great extent on the competitiveness o f the chains, the kinds o f benefits that smallholders can expect, and the extent to which smallholders can participate. The analysis begins with an assessment o f the overall international and regional competitiveness o f value chains for the internationally traded commodities in the study (cotton, tobacco, and sugar). The monetary and nonmonetary benefits o fparticipating invalue chains are examined as well. Monetary benefits are assessed through a quantitative value chain analysis, which presents a snapshot o f the situation in 2007. The analysis o f nonmonetary benefits (such as agricultural inputs and services) i s forward looking and focuses on the potential for innovation and positive change in each value chain. Qualitative value chain analysis is usedto examine the dynamic linkages between chain participants. The Zambia Agriculture Spatial EquilibriumModel (ZAMSEM) was further developed to examine cross-cutting policy and investment recommendations derived from the value chain analysis. The model simulates the impact o f two types o f policy interventions: policies to enhance f& productivity and policies to strengthen value chains. This study made use o f as much information as possible. One particularly pertinent source was the World Bank study on Competitive Commercial Agriculture in Africa (CCAA); the quantitative value chain analyses o f cotton and sugar in the CCAA's "Zambia Competitiveness Report" (Keyser with van Gent 2007) were used and updated for this study. Hichaambwa and Tschirley (2006) provided background for analyzing domestic horticulture. N o prior analysis o f the Burley tobacco value chain was available; this studypresents the first one. The study team conducted six weeks o f fieldwork in Lusaka, Central, Eastern, Southern, and Copperbelt Provinces. They conducted interviews with key informants, including industry stakeholders; held focus group discussions with farmers ineach value chain; and conducted surveys o f wholesale markets.Numerous sources o f information were usedfor verification and triangulation. As mentioned, preliminary results o f the field research were shared and verified with industry stakeholders, including farmer representatives and researchers, at a workshop inLusaka. VALUE CHAIN ANALYSIS Value chains consist o f different producers and marketing companies that work within their respective businesses to pursue one or more shared end-markets. Value chains therefore span all o f the factors o f production (such as land, labor, capital, technology, and inputs) and all o f the economic activities (such as input supply, production, transformation, handling, transport, marketing, and distribution) necessary to create, sell, and deliver a product to its final place o finternational competition. 10 The main stages o f an agricultural value chain are illustrated in Figure 2. In the figure, dashed arrows flow from input supply to all other stages to show that input supply i s a crosscutting function that affects all participants, not just those at the farm level. The dashed arrow from farm production to processing shows that some farmers may deliver their crop directly to a factory, thereby fulfilling the assembly function as well. Direct delivery can occur through a vertically integrated supply chain managed by a large company, or it can occur because o f the scale of a farmer's production or the farmer's proximity to the factory. Figure 2: Stages of the value chain Source: Study team Actors along a value chain often move beyond spot market transactions to establish relations with each other through contracts, vertical integration, alliances, and other forms o f coordination. These relations can cover a multitude o f arrangements for production, processing, and logistics. The benefits that are usually sought from stronger linkages include improved access to inputs, technology, information, markets, and capital.' The strength o f relations within the value chain is determined by the trade-off between the economic incentives associated with stronger relationships and the costs o f losing independence. Chaingovernance This study maps the actors along each value chain, identifies the dynamic linkages between them, and identifies external relations that impinge on the chain's performance. This analysis is vital for assessing whether chain participants can work together effectively to take advantage o f market opportunities. The broad concept o f governance describes the quality of value chain linkages. Governance describes the extent to which interactions between chain participants are organized rather than simply random. Generally speaking, governance occurs when some 5For an exhaustivetreatment of value chain analysis and development, see World Bank (2007). 11 actors inthe chain work to parameters set by others6 Three dimensions o f governance are examined here: (i) chain organization, (ii) institutions, and (iii) legislationand regulation. Chain organization describes how chain participants are linked to each other (vertically and horizontally) and whether these links are mutually beneficial. In particular, it encompasses the ways farmers are linked to agribusiness, how information and services flow along the chain, and pricing mechanisms. Based on these indicators, chains are ranked with respect to the strength o f their inner linkages. Institutions bring different actors together along the chain. Because institutions serve as links between chain participants and outsiders (that is, government), they are neither completely internal nor external to the chain. Their effectiveness affects the capacity o f the value chain to innovate and positively influence its business environment. Legislation and regulation determine how governance external to the chain affects its performance. This aspect o f governance encompasses chain-specific acts and laws as well as general public sector interventions relevant to the development o f value chains. Costs and returns along the value chain The quantitative value chain analysis i s constructed around enterprise budgets. These budgets take into account the total cost o f all factors used in the production and marketing of each agricultural commodity, including labor, land, inputs, and capital. S0m.e general cost categories are described below. A detailed list o f costs occurring along the value chains i s given inthe Annexes. Although the results o f the quantitative value chain analysis can only approximate actual profitability, this approach is particularly useful for answering the central questions in this study, because it provides a detailed breakdown of the private costs and profits accruing to individual participants at each segment o f the chain. (Actual cost structures vary from case to case, and this approach is not designed to substitute for individual investmentplanning or cash flow analysis.) The main indicators reported on are: 0 Net profit =revenues -total cost. 0 Profit margin=net profit/sales price.7 Return to family labor = net profithumber o f days of family labor input. Gereffi, Humphrey, and Sturgeon (2005) present an analytical framework based upon the costs of coordination to identify and,explaindifferent ways in which value chains are structured to deliver effective ovemance. 'The sale price at the farm level is the farm-gate price. The sale price at the processor/trader level is the FOB/market price. 12 Inadditionto assessingprofitability for eachparticipant, the value chain approach canbe used to determine the total value o f each crop, which i s used as a measure of competitiveness. The total value o f the crop i s the total cost o f bringing the crop to the final destination (sale point: factory gate). For each exported commodity, international competitiveness i s determined by comparing the value of the crop at the sale point with a benchmark parity price (domestic FOB price), Ifthe value o f the crop i s lower than the FOB price, then the value chain may be said to be internationally competitive; if the value o fthe crop i s higherthanthe FOB price, the value chain i s not competitive. Unless noted, all prices, tax rates, parity price calculations, and other values are based on conditions that prevailed during the 2007 agricultural season. At the farm level, private costs and returns are measured per hectare and per ton; at later stages o f the value chain, values are measured per ton only. A rate of K 4,285 = US$l.OO (which prevailed in March 2007) was used to convert foreign and domestic values. This particular exchange rate is used because it prevailed when major companies imported their inputs, and the results closely reflect the situation in2007. The opportunity cost of land is normally considered the net value of production foregone when the use of landis changed from one (farming) activity to another. Alternatively, the opportunity cost o f land can be estimated at its purchase or rental value. The crop most commonly produced by Zambian smallholders i s maize, grown mainly for household food security. Zambia i s a land-abundant country, so entering into new agricultural activities (value chains) does not normally require the producer to stop growing maize. Instead, the producer expands production to new landthat i s not being usedfor economic activity. The opportunity cost o f this land was assumed to be zero, because it was not economically productive before. Since most land used in smallholder production systems i s held under customary tenure arrangements (traditional leaders allocate land to households based on their requests), there i s no land market that'would allow one to determine the appropriate purchase or rental value for unused land. For the sugar outgrower scheme, the opportunity cost o f land is also zero, because no other land uses are permitted. Family labor often accounts for a large share o f agricultural production costs, especially insmallholder systems. As family labor is not compensatedwith cash, some proxy value must be applied. A rule-of-thumb estimate was applied to the value chain calculations by charging family labor at 60 percent o f the rate for casual labor hired by smallholders (equal to US$0.75 per day). Smallholders rarely have the opportunity to sell their labor at the full rate every day o f the year, and this method is at least a clear and simple way to recognize the value o fthis input. No charge i s included for family labor inthe calculation o f private costs and returns at the farm level. Family labor does have an opportunity cost, but excluding this value from the private costheturn estimates means that crop profits can be reinterpreted as returns to family labor. The benefit o f this approach i s that different enterprises can be compared without the risk o f applying an incorrectproxy value. Depreciation and cost o f capital are estimated and included in the calculations. At the farmer level, very little capital equipment is used. The main items are sprayers for 13 pesticides. The annual per hectare (or per ton) cost o f such long-term investments used at the farm level has been estimated using a straight line linear depreciation. In addition, general charges for depreciationare included, as well as the cost o f repairs. Smallholder cotton, tobacco, and sugarcane production benefit from outgrower support in which inputs are provided on credit, and services are supplied by a processing company or other agent. Costs related to the coordination of input distribution, extension advice, other services, and overall management o f the outgrower scheme are important components o f the overall cost of the value chain and are included inthe models. Details on the farm budgets used in the value chain analysis are provided in Table 2. Yield differences reflect different landmanagement practices. It is interesting to note the low level o f own labor supplied by sugarcane farmers. It is also important to note that the services provided to smallholders in the sugar scheme include land preparation and cultivation. KASCOL i s also responsible for harvesting smallholders' cane, hiring cutters from withinthe regions for that purpose. Crop Farm-gate price Yield leveland labor input in 2007/08 Low yields Medium yields High yields Cotton US$O.26/kg Yield: 600 k o a Yield: 1,200 k o a Yield: 1,800 k o a Own labor input: Own labor input: Own labor input: 122d 124d 124d Burleytobacco US$l.5O/kg Yield: 800 k o a Yield: 1,600 k o a Yield: 2,000 k o a Own labor input: Own labor input: Own labor input: 400 d 400 d 400 d Tomatoes US$3,75/crate na Yield: 200 crates of na tomatoes from 0.25 ha Own labor input: 51 d Sugar US$40,95/kg Yield: 90 t/ha Yield: 113 t/ha Yield: 123 t/ha Own labor input: 7 d Own labor input: 7d Own labor input: 7 d SPATIAL EQUILIBRIUM MODEL The ZAMSEM programming model simulates market equilibrium conditions for seven commodities-maize, cassava, domestic horticultural products, sugar, cotton, Virginia tobacco, and Burley tobacco-in all nine provinces o f the country. ZAMSEM explicitly and endogenously models the equilibriumproduction, consumption, trade flows (internal and external), and prices. Its multimarket, regional structure makes this framework particularly well suited for analyzing marketing margins, transportation costs, and supply shifts across the country or inspecific locations. The model also simulates the impact o f two types o f policy interventions: policies to enhance farm productivity and policies to strengthen value chains. These cross-cutting 14 issues, identified in the value chain analysis, affect the entire value chain and have particular significance for smallholder incomes. Income and trade flow indicators are generated to compare simulations. Income indicators generatedby ZAMSEM includetotal nominal income inUS dollars, total real income in US dollars, total and regional real farm income in US dollars, and per capita income in Zambian kwacha. Income in real terms is obtained by dividing the nominal income by a price index, which accounts for the consumer price variations of the seven commodities included inthe model. ZAMSEM is implementedusing the Generalized Algebraic Modeling System (GAMS) programming language (Brooke et al. 1998). It is calibrated for the base year 2004, which was the most recent year for which comprehensive and reliable data were available. Furthermore, 2004 was considereda good year for crop production, without major supply or demand shocks. Supply and demand elasticities of ZAMSEM are either based on the literature or derived from similar models implemented in neighboring countries. Model specifications are available uponrequest. 