Tuesday, February 27, 2018

80. What a 240 Cherry Floor Price Means in Rwanda

Feb.27, 2018
Coffee cherry in Rwanda
What does a 240 cherry floor price mean in Rwanda? More poverty for coffee farmers. NAEB has announced a 240 RWF/KG cherry floor price (farmgate price) for coffee cherry for the 2018 season despite research showing that around 25%, one fourth, of Rwanda's coffee farmers will be losing money on every coffee cherry they sell. (See  Figure 1 below.)  When viewing this figure, keep in mind that the threshold used for "profit" here is any amount above 0. The data is credible, as it is based on a 1024 sample survey (AGLCa, 2016), which included estimating cost of production for coffee at 177 RWF/KG cherry (AGLCb, 2016). Most businesses, including the exporters who are pressuring NAEB to keep the cherry price low, would go out of business if profit levels fall below 20%. The red bars in the Figure below would be much higher if we assumed farmers had the right to have 20-30% margins. Then Figure 1 would show that nearly half of Rwanda's farmers are "in the red" at a floor price of 240.
Figure 1: Percent of Coffee Farmers Making Above 0 Profit at Various Cherry Prices

So the 2018 season begins with these "barely getting by" prices for farmers, forced to be this low by exporters who will gorge themselves on 50% margins. Meanwhile, the exporters will publicize their exciting 'investments' in water projects to improve waste water treatment at one coffee washing station, and 'investments' in a training project that brings cows to smallholders. These 'investments' will be so exciting they will end up in articles on the covers of glossy coffee trade press magazines and even in Harvard Business Review case studies about "social enterprises" doing the right thing for poor coffee farmers in Rwanda.

Please don't be fooled. The powerful in Rwanda are hungry enough to eat every coffee farmers' lunch. They would rather invest in projects on the fringe, than work to improve their marketing and sell more specialty coffee at higher prices. They cannot see their way to paying a few cents more, just $.19/lb. green coffee, to ensure that farmers are motivated to plant seedlings, prune trees, conserve their water and buy a cow if they would like to.

Please don't be fooled by projects and trainings. 57% of Rwanda's coffee trees are owned by commercially oriented farmers with .5 hectares or more planted with coffee. Many of them could increase their yields by two or three times this season -- if it is commercially viable to do so.  They know how. But they choose not to because with cost of production at 177/KG cherry, 240 RWF/KG cherry means 64 RWF/KG cherry net income, or a 26% gross margin and they have better options in banana, livestock and other farming businesses. Many will use low-input strategies or neglect the coffee trees completely because they can afford to transition to other business opportunities.

The smallest farmers, with an average of 180 - 200 trees, will not be so lucky. They will suffer yet another year of losses for all their effort on their coffee trees. For them, a training may minimize their costs per unit of cherry produced and therefore minimize their losses. But leaving the coffee and using the same amount of time to pick potatoes as a day-laborer would probably bring more cash into the household.

You might ask "why?" Why do companies implement projects and trainings, but refuse to pay $.07/KG cherry more, (equal to +$.42/KG green coffee, or +$.19/lb green coffee) for a supply of quality, fully-washed coffee? For some it is greed to make a few pennies more this year that drives such decisions. For other exporters it is short-sightedness. Despite the research (AGLCc, 2016) they do not understand that their insistence on cheap cherry means death of a vibrant option for increases in yields and supplies of high-quality cherry, plus rural development in Rwanda. Meanwhile, they keep their options open to move over to Ethiopia or Tanzania once Rwanda's commercially viable coffee farmers have all pulled out their trees.

Pennies -- they are unwilling to pay pennies of investment in the coffee farmers via the coffee cherry price, (i.e. the farmgate price).

Specialty buyers of Rwandan coffee should be outraged at the downward spiral the 240 price can precipitate: lower prices, leading to lower yields, leading to lower motivation from commercially motivated Rwandans living in rural areas. Rwanda was poised to reverse this vicious spiral in the 2017 season. At this time last year NAEB pegged the floor price first at 270, a promising start.  But then they let it decline to 240 later in the season. The weighted average for 2017 was 249. Starting this 2018 season at 240 starts to look like we are headed back to the bad 'ol days of 2015 and 2016. In those years the floor price was 170 and 150 respectively.

