Real talk: prices and profits for all businesses

For all types of businesses, securing buyers that provide sufficient value to stay in business and manage risks is essential. Smallholder farmers are no different.

Sourcing from smallholder farmers is an essential function for food, beverage and textile companies to secure supply according to required product specifications ranging from quality, volume and consistency parameters to traceability to social and environmental attributes.

Alongside procurement departments, the sustainability and marketing teams also leverage smallholder’s stories and images, and ecosystem services, for increasing market share, brand value and product margins.

Leveraging sourcing relationships

Improving sourcing relationships and practices with smallholder farmers has many benefits that are typically hidden or have not been adequately quantified. Four areas where businesses can gain value by improving smallholder-related procurement include:

1. Reducing supply risks caused by negative reward cycles for farming households.
2. Business growth by sourcing sustainable supply that can be used for branding and marketing purposes.
3. Managing increased reputational risks as upstream human rights vulnerabilities become increasingly scrutinised, and as expectations rise that businesses approach societal challenges with the same rigour, thoughtfulness and energy used to deliver profit.
4. Meeting business responsibility and reporting requirements under internationally recognised frameworks such as the UN Guiding Principles on Human Rights or the EU Human Rights Due Diligence.

Price is the best fertiliser for returns on smallholder sourcing and sustainability investments

Appropriately compensating smallholder farmers for the value they contribute and the risks they absorb will significantly influence the above business interests. In short, smallholders need to be profitable and treated as supply chain partners regardless of market price movements and minimum prices set by governments.  Profitable smallholder farmers have the means and motivation to invest in their farms and to do so in a way that does not contribute to negative social and environmental outcomes, which can ultimately effect consumer and investor attitudes towards consumer products and consumer-facing brands.

Farmgate prices influence farmers’ perception and attitude towards a sector and specific buyers, such as their confidence, ambition and crop/supply chain preferences. This in turn affects their decisions and choices related to production and sales, such as which crops to plant and when and which buyers to sell to.

In a positive reward/compensation cycle, farmers receive prices high enough to make production profitable. They then have confidence in the crop’s potential, maintain or expand the land they dedicate to crop production, trust their buyers and reduce side-selling, and actively encourage future generations to stay in farming.

With such a positive cycle, procurement teams have a better chance of long-term supply security at lower acquisition costs while maintaining product attributes required for consistency in meeting consumer preferences. When profitability is high enough, social and environmental risks can be eliminated as farming households can afford to pay workers and send their children to school. They may not feel the need to encroach on forests to expand their production and hence contribute to deforestation. These are also big benefits to sustainability and marketing teams.

In a negative reward/compensation cycle, farmgate prices are too low and volatile, and leave farmers operating at a loss. For many, this is the current scenario. Without decent margins, farmers can’t invest in their farms or afford to pay basic living costs. They may choose to switch crops, like we see among Kenyan coffee farmers (some switch to tea which is suffering from oversupply and depressed prices). They could also use child labour on farms because they can’t afford to pay workers or cut forests to expand their production area with minimal investment, as we observe in the cocoa and palm oil sectors.

For buyers, this can reduce the crop area under commercial production, increase supplier acquisition costs, raise due diligence and market-entry risks, and negatively affect brand value.

Real talk: prices and profits

Real and nominal consumer prices for most food and beverages have increased over the past decades, especially during supply chain disruptions from COVID-19 and the ongoing Russia invasion of Ukraine. Large retailers, brands and trade houses are managing their own risks while increasing sales and/or margins, in tandem with capturing a higher proportion of the end-product price. Shareholders, owners and corporate leaders reap the financial rewards of such business success.

On the flip side, producers, and especially smallholders, have absorbed many of the risks offset by their downstream partners. They receive a declining share of the end-product price and in several supply chains the nominal value of the farmgate price has declined.

Usually, when the subject of higher farmgate prices comes up, companies raise issues around consumer price sensitivity. But what is implied above is that we don’t have a consumer (price) problem, we have a value and risk-sharing problem.

In this next article, we will explore how this problem could be solved