4. BENEFITSGOINGTO SMALLHOLDERS Benefits received by smallholders were assessed in several ways: in terms of the competitiveness of the value chains, the nonmonetary and monetary benefits, the distribution of benefits between smallholders and others in the value chain, and income and employment along the value chain. INTERNATIONAL COMPETITIVENESS Smallholders' participation in global value chains depends to some extent on how successfully those chains compete at the international or regional level. How do Zambia's cotton, tobacco, and sugar industries measure up? As mentioned, considerable information was available to answer this question for cotton and sugar in 2006/07 (Keyser with van Gent 2007). For cotton, the analysis of competitiveness was done for both high-yielding (1,200 kilograms per hectare-the CCAA results) and very low- yielding systems (600 kilograms per hectare). Although the overall competitiveness of Zambia's cotton industry depends on the price build-up of cotton from both systems, for this analysis they could be examinedonly isolation. For tobacco, yields of 1.25 tons per hectare were assumed, and for sugarcane, medium-range yields of 116 tons per hectare were assumed. The CCAA lacked specific data on processing costs, which were obtained by the study team. Because no prior informationwas available on the competitiveness of Zambia's tobacco industry, a newanalysiswas done for this study. Table 3 provides the estimated gin-gate parity prices for Zambian lint that were used in the analysis. Tables 4, 5, and 6 compare the value of each crop with FOB prices in 2007/08 and 2006107 under three exchange rate assumptions: a low, medium, and high kwacha value (K 4,285, 4,000, and 3,500, respectively). The analysis assumes constant 15 foreign costs (denominated in US dollars) and adjusts the value o f domestic cost in U S dollars according to the exchange rate assumption. The FOB price is the factory-gate equivalent price for tobacco, cotton, and sugarcane. Different price conditions naturally prevail at each factory gate depending on transport costs. Source: Study team calculations FOB prices for sugarcane vary quite considerably in different markets, with the EU paying the highest price, followed by the Great Lakes countries, South African Customs Union (SACU), and Democratic Republic o f Congo (DRC). The assumed FOB price is based on the price o f US$386 per ton on the unprotected world market and costs for containerized road freight to Durban and sea freight to northern Europe. Whereas high transport costs to Europe account for an estimated 45 percent o f Zambia's export parity on the world market, lower freight costs are likely to be available to other regional destinations, especially compared to the costs that global competitors face in reaching these destinations. Table 4: Competitivenessof cotton, tobacco, and sugar (US$/t) at low kwacha value (K 4,285 : Source: Study team calculations Note: For yield values see text The data show that Zambia is a competitive producer of cotton and tobacco for the export market, with robust margins, although productivity increases by cotton farmers would improve overall performance. For sugar, even at the higher parity price, the total crop value is slightly higher than the FOB price, so the value chain appears uncompetitive, based on the assumptions used here. The analysis underscores that regional markets are the most competitive for Zambia. 16 Table 5: Competitivenessof cotton, tobacco, and sugar (US$/t) at medium kwacha value (K 4,000 : Source: Study team calculations Note: For yield values see text The sensitivity analysis suggests that the competitiveness of cotton and tobacco is generally robust, but any trade advantage would be eroded by a strongly appreciating kwacha. Under a strong kwacha, Burley tobacco would be uncompetitive. Although cotton would remaincompetitive ifyields were highand`the slightly higher FOB price of 2007-08 prevailed, cotton production under very low yields would no longer be competitive. Table 6: Competitiveness of cotton, tobacco, and sugar (US$/t) at high kwacha value (K 3,500 : Source: Study team calculations Note: For yield values see text In addition to seasonal changes in parity prices, it should be noted that the competitiveness o f individual enterprises depends on each firm's overhead costs, financing arrangements, the timing o f input purchases, procurement decisions, and storage capacity. Because each farm and company has its own specific cost structure, the ability o f each value chain participant to compete at world market prices depends greatly on how each farm or company organizes its own production system. NONMONETARYBENEFITS Smallholders' participation in value chains depends not only on the competitiveness of the chains themselves but on the ancillary benefits smallholders can expect from participation and on the quality o f governance inthe chains. This section summarizes the nonmonetary benefits related to each commodity and describes the governance o f each chain (its organization, institutions, and prevailing legislation and regulations). The main findings are summarized inTables 7, 8, and 9. The cotton and tobacco chains are organized very similarly (Table 7). Farmers and processors are linked via seasonal production agreements in which farmers form loose groups to receive services and inputs. Some firms use company-employed extension 17 agents to operate the schemes; other firms outsource this function to independent private operators. Low prices in 2005/06 owing to appreciation o f the kwacha caused smallholders to abandon cotton and tobacco in substantial numbers, although production andprices were expected to reboundin2007/08. The distributor scheme, pioneered by Dunavant, i s a market-based mechanism in which village-based agents ("distributors") work on commission to mobilize, recruit, and contract farmers, distribute inputs, monitor crops, recover credits, and ensure that all o f the cotton produced by the farmers they supervise is delivered to the company. Distributors are monitored by the company, which also maintains a central registry o f contract farmers, with information dn each farmer, the production area under contract, andthe inputsprovided. Table 7: Chain organization for study commodities Cotton Tobacco Sugar I Domestic horticulture Number of Fluctuates(280,000 Fluctuates(23,000 Stable (161) . , Selling: 170,000 farmers involved in2005; 180,000 in in2005; 8,000 in IIProducing: 500,000 2007) 2007) Number of 5-8 4 1 None agribusinesses linked with farmers Farmer Loosely organized Loosely organized Kaleya None organization farmer groups farmer groups Smallholder Farmers Association Seasonal 14-year cane None production supply agreement; agreement 14-year sublease Provision of inputs advice muchreducedover ---Replant Prepare land None provided by chemicals) (seed, chemicals) agribusiness --Technical Procureand Pickingand the last 2-3 seasons inputs packaging to minimum of 50 -provide Supply --Assured materials ha for some irrigationwater Transport companies -Provide grower market --extensioncrop Transport cane Provide -Provide insurance social services 18 Table 7: Chain organization for study commodities Cotton Tobacco Sugar Domestic horticulture Pricing Ginners set prices Tobacco Price is calculated Sale at farm gate or for grades, price companies set based on formula inwholesale competition for prices for grades, that includesretail markets via seed cotton, purchase at farm price, mill intermediaries. purchase at farm gate or on auction efficiency, sugar Farmersare price gate, negotiation on floor, negotiation quality, and takers and pricing grade on.grade, price division of mechanismsare competition for proceeds (DoP). rarely transparent unprocessed DoP is renegotiated tobacco every 5 years between farmers and processor Source: Study team analysis The contact farmer scheme operates like the distributor scheme, except that legal responsibility for repaying loans i s placed on farmer groups, which rely on peer pressure to ensure that the cost o f the inputs i s recovered. A contact farmer i s still neededto link the farmers with company staff, but the contact farmer i s not individually responsible for distributing inputs and recovering loans. This system is used by Cargill (Clark) Cotton, ZCMT, and Continental Ginnery. Prices inthe cotton and tobacco industries are set by the companies,'based on the market. Negotiations on grades occur between the farmer and agent at the farm gate or on the auction floor. The main difference betweenthe cotton and tobacco outgrower schemes is that tobacco farmers receive fewer services. Another difference lies in the market dynamics created by firms in the two industries. While many new entrants in the cotton industry created additional demand for seed cotton, firms in the tobacco sector have reduced their investmentinBurley. The horizontal and vertical linkages within the sugar chain are far stronger than those in the tobacco and cotton value chains. The sugarcane value chain is characterized by the symbiotic (virtually captive) relationship between the mill and contract farmers. The formal agreement betweencane growers and farmers lasts for 14 years. Growers receive a more extensive set o f services compared to those received by tobacco and cotton farmers. Cane growers have also formed an association to represent their views in price negotiations and provide basic social services. ,The domestic horticulture industry is characterized by a decentralized rural assembly system.8A recurrent theme in field interviews with vegetable producers was the poorly developed markets and volatile prices for horticultural crops. The nontransparent price discovery mechanisms characteristic o f this industry are disadvantageous for smallholders, because they carry a high risk and result inhigh per-unittransaction costs. As a result, very few farmers sell their horticultural produce themselves. Most rely on 8Attempts by agribusiness to work with smallholders have generally failed, because smallholders have been unable to deliver the required quantities consistently. Some efforts to organize farmers through outgrower arrangementsare still being pursued. 19 rural traders ("assemblers"), who travel fiom farm to farm purchasing produce, which they sell inthe city. Smallholders also frequently bringtheir tomatoes and rape to Lusaka for sale to brokers (who charge a commission) rather than directly to wholesalers. Thus links between chain participants are generally weak, occurring deal by deal, albeit with the potential to develop over time. Farmers are not organized and receive no services from agribusiness aside from brokering. Ifthe chains are ranked according to the strengthoftheir inner linkages, sugar is clearly at the top, followed by cotton, tobacco, and domestic horticulture. In the specific industries studied here, the value chains characterized by strong inner links appear more beneficial for farmers, because farmers participating inthese chains receive more services and have greater influence over prices. Cane growers-who have the closest and most regulated relationship with agribusiness (the monopsonist Zambia Sugar Company)- receive more nonmonetary benefits thanfarmers inany o f the other value chains. With respect to governance, the institutions within each value chain vary significantly (Table 8). The cotton industry has developed institutions that play a key role in shaping the industry and provide an interface for all stakeholders. In contrast, no commodity institutions exist for domestic horticulture, which does not bode well for the capacity to innovate and influence the economic environment in this industry. The Tobacco Association o f Zambia, (TAZ) is a statutory authority that employs a small number o f extension officers and operates auction and sales floors. Originally TAZ was also intendedto promote and support research. Smallholders believe that TAZ could improve all three o f these functions. A review o f the responsibilitiesand capacities o f the Tobacco Association seems warranted. Cotton Tobacco Sugar Domestic horticulture Farmer Cotton Association EasternFodya Kaleya None representation of Zambia Association; Smallholder Tobacco Farmers' . Association of Association, Zambia Mazabuka Cane I Association Growers Industry Zambia Cotton Tobacco representation Ginners Association of Association; Zambia Zambia Cotton Pre-financiers Association Research Cotton Tobacco Research None None Development Trust Station In the sugar industry, the presence of formal institutions representing the entire value chain is not as important as it is in the other industries, because the sugar industry has such a small number o f players. The Mazabuka Cane Growers Association (MCGA) is an apex organization for smallholders in ZSC's outgrower scheme and for large-scale 20 commercial growers in the Mazabuka area. The MCGA has no paid staff. MCGA and ZSC maintain ajoint committee where issues of importance are raised. Another component of governance-legislation and regulations-varies significantly in its effect on the individual value chains. The Government of Zambia has enacted general legislation that affects the chains, such as the Agricultural Marketing Act and the Agricultural Credit Act, as well as industry-specific legislation such as the Cotton and Tobacco Acts. Inthe cotton industry, the major players have organized under the Zambia Cotton Pre- financiers Association (ZACOPA) and are collaborating closely with MACO and the Cotton Association of Zambia (CAZ) to propose extensive revisions to the 2005 Cotton Act. A central provision of the Act is the creation of a Cotton Board, composed of private and public representatives, which is mandatedto regulate the production and especially the selling andpurchasingof seed cotton. The mainrevisions being addressedinclude the balance between public and private sector representation on the Cotton Board, the handling of appeals, clarification and proper use of the act's ambiguous terminology (including "cotton," "cotton seed," "seed cotton," "cotton planting seed," and "cotton lint"), removal of inconsistencies between various penalties, and adjustment of licenses from one to two years, taking into account the total cycle o f cropping, ginning, and marketing. An agreement on these revisions and their swift implementation would be in the interest ofall stakeholdersand shouldbepursued. The Tobacco Board of Zambia (TBZ) is a parastatalestablishedby Parliament to regulate the tobacco industry sufficiently.' Although TBZ employs tobacco inspectors, their numberis too low to monitor and regulatethe industry.As with the Tobacco Association, a review o f TBZ's responsibilities, capacity, and funding seems warranted. The government's Outgrower Support Fund, which operates under MACO, is intendedto support the cotton and tobacco industriesby providing funds (inthe form of partial loans) to supplement private efforts to supply inputs, provide extension services, and train farmers. The Cotton Development Trust claims that the Outgrower Support Fundhas had a vast socioeconomic impact by increasing production, encouraging greater numbers of farmers to grow cotton, and raising incomes and employment. Yet the number o f farmers who have benefitedfrom this fund is small compared to the total number of smallholder cotton farmers (approximately 2.64 percent of smallholder cotton farmers in2002103 and 7.95 percent in 2003/04). The experience in the tobacco industry has been similar. It would appear that increased funds, disbursed more transparently," would significantly increase the services (and thus the benefits) provided to smallholders in outgrower schemes. The most relevant legislation for domestic horticulture i s the Markets Act. Markets in Zambia can be managed either by the City Council or Marketeer Cooperatives, though 9The TBZ also representsZambia ina regionalorganizationwith Malawi, Mozambique, Tanzania, and Zimbabwe that is designed to share experiences, reduceprice collusion among buyers, and harmonize tobacco legislation. loKey informants did not fully understand how funds were disbursed. The study team could not fLrther investigatethis issue. 