If you buy Rwandan coffee, you know the FOB price, (called the export price in our scenario illustrated below, $4.30/KG green). Please, demand to know the farm-gate price from your supplier. Farmers want 300 RWF/ KG cherry. Research (AGLCa, 2016) shows 300 RWF provides sufficient motivation for farmers to invest in best practices, which results in high-yielding plants and more specialty grade coffee. A win-win for all. Any exporter paying less than 300 RWF for coffee bound for the specialty market should explain to you why coffee farmers deserve margins only half the size of exporters (Chart 1 vs. Chart 2 below).

 Chart 1: 240 RWF/KG Cherry


Chart 2: 300 RWF/KG Cherry

Tuesday, February 20, 2018

79. Long term impacts of Lean - Resilience of the Toyota Way

Feb. 20, 2018
Great blog today, "The Toyota Way or Entropy?" by David McKenzie, an economist at the World Bank, on the World Bank Development Impact blog. McKenzie takes the most typical criticism of any training, which is that it won't stick, and tests it. Specifically, McKenzie and co-authors Nicholas Bloom, Benn Eifert, Aprajit Mahajan, and John Roberts test whether an intensive management intervention in Indian textile weaving plants can be shown to have staying power. The simplified, contrasting possible outcomes are the“Toyota way” , with systems in place for measuring and monitoring operations and a continuous cycle of improvement vs. the alternative of entropy, or a gradual decline back into disorder. "One estimate by prominent consulting firm Boston Consulting Group, is that two-thirds of transformation initiatives ultimately fail." Fortunately, McKenzie et. al. find different results.

The study results shared in their new paper are somewhere in between the two outcomes described above. There is some entropy, but some improvements are "sticky", and even 8 years later are still in practice. In short, there was more persistence in management practices than the researchers anticipated. We (at Artisan) were most interested to see which practices were the ones that had staying power. They relate very closely to improvements in quality and inventory levels:
  1. recording quality defects in a systematic manner (defect-wise); 
  2. having a system for monitoring and disposing old stock; and 
  3. carrying out preventative maintenance.
We're excited to see this list, as #1 and #3 have been key success areas in the Lean at Origin two-year pilot project carried out at washing stations in Rwanda and Burundi.
#1 - recording quality defects in a systematic manner: In a washing station in Rwanda, the first "big KAIZEN" a work team addressed was to devise a way to measure the defects coming out of the depulping machine. At the very least, monitoring the level of defects alerts the machinist as to when he needs to adjust the discs. In an advanced scenario, the level of defects after the depulper can be an indicator of the overall quality of the cherry the washing station is receiving. This has important implications for farmer education and washing station profits to the extent that revenue is dependent on quality.

#3 preventative maintenance: At a dry mill in Burundi, the operations manager recognized right away how impactful a program of regular maintenance could be for the depulping machines at the 30-some washing station delivering parchment to their mill. No doubt, he also recognized how the quality of the parchment from these 30 washing stations would be improved if machine down-time became less of an issue.

#1 - photos of recording quality defects in a systematic manner at KOPAKAMA:
Devising the "3 cup metric" for depulper defects.

Basin of A3 beans - machinist wants to know when the % of cut beans spikes.

Devising the "3 cup" metric for depulper defects.

Three samples taken each night - beginning, middle and end of shift.
#3: HOROMAMA dry mill plans to implement preventative maintenance at washing stations like Dusangirijambo and 29 others.

Giving Dusangirijambo a new digital scale.

Saturday, November 25, 2017

78. Perspectives on Recent Reports on Farm Profitability

Nov. 27, 2017
An undercurrent of discussions and meetings related to cost of production and farm investments has been on-going in the specialty industry for at least two years, maybe longer. It was 2015 when I first read Chad Trewick's elegant article about cost of production in Specialty Coffee magazine. By 2016 he had organized conference calls for the SCAA's Sustainability Council to learn about cost of production from a consultant, Christophe Montagnon, president of RD2 Vision. I felt fortunate to participate as a guest on one of those calls. Chad understood my curiosity as a grad student writing a masters thesis on this exact topic. Later in 2016 Montagnon's report was available, and just last month a revised and finalized version of the "Farm Profitability" report was introduced to the world by the SCA at the Avance conference in Guatemala. Now comments are reverberating such as the recent "Perspectives" blog post by Kraig Kraft, technical advisor for CRS, which was re-published in Daily Coffee News.