21 some observers in the Ministry of Local Government and Housing suggest that all markets legally belong to the City Council. Market management, the use o f fees paid by marketeers, and land titles have been at the center of serious disputes betweenthe City Council and Marketeer Cooperatives in recent years. Stakeholders (primarily traders but also communities) have therefore proposed an alternative model-Market Management Boards-that would enable them to manage and upgrade markets muchmore actively, as counterparts to public administrators. To create an environment that is more conducive to local trade, stakeholders are working with public officials to increase their awareness of the needto facilitate healthy commercial activity. The MarketsAct is widely perceived as a barrier to this more participatory and decentralized approach, but although its revision i s a high priority, as of this writing there i s no prospect that the legislation will be revised or that the newmanagementmodel will be instituted. Source: Study team analysis MONETARYBENEFITS To assess whether smallholders benefit economically from greater participation in value chains, the study team calculated returns at the smallholder level for the three highly commercialized value chains (cotton, tobacco, and sugar) and for domestic horticulture (Tables 10and 11). Under all yield assumptions, smallholders obtain healthy returns from participating in these value chains. Returns to family labor are positive for all four chains. The results for domestic horticulture are particularly encouraging. They suggest that further investment inthis sector could increasefarm incomesvery significantly. At medium and high yield levels, cotton and tobacco seem to be very good investments for smallholders. Even so, it is important to recall that the competitiveness analysis for cotton and tobacco suggests that although farmer's margins are sustainable now, a very strong kwacha could reduceprofitability. Returns to family labor for cotton and tobacco are also very good, considering that the wage rate for rural casual labor is about US$1.20 per day and that smallholders rarely have the opportunity to sell their labor at the full wage rate every day of the year. Sugarcane farmers earn exceptionally high returns to family labor, partly because the outgrower scheme hires a large amount of labor, but also because of the good growing conditions in Zambia and the general profitability o f the sugar industry. Yet even in the 22 sugar industry, as suggested by the competitiveness analysis, the exceptional profit margins may not be sustainable, and some downward adjustment might have to take place. Value chain Indicator Low yield Medium yield High yield Cotton Returnto family labor 0.65 1.71 2.77 (US$/d) Burley Returnto family labor 0.68 2.44 3.32 tobacco (US$/d) Sugar Returnto family labor 134 183 204 (US$/d) Indicator Tomato production Watermelon productionand trade Returnto family labor 1.94 5.99 (US$/d) It is commonly thought that there is a tradeoff between growing commercial crops and food crops and that farmers cannot grow both kinds o f crops without jeopardizing household food security. Yet there i s no agronomic evidence o f a tradeoff between growing maize and the commercial crops analyzed in this study. Among farmers, it appears to be well known that maize can be grown in rotation with cotton, tobacco, and horticultural crops, ifthere i s sufficient rainfall and soil moisture (usually there is). Infact such rotations characterized most o f the smallholders farming systems examined for this study. Farmers know that maize or any other crop planted in rotation with commercial crops benefits from the residual effects o f fertilizer applied to the commercial crops. As mentioned, the abundance of land also means that farmers do not have to sacrifice maize production (and thus food security) to grow commercial crops and participate in new value chains. Within the cotton industry and in the wider public arena, considerable discussion has erupted over what is a "fair" price to pay to farmers for cotton.'' The debate ranges from arguments that farmers should receive the market price to arguments that farmers should bepaid a minimumrate, regardless o f the market price, to ensure their food security and a reasonable standard o f living. Much o f this debate fails to consider that farm profitability depends not only on the price farmers receive but on the costs they incur-which i s why the yields obtained insmallholder farming systems are so important. Table 10 shows how an increase incotton yield (and consequently a reduction inaverage costs) moves the production system from a modest return at 600 kilograms per hectare to a highly positive return at 1,800 kilograms per hectare. Dunavant's YIELD program has shown that iffarmers make relatively minor investments inmanagement techniques, they are very likely to double their yields from 600 to 1,200 kilograms per hectare (van Gent l1Forexample,see Price (2006). 23 2007). This finding contradicts the conventional notion that smallholders are trapped in low-input, low-output systems. Inconclusion, smallholders certainly appear to benefit financially from the value chains studied here. They obtain good returns to family labor from participating in value chains for cotton, sugar, tobacco, and domestic horticulture. These activities do not preclude the production o f food crops, and they provide cash to invest inhumanand physical capital. NETINCOMEAND EMPLOYMENT DISTRIBUTION ALONG THE VALUE CHAIN Based on the costs and margins for each value chain, the value accruing at each stage along the value chain was calculated, taking into account profit margins, the costs o f hiredlabor, and the cost of own labor inthe case o f farmers. Because it reflects the often vastly different volumes handled by participants at each stage in the value chain, this analysis o f net income gives a more accurate picture o f the true distribution o f benefits thanthe analysis o fcost andmargins. A very rough estimate o f the number o f people employed in each value chain (as wage laborers and as farmers) is provided in Table 12. Earnings per person per day are also calculated, based on a very rough division o f total sector earnings by the number o f people employed inthe sector. This would include cost o fproduction and profits accruing to processors and should be interpreted only interms o fthe relative returns to each sector. Having said that, daily returns inthe cotton, tobacco, sugarcane and domestic horticulture sector look to be within the range o fthe studyteam's estimates. 24 Source: Various sources, including ZNFU and FSRP 2006 and studyteam calculations Note: Earnings based on 220 d work peryear Some of the figures are open to interpretation and differ from study team findings. For example, only 161 smallholder farmers grow sugar inthe Nakambala scheme, yet ZNFU and FSRP (2006) suggest that more than 1,692 smallholders grow sugar. Certainly this may be the case if artisanal sugarcane growers are included, but at best they would plant only a few square meters per household. Inaddition, many activities in each value chain are undertaken by subcontractors such as transporters, for whom the breakdown of transport costs, actual wages, andprofit margins is unknown. The value of wage employment differs significantly across industries, locations, andjob types, and it is quite difficult to identify a common (or even indicative) set of daily rates. For example, rural agricultural wages are around K 5,000 per day (US$1.20), but they differ by location, activity (such as harvesting, weeding, or land preparation), the opportunity cost of labor, and the period of employment (long term or seasonal). For long-term employment, benefits such as social security, leave, and other bonuses need to be taken into account. Estimates by ZNFU suggest that the true cost of unskilled labor is aroundUS$5 per day when all labor law requirementsare included. Figure 3 compares wage costs and profit margins for the smallholder cotton, Burley tobacco, and sugarcane value chains. The calculations present the total value for each industry, taking all actors into account (cost per kilogram * kilogram per person * number of persons), so they are obviously skewedtowards those value chains with more actors. Inother words, the results show the contribution of each value chain to Zambia as a whole, rather thanon aper-personbasis (for which Table 12 presents a better estimate). For the cotton value chain, Figure 3 shows the highvalue createdat the farming stage and the importance of wage labor. The cotton industry clearly provides significant income, not only to smallholders but to wage employees. In comparison, the absolute profit of processors is relatively small, given the size of the industry.Processor profit margins are estimated to be in the range of US$0.0054 per kilogram, or US$990,000 for the whole crop, which is similar to industry estimates (Dunavant in fact reports a net loss). The same observation cannot be made for the sugar and tobacco chains, where the shares of value are about equal inthe growing and processing stages. 25 Figure 3: Income distribution alongthe cotton, tobacco, and sugar value chains I 40,000,000 35,000,000 tff 9 30,000,000 v Q, 25,000,000 20,000,000 -E 3 15,000,000 10,000,000 5,000,000 0 Cotton Burley Tobacco Sugar Source: Study team calculations What is the relative contribution o f the smallholder cotton, Burley tobacco, and sugarcane value chains to Zambia (Figure 3), considering the numbers o f actors in each chain and the daily rates per person (Table 12)? The cotton value chain makes a bigger contribution to the Zambian economy than the chains for tobacco and smallholder sugarcane. This i s obvious, since the cotton industry provides employment to over 280,000 smallholders compared with only 9,000 tobacco producers and 161 sugarcane farmers. Burley tobacco and smallholder sugarcane production contribute about the same gross value to Zambia, in terms o f returns to smallholder farming as well as to wage employment, despite the vast difference inthe number o f people employed ineach value chain. 5. INCREASINGTHE BENEFITS GENERATED BY SELECTED VALUE CHAINS The analysis has shown that smallholders not only benefit from participating in value chains for cotton, tobacco, sugar, and domestic horticulture, but that these benefits could be increased by improving agricultural productivity and strengthening links along the value chains. Higher yields obtained by smallholders could potentially deliver large increases in returns to family labor. For cotton, it appears that yields can be increased solely through better farm management practices, without costly cash outlays for inputs. The governance analysis emphasizes that overall competitiveness and benefits for smallholders improve when stakeholders in value chains work more collaboratively to take advantage o f market opportunities. Strong linkages among commercial stakeholders (farmers, traders, and processors) can improve technology, infrastructure, and access to markets. Given these findings, could specific policy interventions potentially increase the benefits receivedby smallholders and improve value chain performance? To answer this question, the ZAMSEM model was usedto simulatethe response to alternative policy interventions 26 in the short and medium term. The interventions included policies to enhance farm productivity and policies to strengthen value chains. Each simulation is implemented by changing the corresponding parameters in ZAMSEM. In general, the changes applied in the simulations presented in this report are small. They reflect realistic changes in parameters based on the proposed interventions. (It i s also useful to recall that the model covers seven commodities-maize cassava, domestic horticultural products, sugar, cotton, Virginia tobacco, and Burley tobacco-and all o f Zambia's nineprovinces. POLICIES TO ENHANCE FARM PRODUCTIVITY A broad range of policies can enhance farm productivity, including policies to strengthen extension, supply inputs, support research, and provide irrigation. In ZAMSEM, the impact o f such policies i s simulated by changing the yield levels for each crop and region involved inthe simulation. ZAMSEM supply data distinguish between small- and medium-scale farms and commercial farms; for obvious reasons, the simulations presented here focused on yield changes for small- and medium-scale farmers. Two simulations were done: (i)A10percentyieldincreaseinallcropsforsmall-andmedium-scalefarmers. (ii) 30percentincreaseincottonandtobaccoyieldsforsmall- andmedium-scale A farmers. Overall, the major effect o f these policies i s to boost production, consumption, and exports (Table 13). In general, the effects recorded in these simulations are qualitatively similar, meaning that the sign of the change of the outcome variables tends to be the same. Inthe first simulation, the 10 percent yield increase raises real farm income from all crops by approximately US$15.4 million (6 percent higher than the base scenario). The increase o f total income inreal terms is substantially higher (about US$l55 million) owing to a significant decline in the price index (approximately a 3.4 percent drop from the base scenario level). In the second simulation, which concerns cotton and tobacco only, the change in real farm income i s less substantial (US$7.2 million), as one would expect, given that the intervention i s more targeted. Inthis case, the changes infarm, real, and nominal total income are equivalent, because the consumer price index (CPI) does not change. 27 Table 13: Selected income and trade indicators for policiesto enhance farm productivity Source: Study team calculations, based on ZAMSEMresults. Note: Except percentage change, all values inUS$millions. The regional impact of the two policy options differs because of differences in the geographic distribution of the crops. Table 14 shows the effect of this simulation on per capita income and aggregate f m income by province. Inthe first simulation, the effects on real farm income are larger in provinces where agriculture traditionally is dominant, especially Central, Eastern, and SouthernProvinces.These are also the provinces where a policy focused on increasing cotton and tobacco yields would have the largest impact on farm income, eventhough the effect inSouthernProvince would be modest. A policy that increases yields of basic food products (as reflected by the first simulation) would also benefit real per capita income inprovinces with larger urbanpopulations, such as Lusaka and Copperbelt, because the CPIwould decline by about 2 or 3 percent. Clearly, the benefits of these two options should be viewed inlight of the different scope, and hence costs, of each. The costs of a policy focused on cotton and tobacco yields would certainly be more contained. Such a policy might also be easier to implement, given the widespread diffusion of outgrowing schemes and associated private extension arrangementsinthese two industries. If the YIELD program for cotton, implemented by Dunavant with support from donor agencies, were extended to all cotton and tobacco smallholders, it could significantly benefitZambia by increasing farm incomes and export values. The cost of implementing a policy to raise yields of all crops i s unknown but likely to be high. The YIELD program, which is regarded as relatively cheap and cost effective, trains 45,000 farmers per year at a cost of US$920,000. More thanhalf of these farmers (28,900) doubled their cotton yields. The simulation in which cotton and tobacco yields rose by 30 percent calculated the yearly benefit to real farm income at US$7.2 million. At a cost of around US$20.44 per farmer; the YIELD program would cost US$6.13 million to implement for all 300,000 smallholder cotton and tobacco farmers. Thus a one-time training of US$6.13 million would generate real farm income benefits of US$7.2 million per year. Even in a worst- case scenario, in which the benefits are only transient and evaporate after five years, the internal rate of return would be 112 percent-a significant return on any investment in improving farm productivity. 28 Table 14: Selected regional income indicators for policies to enhance farm productivity Source: Study team calculations,basedonZAMSEM results Note: Exceptpercentagechange, all values in US$millions. POLICIES TO STRENGTHENVALUE CHAINS Policies to strengthen value chains support better coordination-and hence better efficiency-among the participants in the value chain. This approach normally requires appropriate institutional mechanisms to be set inplace. The value chains analyzed inthis study face very different challenges. The performance o f the cotton and tobacco industries?inwhich the linkages between agribusiness and smallholders are quite close, is seriously limited by ineffective enforcement of contracts. In contrast? the ties between agribusiness and smallholders growing horticultural crops for the domestic horticulture market are very weak. The performance of this industry would benefit substantially from support for marketing services and a more transparent and competitive trading environment. The following discussion first considers the specific issue o f contract enforcement and thenpresentsresults ofa simulation ofpolicies to improve coordination invalue chains. Contractenforcement Agribusinesses like Dunavant have invested heavily in outgrower schemes to build their supply base and processing capacity. The development of a smallholder sector with the technical capacity to supply a consistent production base is no easy task. In 2006/07 alone, Dunavantprovided over US$lO million ininputs on credit to its outgrowers. It is universally recognized within the industries examined here that contracts are broken on an almost daily basis. The effect o f broken contracts on loan recovery and ultimately on the financial viability o f the value chain is quite serious. For example, in side-selling cases (Box 1) farmers receive inputs, equipment, and extension on credit from one company but sell their production to a second company (either at the second company's urging or on their own initiative). The first company does not recover the cost o f the inputsprovided. Itis left with a heavy debt and no product to process. Box 1: Farmers' and firms' reasonsfor side-trading and its costs 29 Key informants indicated that there is a real danger that cotton and tobacco companies will cease operations because o f poor returns and side-marketing. Zambia Leaf has already pulled out of Burley tobacco production in Eastern Province because o f poor credit recovery, while Dunavant contends that the low returns to cotton processing made them question their investment in Zambia. If any of the major firms in the cotton or tobacco industry reduce their involvement, particularly Dunavant (with its nearly 200,000 outgrowers), the impact on Zambia's economy would be marked, From the perspective o f an agribusiness with a large outgrower base, it is virtually impossible and financially infeasible to recover all o f the credit extended to farmers. Even so, sophisticated mechanisms have been developed to make contracts self-enforcing and avoid costly disputes-market-based mechanisms, peer-pressure mechanisms, blacklists o f defaulters, and coordination among ginneries through existing and new institutions. These mechanisms significantly increase the cost o f doing business, however, and their performance is not satisfactory, as recent events have shown. It is critical for all stakeholders to solve this problem. Any solution will require efforts from all chain participants and the public sector. Industry must continue to coordinate stakeholders' efforts through the institutions that have been established for this purpose (see the previous discussion o f chain governance). Zambia's experience with outgrowers has contributed to recommendations on best practices for outgrower schemes (World 30 Bank 2006). The recommendation to register growers andmaintain records is particularly relevant for enforcing contracts: Inorder to ensure goodandtransparent managementpracticesofout-groweroperationsit is imperative to develop Management Information Systems which would include information regarding personal details of participating smallholders, location, credit ' provision, and previous crop history. Computer programs could be designed to facilitate monitoring the performanceof individual smallholder farmers.... World Bank (2006:68) It is equally important to reach out to farmers to increase their awareness o fthe problem. They are trapped in the prisoner's dilemma, in which individual profit maximization through side-sellingleads to a suboptimal outcome for everyone. In addition, several mechanisms could be incorporated into any contracting process to strengthen informed consent and reduce the risk o f default without interfering with the terms and conditions o f the contract: To increase farmers' understanding o f contract terms and conditions, contracts should not only be inEnglish (as is currently the case) but inthe local language, withthe Englishversion beinglegally binding. Contracts should be induplicate. Smallholders can retain a copy for their records andcompanies canrefute claims that farmers didnot know what was stated inthe contract. Contracts should have a clause stipulating that insigningthe contract each party attests that it has received a copy o fthe contract. For farmers to understand the returns they are likely to achieve under the contract, contracts should specify a particular price-by-grade matrix that will be applied on delivery o fthe product. Ifthe end-of-season price cannot be specified inadvance, thenthe contract should statehowthat price will be determined andprovide the likely worst- and best-case scenarios. Contracts should specify the penalties incurred for breaking or partially breaking the agreement. Finally, to facilitate cooperation betweenvalue chain participants, the public sector must provide an enabling environment, characterized by an effective, formal contract enforcement system that involves credible sanctions for breaking contracts. Several mechanisms can be used, but the design parameters should be local and cost effective. Traditional authorities could play a role and should be involved inthe design. Value chain coordination Aside from contract enforcement, what other strategies might strengthen the value chains inthe study? Better coordination among value chain participants is contingent on private sector initiatives but can be facilitated by a transparent, stable public policy environment, clear regulation to promote competition, public support to increase access to market and price information, and promotion o f market linkages (for example, through trade fairs). 31 Two sets o f simulations were done to assess the effect of policies to strengthen value chains. The first simulation involves a decline in domestic marketing margins for all crops. The second simulation examines the effect o f improved coordination within value chains, which can result in modest and simultaneous changes in three parameters (marketing margins, yields, and transportation costs). The specific changes for each simulation are: (i)A 20 percent decline indomestic marketing margins, for all crops across the country. (ii) 10percentdeclineindomesticmarketingmargins, combinedwitha5percent A increase in yields and a 5 percent decline in transportation costs, for all crops across the country. Results o fthe simulations are presented inTables 15 and 16. Table 15: Selected income and trade indicators for policiesto strengthenvalue chains I Intra- Inter- Simulation changes income income income value I trade trade IBase scenario value 4,524.7 4,524.7 246.8 I II 121.8 380.6 ~ _ _ ~ ~ For all crops, dome& II 7.4 83.4 I I I 1 I ~ marketingmargins I 0.2% 1.8% 5.1% 2.6% 0.3% -0.9% policies marketingmargins decline lo%, yields increase 5%, transport 0.2% 2.5% 6.2% 15.1% 0.6% -2.2% costs decline5% Source: Studyteam calculations basedon ZAMSEMresults. Note: Except for percentagechange, all values inUS$ millions Table 16: Selected regional income indicators for policiesto strengthenvalue chains policies marketingmargins decline IO%, yields increase5%, transport costsdecline 5% 7.2% 4.7% 7.8% 3.1% 4% 3.9% 3.5% 7.5% 3.3% 32 These policies, which are expected to reduce marketing margins at various levels o f the marketing chain, benefit farmers and consumers alike. Producer prices increase, in most cases, and consumer prices decline or remain stable; these effects in turn stimulate production, consumption, and exports. The changes inincome levels are positive for both total income and farm income, and the regional effect i s caused by geographical patterns o f crop production. Under the first policy scenario, at the national level farm income increases by approximately US$12.5 million. Total income in real terms grows by US$83.4 million. Under the second policy scenario, farm income increases by approximately US$l5.3 million and total income inreal terms grows by U S $ l l 4 million. The largest impact is on maize production and exports. This result may appear surprising, considering that maize has a relatively loosely structured value chain, similar to that o f domestic vegetables and cassava. One might expect the highest export response to be seen in value chains that are relatively better organized and governed, which would be better positioned to capture the benefits o f improved chain efficiencies. However, there are diminishing marginal returns to improving efficiency, and the cotton and tobacco chains are already arguably more efficient (and organized) than the maize and domestic horticulture chains-as seen inthe relatively high effect of both simulations on real farm income inLusaka and Copperbelt, the two most urbanprovinces. This result is explained by the importance o f the vegetable industry in those provinces and the large effect o f increased marketing efficiency on this subsector. Given the large potential benefits from improving market linkages and increasing marketingefficiency for smallholders raising horticultural crops for the domestic market, a vital first step would be to develop a strategy to improve market lirikages and marketing efficiency. The governance analysis in this study emphasized that revising the Markets Act i s an important means o f improving the trade environment for local markets, increasing markettransparency, and facilitating value chain coordination. 6. CONCLUSIONSAND RECOMMENDATIONS Under yield assumptions rangingfrom low to high, Zambiansmallholders obtain healthy returns from participating in four commercial value chains. They have significant potential to achieve higher returns by increasing farm productivity. Returns to family labor are positive for all four value chains. The results for domestic horticulture are especially encouraging, because they suggest that investment in this industry would contribute significantly to raising farm incomes. Profit margins and competitiveness in the smallholder cotton and tobacco industries are fairly robust but would be reduced by a stronger kwacha (that is, at levels higher than K 3,500 : US$l.O). Sugarcane farmers benefit fiom very high profit margins and exceptionally high returns to family labor, largely because o f Zambia's good growing conditions, the industry's general profitability, and how the outgrower scheme is 33 organized. Even so, some downward adjustment might have to take place to increase the industry's international competitiveness. The nonmonetary benefits that smallholders receive byparticipating invalue chains, such as inputs and extension services, play an important role in transferring agricultural knowledge in Zambia. The quality and availability o f public extension services were greatly curtailed following the 1991 reforms and subsequent budget cuts. Ta compensate, the cotton and tobacco industries have invested heavily in supplying extension services and inputs to producers. Managing outgrower schemes accounts for 8 percent o f cotton processors' costs and 14 percent o f tobacco processors' costs. In contrast, smallholders who grow horticultural crops for the domestic market receive no services whatsoever, because they are only weakly linked to agribusiness. Sugarcane growers receive the highest nonmonetary benefits because o f their symbiotic relationship with the monopsonist ZSC. These findings suggest that targeted investments by the public sector to support value chain development and outgrower schemes could greatly support the government's strategy for equitable growth and agricultural diversification through growth in commercial agriculture. Based on the findings and the level of monetary and nonmonetary benefits obtained by smallholders, this study concludes that smallholders do benefit from participating in these value chains. The favorable returns from these value chains indicate that Zambia has an important opportunity to move forward with an agenda to diversify agricultural production systems. The public sector can take steps to promote value chain development and, in particular, sustain and increase the benefits to smallholders who participate in value chains. In the short term, the focus should be on strengthening value chain linkages. Inthe medium to longer term, investments intransport, energy, and telecommunications inrural areas with the highest potential for agricultural growth will be essential for generating new economic opportunities, facilitating value chain development, and increasing the number o f smallholder participants. In the near term, two kinds of policies can strengthen value chain linkages: policies to ensure that contracts are enforced and policies that improve coordination among value chainparticipants andthus increase the chain's efficiency. Weak contract enforcement is endemic inthe industries studied here. The profitability o f the cotton and tobacco value chains i s seriously undermined by routine side-selling and side-buying. Contract enforcement systems develop gradually as an economy develops, and when an economy i s small, informal means suffice to resolve conflicts (World Bank 2002). As Zambia's economic activity becomes increasingly complex and commerce expands, the demand for formal intervention has grown. The government should meet this demand by ensuring that commercial disputes in rural areas can be resolved effectively, in a timely and affordable fashion. In this respect, important steps towards improving the business climate include developing an improved local system for sanctioning contract-breaking and building farmers' awareness o f the consequences, especially the costs, o f side-selling. 34 Inaddition to public efforts to improve contract enforcement inrural areas, the tobacco and cotton industries can take several actions to ensure that sanctions for contract violations are applied only rarely. First, firms can invest in information management systems to improve their monitoring o f farmers. Second, they can adopt better contracting practices, such as informed consent and the use o f local languages, to reduce misunderstandings about the mutual responsibilities specified in the contract. Finally, coordination among all stakeholders can be improved through the institutions established for this purpose. Although improving the coordination among value chain participants i s contingent on private sector initiatives, it can be facilitated by the public sector inseveral ways: through a transparent and stable policy environment; clear regulations to promote competition; public support for better access to market and price information; and active promotion o f market linkages. Revisions of the Market and Cotton Acts are significant steps towards these goals. Inthe tobacco chain inparticular, coordination could be further improved by a thorough review o fthe responsibilities, capacity, and funding o f the Tobacco Board and Tobacco Association, to enable themto provide better services to the industry. Some financial assistance has already been provided to support value chain coordination through MACO's outgrower fund, which has had some notable achievements despite its limited funding. Value chain coordination could probably be improved by increasing these funds and disbursing them in a more transparent manner to foster new partnerships betweensmallholders and agribusiness. Finally, it would appear that combined public and private support for knowledge transfer could offer very significant benefits to smallholders and value chains. Private outgrower schemes have proven very successful in transferring knowledge to farmers, with implications for organizing other extension efforts. A one-time investment in training all 300,000 cotton and tobacco farmers to use better farming practices and improved technologies would cost US$6.13 million and generate real farm income benefits o f US$7.2 millionper year. Evenifthese benefits last for only five years, the internal rate o f return to this training would be 112 percent, a significant return on any investment in improving farm productivity. 35 REFERENCES Brooke, A., D. Kendrick, A. Meeraus, and R. Raman. 1998. GAMS: A User's Guide. Washington, DC: GAMS DevelopmentCorporation. Dunavant. 2005. "Cotton Training Guide for Area Coordinators to Support Training for the Expanded YIELD Programme," DunavantZambiaLtd., Lusaka. .2007. "YIELDKmiA Programme2005-2007: Sustainable and ImprovedFarmer CottonYields," DunavantZambia Ltd., Lusaka. Estur, G. 2006. "Quality andpricing of African uplandcottons." Presentationto World Bank, Washington, DC. FAOSTAT. 2007. FA0 Statistical Database. Rome: Food and Agriculture Organization of the United Nations. GDS (Global Development Solutions). 2006. "Value Chain Analysis for the Cotton-to-Garment Sector in Zambia." Report for the Ministry of Tourism, Environment, and Natural Resources and the Ministry of Industry,Trade, and Commerce, GDS, Lusaka. Gerefi, G., J. Humphrey, and T. Sturgeon. 2005. "The Governance of Global Value Chains." Review of International Political Economy 12(1): 78-104. Hichaambwa, M., and D. Tschirley. 2006. "Zambia Horticultural Rapid Appraisal: Understanding the Domestic Value Chains of Fresh Fruits and Vegetables." Working Paper No. 17. Food Security ResearchProject MarketAccess, Trade, and EnablingPolicies(MATEP) Program, Lusaka. INESOR(Institute of Economic and SocialResearch). 2005. "Value ChainAnalysis for SelectedCrops and Access to Market Information for Increased Market Share." Institute of Economic and Social Research and University of Zambia for the Business Experience Exchange Programme (BEEP), Lusaka. Keyser, J.C., with R. van Gent. 2007. "Zambia Competitiveness Report." Washington, DC: World Bank, Environmental, Rural, and SocialDevelopmentUnit. Nsiku, N., and W. Botha. 2007. Tobacco Revenue Management: Malawi Case Study. Manitoba: InternationalInstitutefor SustainableDevelopment. Price, A. 2006. "Cotton Formula Price Model: Presentation to the Ministry of Agriculture and Cooperatives." Smallholder Enterprise and Marketing Programmme, Agribusiness Development Component (SHEW-ABC), Lusaka. Tschirley, D., and S. Kabwe. 2007. "Multi-country Review ofthe Impactof Cotton Sector Reformin Sub- Saharan Afiica: Zambia Country Study." World Bank, Lusaka. van Gent, R. 2007. "Socio-Economic Impact o f the `Cotton made in Africa' Project in Zambia." Agridev Consult for DeutscheInvestitions-undEntwicklungsgesellschaft MBH, Lusaka. World Bank. 2002. Building Institutionsfor Markets. World DevelopmentReport 2002. Washington, DC: World Bank . 2006. Zambia - Smallholder Agricultural Commercialisation Strategy. Report NO.36573-ZM. Washington, DC: World Bank,Environment, Rural, and Social Development Unit. . 2007. Using Value Chain Approaches in Agribusiness and Agriculture in Sub-Saharan Afiica. Washington, DC: World Bank. ZANU and FSRP (Zambia National Farmers' Union and the Food Security Research Project. 2006. "Potential Impact of the Kwacha Appreciation and ProDosedTax Provisions of the 2006 Budget Act on Zambian Agriculture." Zambia National Farmers' Union and the Food Security Research Project, Lusaka. 36 ANNEX A: THE COTTONVALUE CHAIN GOVERNANCE Organization A.1 Cotton is grown and harvested by farmers, who then transport it to a collection point where it is bulked. From there it is sent to a district collection point and then to a ginnery for processing. The structure of the industryand the main players are depicted in a marketingchain format inFigureA.1. A.2 Eight ginning companies currently operate in Zambia (Table A.I), a number of them recent entrants. Ginners engage in price competition for seed cotton. Prices paid to farmers are based on international market prices, with deductions for all processing and marketing costs. Pricing factors include margins and return on capital investment, as well as returns to shareholders. Dunavant provides a preplanting price, which is the minimum guaranteed price. Cargill typically follows Dunavant's pricing.UsuallyDunavant acts as a price-setter (Stackelberg Leader), and the other firms set slightly higher prices, once Dunavant's price is announced. Attempts have been made to introduce a pricing formula as a means to develop transparency in the industry (Estur 2006; Price 2006), but difficulties in achievinga consensus on industry costs andreturns havehamperedthese activities. A.3 The entrance of many new buyers in recent years shows that Zambian cotton is attractive for foreign investors. It also suggests that competition among ginneries for seed cotton will increase, which should raise prices paid to farmers. On the other hand, the cotton industry in Zambia has a long history of credit default by smallholders, and side-selling and -buying are on the riseagain. Dunavant reports that creditrecoveries have fallen below 70 percent. A.4 The dysfunctional contract enforcement system in rural areas and the need to reduce transaction costs has caused the ginning companies to adopt different strategies to organize farmers in groups and recover their investments. Dunavant's distributor scheme involves appointingvillage-based agents ("distributors") who work on commission to recruit and contract farmers, distribute inputs, monitor crops, recover credits, and ensure that all of the cotton produced by the farmers under their responsibilityis delivered to the company. Distributorsare monitored by company staff. The company maintains a central registry of all contract farmers listingtheir personaldetails, the area contracted, and inputs provided. AS The contact farmer scheme is similar to the distributor scheme but provides credit to groups of farmers, who are jointly responsible for repaying the debt. The contact famer is the liaison between farmers and the company but is not responsible for disbursing inputs or recovering credits. This system has been adopted by Cargill (Clark) Cotton, ZCMT, and ContinentalGinnery. 37 marketing services , I I Cotton lint to Zambian South Africa (SA) spinner -weavers manufacturers and others I I I' I I Zambian oil refiners and livestock producers * Processed by Zambian Processed by Malawi, China, spinner-weavers spinner -weavers EU,and other international spinner-weavers I SA garment Zambian garment Other international garment manufacturers manufacturers manufacturers 1 SA domestic and Zambian garment international garment export markets markets for China and other markets (e.g., USA) international manufacturers FigureA.l: Structure of the cotton industryin Zambia Source: GDS 2006 Note: Excludes yarn exports from Zambia. Includes large-scale commercial farmers producing seed cotton under irrigation, but although this may have been the case previously, all cotton currently produced in Zambia i s grown by smallholders. AGOA = Afiican Growth and Opportunity Act. 38 Source: TschirleyandKabwe 2007 Note: na = notavailable Institutions A.6 The CAZ, a semiautonomous association formed in 2005, is affiliated with the ZNFU. It provides an organized body for farmers to work with the Zambia Cotton Ginners' Association (ZGCA) on key issuesaffectingsmallholders. Previouslystakeholderswere representedunder the Oil Seeds Committee of the ZNFU, but in view of the importance of cotton in Zambia, responsibilitywas devolved to a separate Cotton Committee, which evolved into the CAZ. The CAZ still is a very young organizationand is fully dependent on donor support (Dutch, Swedish, Smallholder Enterprise and MarketingProgramme-Agribusiness Development Component, and Cordaid). Many smallholder cottonfarmers are not yet aware of its existence. A.7 All ginners in Zambia belong to the ZCGA. The ZCGA consists of its members (the ginners) and representatives from ZNFU, MACO, the Cotton Development Trust (CDT), andthe Textile Producers Association. Its main functions are to liaise between outgrower schemes to minimize side-selling, to develop strategies to expand cotton production (area and yields), to assess marketpricetrends, andto liaise on prices, especially for localspinners. A.8 The recently created (March2007) Zambia CottonOutgrower Pre-financiersAssociation (ZACOPA) safeguards the interests of established ginners that pre-finance inputs in their outgrower schemes andattempts to prevent side-sellingand side-buying. A.9 The CDT, formed in November 1999 by MACO, is a semiautonomous, grant-dependent organization, funded mainly by MACO through its Soil Crop Research Branch (SCRB). The CDT aims to develop agriculture in Zambia by strengthening the cotton subsector, mainly through research and development, while ensuring that pure cotton seed is available for farmers through a cotton maintenance breeding program, which produces breeder and prebasic seed for multiplicationby the ginneries or contract farmers. Legislatiodregulation A.10 The major players in the cotton sector, organized under ZACOPA, have worked with MACO and CAZ to propose extensive revisions to the 2005 Cotton Act. The main revisions include the balance between public and private sector representation on the Cotton Board, the handlingof appeals, clarification and proper use of terminology relatedto cottonproductionand marketing, the removal of inconsistencies between various penalties, and making licenses available for two years rather than one, to encompassthe entire cropping, ginning, and marketing 39 cycle. Agreement on and swift implementation of revisions would be in the interest of all stakeholders. A.11' The Agricultural Credit Act regulates credit default, but given the high prevalence of default in the industry, better local mechanisms for contract enforcement are needed. For example, underthe AgriculturalCreditAct, the penaltyfor defaultingon a contract is the value of the inputs provided, when the value of the crop secured against the loan would be more appropriate. A.12 The governmentsupports the cotton industrythrough MACO's Outgrower Support Fund, which offers funds (partial loans) to supplement the private sector's efforts to supply inputs, extension, and farmer training.Althoughthe CDT found that the funds increasedproduction, the number of cotton growers, incomes, and employment, the program was able to reach only 2.64 percent of cotton farmers in 2002/03 and 7.95 percent in 2003/04. Some observers maintainthat the criteria for distributing the funds are unclear. The 2004/05 allocations to the two largest companies, Dunavant and Clark, financed only 1-2 percent of the area they had covered in the previous year, whereas allocations to smaller companies were substantially largerrelativeto their previous area. Overall, an increase in funding and a more transparent disbursementprocessseem warranted. COSTSAND RETURNS A.13 The value chain for cotton is typical: cottonis grown under contract, picked, transported to a ginnery for processing, and then shipped to Durban in South Africa for export. There are three main cotton farming systems, characterized by different levels of yields and management: low-yielding (600 kilograms per hectare), medium-yielding(1,200 kilograms per hectare), and high-yielding(1,800 kilogramsper hectares). At the farm level A.14 At all yield levels, cotton productionunder an outgrower system is profitable. Farmers earn from US$79to US$343 per hectare (Table A.2). Profit margins range from 50 percent for low-yieldingsystems, 68 percent for medium-yieldingsystems, and 73 percent for high-yielding systems. Farmers who attain medium yields would have a profit margin of 73 percent if they engaged in side-selling(assumingthat the side-buying price is only K 20 per kilogramabove the outgrower price). Naturally, the profit rises ifthe side-buyer pays more. In2002, the markup was between K 100 and 130 per kilogram, depending on the grade, showing that such large differentialsdo occur. A.15 Figure A.2 shows the costs and returns at the farm level for medium yield levels produced by farmers in an outgrower scheme. Chemicals comprise the largest component of the farm-gate price (23 percent), followed by hired labor (7 percent), transport, and seed (both 1 percent). Balingis paid by the outgrower, so only the economic cost of actuallytransportingthe bales to the depot is includedin the farm budget. Under low and highyields, the compositionof costs does not change significantly,except that ordinaryfarmers do nothire labor. At the processinglevel A.16 In assessing costs and returns for cotton processing, it is assumed that the chain concentrates on ginning seed cotton to separate the lint from the seed (which is sold for animal 40 feed). Figure A.3 shows the breakdown of costs for processing and distributing cotton. At 1 percent, the profit for this activity is only marginal for ginners inZambia.'' A.17 Clearly the purchase of raw material is the highest cost at this stage of the value chain. Transport costs are also significant, constituting 29 percent of the FOB price. It is interesting to note that the cost of organizing the outgrower schemes (8 percent) is higher than the cost of the core activity at this stage, the actual processingcost (7 percent). Low yield Medium yield High yield Returnto family labor 0.65 1.71 2.77 (US$/d) Net profit (US$/ha) 79 212 343 Profit margin(%) 50 68 73 -fertilizer, Seed, 1.120/ 0.00% f \ Chemicals,22.69% / Labor,6.87% Profit 67. Source: Studyteam calculations Note: Foryield values see Table 2 Figure A.2: Farm-level costs and returns for cotton farmers obtaining medium yields in an outgrowerscheme `*Indeed, ginners such as Dunavantclaimthat in2006/07 they posteda loss. 41 Processormargin Comoanvoverheads 1 Transportto FI 19% ' 'urchase of crop 44% Packi 2% Processing 7% Transport Depotto - ginnery Cost of outgrower 10% scheme 8% Figure A.3: Cost of processingand distributingcotton from outgrower schemes Source: Studyteam calculations A.18 Generally, it costs more to operate contact farmer outgrower schemes than distributor schemes, because additional extension and field staff are required to organize procurement. These additional procurement costs are significant when averaged over the entire harvest procured by the companies and comprise a substantial financial burden.Interviewswith Continental Ginneries revealed that in 2006/07 Continental abandoned the contact farmer scheme for the distributor schemeto reducethe cost of its outgrower support. Side-buying is more profitable than outgrower schemes because companies avoid the costs of managing farmers and avoid paying district levies at checkpoints by usingside-roads. A.19 Whether contract farmers obtain high or low yields has no influence on processing costs, since these costs are calculated per kilogram and thus do not vary with yield levels. Given the significant overcapacity o f ginners, and the fact that most of their costs such as labor are rel.atively fixed, reasonable changes in yields are not expected to have much of an effect on processing costs. Total value chain A.20 Table A.3 shows the values o f all cost items for the whole cotton value chain as percentageof total value chain cost. The total transport cost accounts for almost 30% o f overall cost. Interestinglythe cost o f managing the outgrower scheme is higher than the actual processing cost. Note that farmer margins are not returns to family labor, as the opportunity cost of labor i s fully includedinthis calculation. Farmer margins could therefore rather be interpretedas net returns to family capital. 42 Share of total costs Cost item (YO) Landpreparation I IFuzzy seed 0.5 Note: For yield values see Table 2. Family labor valued at US$0.75 per day 43 ANNEX B: THE BURLEY TOBACCO VALUE CHAIN GOVERNANCE Organization B.1 Most smallholder tobacco is Burley tobacco, grown in Eastern Province under contract with four companies: Alliance One (Stancom/Dimon), Zambia LeafTobacco Company (ZLTC), Africa Leaf (Zambia), and Tombwe Processing Limited. Tombwe is the only tobacco processor operating in Zambia. The other firms only purchase tobacco and either ship the unprocessedleaf to Malawi or Zimbabwe or process small amounts through the Tombwe facility for a fixed charge (currently US$0.30 per kilogram of green leaf). B.2 Companies cannot purchasetobacco without a license from the government. To obtain a license, the buyer must sponsor a minimumtobacco production area (currently 50 hectares in a prescribed area). Sponsoring involves providing inputs on credit to smallholders under an outgrower arrangement. Companies then use the purchasing license to procure well over the quantity o ftobacco produced inthe sponsored area (Table B.1). Number of Number of Estimated Tobacco permanent smallholders Area production purchased Company staff sponsored sponsored(ha) (4)' 2006/07(kg) Alliance One 140 8,000 3,600 3,600,000 3,200,000 Afiica Leaf 6 1,000 350 350,000 700,000 Zambia Leaf 5 28 54 54,000 800,000 B.3 Some of the tobacco growers in Eastern Province operate under tenant farmer schemes. Alliance One leases landI3 from TBZ to operate its Zemba Tobacco Scheme, in which tenant farmers work 2 hectares on average. The array of crops they can grow is restricted to prevent pests and diseases from moving to tobacco from other crops, especially cotton. B.4 Tobacco outgrowers-whether they are tenant farmers or work their own ,land-are organized indifferent ways. For example, farmers contracted by Alliance One are required tojoin a farmer group with collective responsibility for repaying loans. Tombwe employs scheme operators who use their own finds to run the outgrower scheme and collect the harvest. The scheme operator receives a commission from Tombwe, which also covers the costs of transporting the harvested tobacco to Lusaka. Scheme operators protect themselves against defaulting farmers by organizing the farmers into groups (for example, of 10 farmers). The scheme operator may withhold part of a group's payment for the tobacco crop ifsome of the farmers inthat group have failed to repay their loans. B.5 Normally nearly all tobacco grown near the Malawian border is sold over Zambian buying floors and then shipped to Lilongwe. In Malawi, three firms control most tobacco procurement (versus 16 in Zimbabwe): Limbe Leaf, Dimon, and Standard Commercial-Alliance 13 Originally ownedby the NationalTobacco Company (NATCO), TBZ's forerunner. 44 One, These three firms control nearly 95 percent of the buyer market and have maintainedtheir market shares over time with only minorvariations (Nsiku andBotha2007). B.6 Farm-gate prices for tobacco vary depending on the type of tobacco and how it is purchased. All tobacco is sold over a buyingfloor, either by growers, their representatives, or an independent agent who purchases the crop directly from the farmer (usually with an immediate cash payment) and then grades and resells it over the floor, acting for all intentsand purposes as the licensedgrower. Procurementchannels for tobacco are outlinedinFigureB.1. Sponsored Sponsored Grower (Tobacco Grower Unsponsored Company) (Farmer Grower Association) v 1 1 v Independent Independent SpOnMted Company Agent Managing Tobacco Farmer Agent at Primary Sponsored b Company 4- Tobam Association (Spot Rate) * Tobacco Assembly Shed 5::::;- Assembly Shed Market Pre-SaleWeighing I Side-Sellin Buying Floor Pre-SaleAgreement to Sell 1 Exclusivelyto Buyer I I _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 1 I I I Farmer Representation Arbitration Representation II Tobacco I Organize Paymentto Farmers I Company I i_----_----------------- Figure B.l: Tobacco procurement channels,Zambia Source: Study team analysis B.7 The sales floor classification process assures farmers that their product will be graded fairly, especially since an independent arbiter is available if disputes arise. One drawback is that payment is not immediate, as it is when farmers make direct (spot) sales to buyers at the farm gate or local collection sheds. Inthis primary market, prices are typically 70 percent of the floor price; the discount covers transportation costs, floor fees and levies, the opportunity cost of capital, and risk. Tobacco is purchased from farmers from April to June/July but not sold until AugustdSeptember. The final price for processed tobacco is not known when the green leaf is purchased, makingtobacco buyinga highly speculative, high-riskactivity. B.8 The auction and sales floors are operated by T U , the statutory authority for tobacco. Smallholder Burleytobacco farmers inEasternProvincecontendthat the sizeable reductioninthe 45 number o f auction floors (from 96 to only 11) has made it more difficult for them to market their produce. B.9 Prices for different grades o f tobacco are set by the tobacco companies at the beginning o f the buying season. Before the bales reach the floor, buyers and sellers have already agreed to enter the selling processon an exclusive basis, so the sale is really a negotiation over the grade o f the leafbeing sold. B.10 Side-marketing and informal trade are significant in Eastern Province. Chipata is close to Malawi and Mozambique, so traders easily enter Zambia to source sponsored tobacco. Alliance One estimated that it lost approximately 500,000 kilograms of tobacco to side-marketing in 2006/07, and significantly reduced its investment in2007/08 (Table B.2) Source: Study team interviews Institutions B.11 As inthe cotton industry, most smallholder tobacco growers participate inthe value chain through loosely organized interest groups. Although most farmers have a commercial interest in growing tobacco with one company or another, as a group their interests do not extend beyond this point. Farmers' interests may shift from year to year. For example, a farmer may decide not to grow tobacco but another cash or food crop, or to grow tobacco with another company. B.12 Unlike the cotton industry, in the tobacco industry very few organizations link tobacco farmers to the value chain. The Central Growers Association for Virginia tobacco is quite successful, in contrast to the Eastern Fodya Association for Burley tobacco growers, whose constituent farmers expressedserious discontent. B.13 TAZ was formed in 1964 as the Virginia Tobacco Association of Zambia (VTAZ). Among its objectives were to promote and support research and training to ensure the industry's continued development and expansion. VTAZ was also responsible for linkages with training and research organizations, including the Tobacco Research Board (TRB) and the Blackfordby Agricultural Institute o f Zimbabwe. TAZ currently employs a small number of extension officers, but smallholder farmers consider their number inadequate. B.14 The parastatal TBZ, established by Parliament to regulate the tobacco industry, participates in a regional body with Malawi, Mozambique, Tanzania, and Zimbabwe to share experiences, reduce price collusion by buyers, and harmonize tobacco legislation. Like TAZ, it is insufficiently staffed, employing too few inspectors to monitor and regulate the industry adequately. 46 Legislatiodregulation B.15 The licensing system for tobacco buyers has already been described. Some support for growers is available from MACO's Outgrower Support Fund, but as with cotton, the impact has been limited. To stop the surge of credit default in the industry, local enforcement of the . Agricultural Credit Act must be strengthened (for example, by increasing the penalty for defaulters from the value ofthe inputs providedto the value of the cropsecuredagainstthe loan). COSTAND RETURNS B.16 Based on the fieldwork and secondary sources, a Value Chain Analysis Tool was constructed in Excel for Zambia's smallholder tobacco industry. Results are available for: (1) smallholder flue-curedVirginia, transported to Tombwefor processingand shippedto Durbanfor export; (2) smallholder flue-curedVirginia, transported to Harare for processing and shipped to the port for export; and (3) smallholder Burley, transported to Lilongwe for processing and shipped to the port for export. Here only the results for Burley production are presented, as it is the most importanttype oftobacco for smallholders. Farm level B.17 Burley production is profitable at all yield levels (Table B.3). Net profits range from US$274 to US$1,329 per hectare. Returnsto family labor are quite high at mediumto highyield levels (profit margins reach 61 percent for high yields). If smallholder Burley producers can achieve adequate yields and continue to receive outgrower services, Burley will remain an attractive option. Overheads and administration (15.3 percent) and fertilizer (17 percent) are smallholders' largest cost factors (FigureB.2). Processing level B.18 FigureB.3 shows the breakdown oftobacco processingand distributioncosts. Clearly the cost of organizingoutgrower schemes represents a very large share of total costs, comparable to processingcosts. Participationin Zambia's smallholderBurleyvalue chain is relatively profitable for buyers within Zambia who sell into the Malawian value chain. Burley production is concentrated in Eastern Province, where high transportation costs and lack of infrastructure curtail production and access to markets. The high costs of transportation to Lusaka make it cheaper to source tobacco from Central and Southern Provinces (which grow mostly Virginia tobacco). Low yield Mediumyield High yield Returnto family labor 0.68 2.44 3.32 (US$/d) Net profit(US$/ha) 274 978 1,329 Profit margin(%) 31 56 61 47 Seed, 0.9% Fertilizer,17.5% Chemicals, 3.9% Energy, 0 0% Packaging, 3.1% Overheads and /' administration, 15.3% Figure B.2: Farm-level costs for smallholder Burley tobacco production at medium yield level Source: Study team calculations Note: Foryield values, see Table 2 ProcessorMargin 3% 1 Overheads (rent,office, vehicles and stam -, 0 Interest and Financing 6% Transport to Port Purchaseof the crop 4% .d 43% Packaging 2% Processing Costs 14% Transport Depotto - Factory 2% Cost of o z r Scheme 14% Figure B.3: Processing and distribution costs for smallholder Burley tobacco grown in Zambia and processed in Malawi Source: Study team calculations 48 Total value chain B.19 Table B.4 shows the values of all cost items for the whole burley tobacco value chain as percentageof total value chain cost. Interestingly the cost of managingthe outgrower scheme is as highas the actual processing cost. Note that farmer margins are not returns to family labor, as the opportunity cost of labor is fully included inthis calculation. Farmer margins couldtherefore rather be interpretedas net returns to family capital. I Packing 1.4 49 Transport to port 3.6 Interestand financing 5.9 Administration 5.6 Overheads(rent, ofice, vehicles, and staff) 5.6 Processormargin 3.4 50 ANNEX C: THE SUGAR VALUE CHAIN GOVERNANCE Organization C.1 In2006, ZSC crushed 1.8 million tons of cane, including deliveries from its own estate and outgrowers, for a record 239,000 tons of processedsugar. Around 92,000 tons (38 percent) of this output was sold into the domestic market,I4and 147,000 tons (62 percent) was exported (and accounted for more than 90 percent of all Zambian sugar exports). ZSC i s undertaking a major expansion, and by 2009 production of processedsugar is expectedto increase by 85 percent, from 239,000 to 440,000 tons. C.2 Inaddition to ZSC, two new sugar projects have been set up by private investors within the past five years. The first is a relatively small project near Kasama in Northern Province (Kalungwishi Estates, at 500 hectares), where lower irrigation costs and closer proximity to markets in the Great Lakes region are likely to be significant advantages. The second (Kafue Sugar, at 2,000 hectares) is on the other side of the Kafue River from Nakambala and came into production in 2005/06. Both operations have their own facilities for crushing cane and producing refinedsugar. C.3 ZSC classifies its outgrowers as follows: 0 40hectares: Smallholderfarmers(161smallholders operateunderKASCOL). 0 10-100 hectares: Medium-scale farmers (4), some with center-pivot irrigation systems. 100-1,100 hectares: Commercial farmers (3, including KASCOL), with center-pivot irrigation and flood irrigation. C.4 In the Nakambala scheme, KASCOL is responsible for harvesting both the KASCOL core estate and outgrowers' cane. The commercial growers are responsible for delivering their own cane, as is ZSC, with its own estate. All three types of delivery need to be coordinated with the ZSC mill to ensure that daily deliveries meet target mill operations. KASCOL is responsible for transporting the cane but outsourcesthat task to a local transporter. C.5 The cane supply agreementbetween ZSC and KASCOL has been in force since 1990 and is open-ended, although it i s currently under revision. Stakeholders are discussing the introduction of quotas based on volume rather than area planted. KASCOL and the large-scale commercial growers have the same agreement with ZSC. C.6 The 161 outgrower farmers are organized under the Kaleya Smallholder Farmers' Association (KASFA), which was recently transformed into the Kaleya Smallholder Trust (KST) to facilitate the transfer of shares to smallholders. KASFA was established in October 1990 as a forum for the smallholders inthe scheme to represent their interests. C.7 ZSC provides irrigation water, two extension officers, and agronomic services. KASCOL provides a range of field management services to outgrowers, including land preparation, replanting, input procurement and provision, irrigation water supply, grower extension, and cane transport. Cane cutting has been outsourced to KASFA so that it can generate income (this l4Mainly to industrialclients such as Coca-Cola. 51 activity, like cane transport, is regardedby the company as a noncore activity). KASCOL also provides crop insurancefor growers, notably against malicious cane fire, flooding, and drought, and it also grades the main outgrower roads up to several times a year. Parallel to the sublease, farmers sign a Cane Supply Agreement, which stipulates good crop husbandry requirements for farmers and describes the division of responsibilities and rights between the grower and KASCOL. The agreement includes a code of conduct that farmers must follow or risk being expelled fromthe scheme. C.8 InprincipleKASFA was to offer arangeofsocial services, includingfarmer coordination and management, domestic water supply, health and education services, emergency credit, and funeral assistance. In practice, many of the services were providedby KASCOL, but lately the company hasbeenwithdrawingfromthese services, which has causedtension towardsKASCOL withinKASFA. C.9 FigureC.1depictsthe structure of sugarcaneproductioninZambia. I Kalungwiehi 1 4 Estate(500 ha) KafueSugar Estate 230,000 z a m p b ~ ~ ~ l ~ ~ n eI 57,500 (2,000 ha) Cane (2,313,099 tonnes Cane) t- Cane ___--Commercial Farmers 313,238 2,025,599 tonnes Cane I , Membership I ' I t Factow I . 1,264,000 Zambia Sugar Mazabuka Cane Core Estate Cane (I 15tlha) (11,000 ha) (MCGA) Kaleya Smallholder 127,690 tonnes Kaleya Smallholder Core Estate ' (1,130 ha) (113Vha) Cane Company I (KASCOL) I II - 120,671 L_------------------- Kaleya Sugar Farmers tonnes Smallholder Farmers Association (KASFA) Cane (161farmer.?., 1,067 ha) (113tlha) C.10 The price of processedsugar is K 1,265,000 per ton (US$3 16.25, at K 4,000 per US$1) and is directly relatedto the sugarcane price. Outgrowers get paid approximatelyUS$41 per ton of sugarcane (calculated on yields of approximately 110 tons per hectare). This payment depends 52 on the sugar price, the estimatedrecoverable crystals (ERC)," andthe divisionof proceeds(DoP) formula. The distributionof payment is 59 percentto the grower and41 percentto the miller (5.2 percentand 7.9 percentofthe ERC, respectively)and is renegotiatedevery five years. C.11 More than half (57 percent) of the payment going to KASCOL is retainedfor company operations, and 43 percent goes to the farmers (4.5 percent and 3.4 percent of the ERC, respectively), less KASFA deductions. Thus every 100 tons of sugarcane brings a payment to farmers that equals the price of 3.4 tons of sugar. The grower is paid 50 percent of hisker net proceeds when the cane is delivered (from the 92 percent ZSC installment at delivery), and the remaining50 percent is staggered over the following 11 months to assist the grower in cash flow management. C.12 A potentialarea of conflictbetweenKASFA andKASCOL is that the cost ofKASCOL's individual services-overed by the 57 percent of proceeds that are retained-is not clear. Discussions with smallholder cane farmers suggest that friction between farmers, KASFA, KASCOL, and ZSC is steadily increasing. Smallholders view KASCOL with a high level of mistrust, feel excluded from making basic decisions, and feel a complete lack of control over their livelihoods. The nature of the complaints and alternative views indicate that the main problem is a lack of transparency and communication between the parties. Now that the association has become a trust that owns KASCOL shares, growers will obtain voting rights as full members of the KASCOL board (versus the observer status they had as an association) and should get access to the full cost breakdown. Institutions C.13 The MCGA is the apex organization for KASCOL, KASFA, and large-scale commercial growers in the Mazabuka area. The association has no paid staff. MCGA and ZSC have a joint committeewhere issuesof importance are raised. Legislatiodregulation C.14 In terms of government policies, the single most important issue is the adoption of the new Energy Policy, in particular with regard to alternative sources of energy such as biodiesels and (inthe case of sugar) bioethanol. Operators eagerly await the government policy on blending as a meansof import substitution. COSTAND RETURNS C.15 The three main sugarcane production systems are characterized by differences in ownership rather than by any underlyingagroeconomic or yield differences: commercialestates, cooperative estates (or smallholder estates under the KASCOL smallholder company), and smallholder farms (outgrowers). Based on the fieldwork and secondary sources, a Value Chain Analysis Tool for the sugar industry in Zambia was constructed in Excel. Only the ZSC value chain (Figure (2.2) was analyzed, because it accounts for 90 percent of the sugar produced in Zambia and is the only one with any productionby small-scale outgrowers. After smallholders grow and harvest the crop, the cane is transported to ZSC's Nakambala factory for processing intovarious productsandthen exportedor consumeddomestically. 15The ERC is the productof the sucrose contentofthe cane (which currently averages 15.1 percentbut is nohigherthan 15.42 percent)times the millefficiencyrate (currently averaging87 percent). 53 EuropeanUnion DomesticMarket Great LakesArea SACU Democratic Republic of Congo (27,000tonnes) (120,000tonnes) (49.000tonnes) (10,000tonnes) (60,000 tonnes) Reflned Sugar Household Brown Molasses (7,000tonnes) (20,000tonnes) (239,000tonnes) (60,768tonnes) I J I i L t t 266,103 tonnes Sugar 7Joint Commffle ---- Zambia Sugar CommercialFarmers Company (ZSC) 2,025,599 Processing (Mill(POL 15.1%) - I (7 farmers,4,500 ha) Cane (114Vha) NakambalaSugar tomes Cane- Factory Emciency a70/) Membership ! 1,264,000 Zambia Sugar Mazabuka Cane Core Estate Growers Association (MCGA) ices Kaleya Sugar Farmers tonnes Smallholder Farmers Association(KASFA) - 120,671 Cane (161 farmers, 1,067ha)' (113th) ff Land preparation (clearing.plowing,ridging) Planting Infrastructure(roads,canals, culverts) KASCOL Services 1fT Input supply (fertilizers,chemicals.sprayer equipment) Loading Extensionservices Services TT Haulage f TT irrigation (1" rotation) Management Administration and Finance t Services: Social Services (Health, Education, Services: KASFA Services Water, Emergency Finance,Funerals) Zambia Sugar f Extension (2 agronomists) tt Harvesting Services T TechnicalAdvice ManaQementand Coordination I I It Water supply Figure C.2: Supply chainfor sugar under Zambia Sugar Company Source: Study team analysis Note: Pol = sucrose level inraw cane. 54 Farm level C.16 The farm budgets exclude the cost of planting, which is done every 5-6 years (but can extend to as many as 10 years). The costs, which would need to be amortized over the interplantingperiod, were not available. In any event they would be almost identical for every kindof enterprise anddo not affectthe comparison ofprofitability.'6 C.17 Under all yield scenarios, sugarcane production is highly profitable for smallholders in KASCOL's Nakambala scheme. Even when smallholders' yields are low, sugarcane production is still highly profitable at US$929 per hectare (Table C.l). (However, KASCOL itself loses US$40 per hectare, because the division of proceeds from the Nakambala mill does not cover their production costs.) At medium yield levels (average yields in KASCOL's Nakambala scheme), sugarcane production is also highly profitable for smallholders at US $1,270 per hectare, with an additional profit of US$361 per hectare going to KASCOL. Finally, the high yield (and most profitable) scenarios are indicative of newly planted cane in the first to third rattoon. KASCOL smallholders who obtain high yields obtain profits of around US$1,420 per hectare, with an additionalprofit ofUS$535 per hectare goingto KASCOL. C.18 For smallholder farmers the returns are much higher for sugarcane than for other activities. Figure C.3 shows the breakdown of costs at the farm level for sugarcane production under mediumyield levels. Low Medium High Returnto family labor 134 183 204 (US$/d) Netprofit(US$/ha) 937 1,279 1,428 Profitmargin(%) 24 35 39 l6They would be useful if alternative crops needto be evaluated, but under the estate production system and KASCOL, farmers cannot use the landto grow crops other than sugarcane; if they wish to do so, they haveto vacatethe farm. 55 Other overheads,2.73% Charges and levies, 35.45% Culti Fertilizer,6.87% KASFA costs, 1.96% Planting, 0.00% Inputtransport, 0.04% FigureC.3: Farm-level costs for smallholder sugarcane production under medium yields Source: Studyteam calculations Note: For yield values see Table 2 Processinglevel C.19 Although three value chains were investigated (commercial estate, smallholder estate, and smallholder farm), there are no substantive differences between the chains on the processing side, so only results for the smallholder farm chain are reported here. C.20 Sugarcane costs approximately US$15.26 per ton to process, which translates into a processedsugar value of around US$432434per ton, depending on the sugarcane purchaseprice (which depends in turn on the ERC and the division of proceeds formula). Overheads comprise US$46-47 per ton of sugar, resulting in a profit margin of US$37-38 on the final FOB price of US$517.47 per ton.I7 l7The final FOB price of US$517.47per ton translates back into a price of US$0.235 per pound for sugar, which is substantially above the internationalprice of sugar. The main reason for this difference is that African sugar gets preferential access to the EU market under the Everything but Arms and Africa, Caribbean, and Pacific protocols as well as to the U S and Southern African Development Community (SADC) markets (mainly into DRC). While the world price averaged around US$O.lO per pound in late 2006 and early 2007, Illovo reported an average return on US$0.1492 per pound for their African operations, with an estimated premium for Zambian sugar of US$0.086 per pound; resulting in the final price ofUS$0.235 perpound(US$5 17.47 per ton). 56 C.21 The breakdown of processing and distribution costs (Figure C.4) for sugarcane from smallholder farms indicates that processing is profitable for ZSC. O f the final FOB price, the profit margin is 7.2 percent. The purchase of cane i s the largest single cost item (61.1 percent of the final FOBprice), followed by wages, manufacturing costs, company tax, depreciation, interest payments on working capital, and duties and levies. Wages, 17.6% Interest on Working Manufacturing r Costs, 5.2% Capital, 1.6% .2% Purchaseof Can 61.1% 4.6% VMargin. 7.2% Figure C.4: Processing costs for sugarcane from smallholder farms Source: Study team calculations Total value chain C.22 Table C.2 shows the values o f all cost items for the whole sugar value chain as percentage of total value chain cost. Among the largest cost factors are cultivation labor, wages, and farmer margins. Note that farmer margins are not returns to family labor, as the opportunity cost of labor is fully included in this calculation. Farmer margins could therefore rather be interpreted as net returns to family capital. 57 Share of total costs Cost item (YO) Production Inputtransport 0.02 Fertilizer 4.2 Chemicals 0.4 Irrigation water 0.7 Irrigation electricity 2.2 Cultivation labor 10.9 I Fertilizerherbicide labor 0.1 Fuel 0.0 Harvesting I Labor 1.9 Fixed costs and overheads Zambia Revenue Authority tax 1.8 Crop insurance 0.03 I KASFA membership 0.5 KASFA clinic 0.1 KASFA school bus 0.6 KASCOL extension 0.5 I KASCOL share DurChaSe 1.7 IIFinancial charges 0.1 Overheads 6.9 Margins IIFarmer (net return to family capital) 16.8 KASCOL 4.8 IIManufacturing costs 5.2 Wages 17.6 Interest on working capital 1.6 Council levies 0.02 Local authority levies 0.1 Customs and excise 0.5 Depreciation 2.2 Company tax 4.6 Processor margin 7.2 58 ANNEX D:THE DOMESTICHORTICULTURE VALUE CHAIN GOVERNANCE Organization D.1 Horticulturalcrops grown for domestic consumers-generally vegetables but also hit- are marketed through two chains: the extremely fragmented, informalmarketingchain, in which largenumbersof agentsoperateat eachlevel,andthe formal, organizedmarketingchain. . D.2 In the informal chain, small-scale farmers grow horticulturalcrops for sale in wholesale and open-air markets. The retailers sort and grade the produce, setting aside unripe produce for sale at a later stage.The produce is usuallysold for a fixed priceandthere is no bargaining. D.3 A recurrenttheme in interviewswith vegetable producersis that marketsfor horticultural crops are poorly developed and prices are volatile. Price discovery mechanisms are not transparent, so per unit transaction costs are high and farmers are at a considerable disadvantage inmarketingtheir own produce.Mostfarmers rely on itineranttraders ("assemblers") to purchase produce at the farm gate and take it to the city for sale, although smallholders frequently bring their tomato and rape crops to Lusaka, where they usually sell to brokers (who charge a commission) rather thandirectlyto wholesalers. D.4 The organized marketing chains operated by supermarkets provide an alternative to tradingthrough the public markets. An importantintermediaryis FreshMark, which is owned by the same parent company as Shoprite. About 75 percent of FreshMark's business is to supply produce to the 18 Shoprite stores throughout Zambia; the rest is sold to other grocery stores and informal traders. FreshMark also exports some Zambian produce to Shoprite stores in Uganda, Malawi, and even South Africa. FreshMark imposes standards and puts a high premium on quality. It sources about 40 percent of the produce it trades directly from local sources-mainly large-scale commercial farmers but also other domestic sources. The remaining produce is imported, mostly from South Africa and Zimbabwe, partly because it is cheaper than locally grown commodities. D.5 Figure D.l shows how horticultural produce flows into Lusaka (Hichaambwa and Tschirley 2006); a map for Ndola would look similar. The map distinguishes between "small," "medium," and "large" flows of produceand, where possible, indicatesthe primaryitems flowing through eachchannel. HichaambwaandTschirley's (2006) qualitativeclassificationofthe size of each flow was based on informationfiom large farms, first sellers in wholesale markets, retail traders, and consumers. Boxes in the map, indicatingmajor market segments, are drawn only to approximate size at the farm and wholesale levels, becausequantitativedata are not available. At the retail level, preliminary estimates of the market shares for different outlets exist and are indicated. 59 T 1 . ___.* Small Flow LMedium Flow Large Flow Figure D.l: Simplifiedsupply chain map of Lusaka's fresh fruit and vegetable system Source: Hichaambwaand Tschirley 2006 D.6 Inthe future, supermarkets could play a critical role inthe vegetable product value chain. These firms represent a very attractive market because they are reliable and pay better prices to producers, but their share o f the retail market for vegetable crops is still small in Zambia. Even though food retailing accounts for 90 percent of the sales in supermarkets such as Shoprite, supermarkets still have only a minor role in marketing agricultural produce in Zambia. Key informants estimated that other market channels, including the farm gate, street vendors, and other local markets, provide more than 75 percent of crops such as tomatoes and potatoes to consumers. D.7 FreshMark and Shoprite, as well as hotels and lodges, have sought to source produce from smallholders under a number of cooperative arrangements, but these attempts failed. The main problems were that smallholders could not supply sufficient quantities, the quality of the produce was also unreliable, and there was no system to trace produce suppliedby smallholders. Until smallholders overcome these hurdles, their prospectsfor accessingthis high-end market are remote. These producers are better off attempting to access more traditional market outlets within the surrounding district. Institutions D.8 Markets in Zambia can be managed by the City Council or Marketeer Cooperatives, though some in the Ministry of Local Government and Housing have suggested that all markets legally belong to the City Council. Disagreements between the City Council and Marketeer Cooperatives over how the markets are managed, how marketeer fees are used, and who has title to the landhave been at the center of serious disputes inrecent years. 60 D.9 Most of the Lusaka City Council markets, such as Matero and Chilenje, were council taverns used for selling opaque beer. After that business ceased, community members formed marketeer cooperatives andbuilt stalls inthe taverns for sellingfresh produce and other products. These markets were eventually taken over by the City Council, because they owned the structures. The markets are managed by the City Council through its Market Advisory Committees and by the marketeers throughtheir cooperatives, Marketeerspay daily leviesto the City Counciland contributeto their respective cooperatives. D.10 Still other markets have been developed by community members, who put up the infrastructure(of varying permanence) and formed cooperatives to runthem. These "cooperative markets" mostly do not pay levies to the City Council, and any monies collected are used for the benefit of the members. The Lusaka Union of Marketeer Co-operatives, the umbrella body of these markets in Lusaka, welcomed the government's recent decision to introduce market management boards as longas its membershipwas not sidelined inthe process. Landtenure is an additional concern of marketeers. In many cases, cooperatives lack titles to the land on which they operate, andthe traders are therefore subject to the risk of eviction. Legislatiodregulation D.11 The EU-funded Urban Markets Development Program (UMDP) is a major effort to improve urban marketing in Zambia by improving physical infrastructureand promoting a new market managementmodel. The model-the core of the program-emphasizesmuch more active participationby stakeholders(primarily traders but also communities) inupgradingand managing markets through Market Management Boards, which will function as counterparts to the public administration. The program also seeks to orient public officials towards greater facilitation of healthy commercial activity. To this end, one component of the program is to review and revise legislationand bylawsfor local markets. D.12 The Markets Act is widely perceived as a barrier to this more participatory and decentralized approach. Although revision of the Markets Act is therefore a high priority, the specific revisions proposed for the Act are not yet publicly available, and marketeer representatives are concerned that the new Act will not fully meet the needs of the trading community.In light of past conflicts between marketeers and public officials, complete openness inrevisingthis key legislationis warranted. COSTSAND RETURNS Farm level D.13 The profitability of horticultural crops depends very much on the particular crop, the area, the season, prevailingprices, and managementpractices. It is beyondthe scope of this study to develop partial budgets for each horticulturalcrop. Instead, indicativebudgets are providedfor farmers and traders in the tomato and watermelon value chains. More specifically, the first example is a tomato producer who sells his produce to an intermediary, who then sells it in the wholesale market. The second example is a watermelon producer who sells his product at a wholesale market and does not use an intermediary.Resultsare presentedinTableD.1. 61 Table D.l: Farmer benefits from domestichorticulture: two examples I Tomato production I Watermelontrade production and I Returnto family labor (US$/d) 1.94 5.99 Net orofit fUS$lha) 99 538 IProfit margin ("A) 1 20 I 36 Source: Studyteam calculations D.14 Both activities are profitable: the tomato farmer earns US$99 per hectare, and the watermelon farmer earns US$538 per hectare. Watermelon is clearly a high-value crop with high returns for the farmer. Note, however, that the watermelon returns also include the return to marketing. D.15 Figures D.2 and D.3 show farm-level costs for the tomato and watermelon producers. Tomato production requires highcash outlays for inputs. Although input costs are also important for watermelon production, they account only for a small share o fthe cost of bringingthe product . to market-transport costs plays a far greater role. Although watermelon production is very profitable for the farmer, a more coordinated assembly system would offer considerable scope for reducingtransport costs. Figure D.2: Farm-level costs for smallholder tomato production Seed 5% Chemicals 51% Source: Studyteam calculations 62 Figure D.3: Farm-level costs for smallholder watermelon production and trade Inputs ..- :en hire accommodationLevies /' 51% 2% 2% Source: Studyteam calculations Trader level D.16 The study team determined the costs and returns for (i)an assembler who buys tomatoes at the farm gate, transports them to the market, and acts as a wholesaler and (ii)for an assembler who buys tomatoes at the farm gate and sells them via a commission agent, who takes a flat percentage o f the sale price. Figures D.4 and D.5 show that inboth cases, the assemblers incur the highest costs in purchasing produce and transporting it to the market. Their profit margins are between 7 and 8 percent. D.17 Although these results are for a high sale price, markets for horticultural crops are poorly developed and prices fluctuate considerably. Vegetable prices can often be very low. Interviews with traders indicate that depending on supply and demand, the price per crate can range between K 10,000 and K 20,000. Traders break even at around K 18,550. Ifthe price drops to K 15,000- 10,000, traders incur losseso f 85 and 23 percent. Purchase of Labor . Transport 38% 7% `1% Market levies 1% Figure D.4: Wholesaler costs and benefits from tomato sales Source: Studyteam calculations 63 Agent Profit margin commission 8% 6% Transpo Purchase of cost produce 25% 57% Laboi 4% Figure D.5: Costs and benefitsfor an assemblerselling tomatoes through a commission agent Source: Studyteam calculations Totalvalue chain D.18 Table D.2and D.3 show the values of all cost items for the whole watermelon and tomato value chains as a percentageo ftotal value chain cost. The highest cost items are transport cost (truck hire) and inputcosts.Note that farmer margins are not returns to family labor, as the opportunity cost of labor is fully included inthis calculation. Farmer margins could therefore rather be interpreted as net returnsto family capital. Cost item Percentof total Seeds 0.54 Fertilizer(Super D) 3.89 Pesticide (Ballpark) 0.39 64 Source: Study team calculations Note: Basedon two-hectareplot; family labor valued at full daily wage ratefor casual labor Cost item Percent of total Seeds 2.50 Fertilizer (Super D) 6.00 Fertilizer (Urea) 6.00 Pesticide(Metaphos) 4.38 Pesticide(Uthane) 12.50 IPesticide(Sticker) I 5.00 I Source: Study team calculations Note: Basedon 0.25-hectare plot producing200 crates oftomatoes, assuming ahighprice; family labor valuedat full daily wage rate for casual labor. 65