I would like to add to these comments. First, I'll share 3 key points to consider when reading the SCA/RD2 Vision report. Then I'll share 3 points as comments to Mr. Kraft's article review. For both sections, the following three equations are important to keep in mind:
  1. Profit (or net income) = (KGs x Price) - Costs
  2. Cost of Production = All Costs/Total KGs produced
  3. Farm Investments = All Costs/Total productive asset (such as land, ha; or # of trees) 
Comments on Key Findings of the SCA/RD2 Vision "Farm Profitability Report"

  • Key Finding 1 (of the SCA report): Yields increase with higher costs per hectare, especially in the short term, and hence may decrease a farm’s profitability. In other words, production yields are not necessarily correlated with farm profitability.
    • Africa Great Lakes Coffee (AGLC) data also shows that increased investments per asset (measured in ha or tree) leads to increased productivity (or yield). (Note: “investment” is more accurate than “cost” in this case, because we are talking about an asset, namely hectares.)
    • The SCA report seems to be saying that farms with the highest yields (most productivity per asset) are not the most profitable. AGLC data shows this correlation also, by stratifying the farms by size. Large farms have the lowest productivity (KG/tree) and the highest operating profit.
    • When I think about it in terms of factories it makes total sense. “Land and trees” are assets, like machines are assets in a factory. Just because your machine is producing widgets 2x as fast as my machine, doesn’t mean you have a more profitable business.
    • The SCA report is disappointing because it doesn't point out how the metric, cost of production, can be a very useful one, to manage investments and ensure they are increasing profitability.
    • It is also disappointing that key findings like this one fail to mention the critical role of price in determining whether farmers have profits. I would suggest re-writing this "finding" this way: Farmers must be careful to increase investments only as long as those investments lead to lower cost of production per KG, which, assuming price is constant, will mean increased profit.

  • Key Finding 2: Good Agricultural Practices (GAPs) are effective tools for increasing yields but do not automatically translate into more profit for the farming system.
    • This is why it is important to understand cost of production (CoP). The objective of GAPs is to lower cost of production per KG. By lowering cost of production of a product, you are increasing its profitability for the farmer, as long as the price is constant. By definition this is true, no research needed. These are principles of Econ 101.
    • Our research is looking for the “other factors”, that are enabling GAP to lower costs in ways that increase productivity, thus lowering CoP/KG and increasing profits. For example, we find that cooperative members:
      • Adopt best practices at a higher rate than non-coop members
      • Are 14% more productive per tree
      • Receive 52% more income from coffee than non-coop members
      • Have 22% lower cost of production than non-coop members
o    We’re not saying “every farmer will be more profitable in a cooperative”, but in Rwanda, something is happening in cooperatives that helps farmers. Because of the data that shows this, we can do a better job of discovering why.
  • Key Finding 3: There is wide variability of situations in coffee production. When production costs and profitability figures are given as an average at a country, or even regional level, this high degree of variation is not being accounted for. 
    • Couldn't agree more! The most important disaggregation to look for or insist on is farm size. What is cost of production on small, medium and large farms in the area of focus?
Kraig Kraft writes in "Perspectives on the New SCA Report on Farm Profitability."
  • Key Finding 1: Calculate net income using: Net Income = (yield x price) - (cost of production)
    • We prefer to use the term 'production' or 'KGs' instead of yield in this equation. So Net Income = (KGs x price) - Costs.
  • Key Finding 2: Producing more coffee is expensive, costly and cuts into a farmer's margins....the law of diminishing returns.
    • Kraft correctly describes the law of diminishing returns, but falls short of describing how cost of production/KG plays a critical role in helping farmers determine "how far to go" with their investments. Farmers are still optimizing their profits if they continue to invest up until the point where the next investment pushes the farmer into increased cost of production per KG instead of decreasing CoP.
  • Key Finding 3: MACERCAFE... the key to their profitability is to maximize efficiency, not yield.
    • I would clarify the term "efficiency" further and state that MACERCAFE is maximizing profit by investing in coffee only up until the point where their net income is protected, given the price. Looking at the equation above, if price is low, the farmer needs to keep the costs low, to protect his/her profit. We show in AGLC data from Rwanda that large farmers (perhaps similar to MACERCAFE in Nicaragua) reduce their investments in coffee when price goes down. They are protecting their gross margin, even if it means investing nearly nothing - i.e. neglecting the trees completely. Large farmers will do this until the price improves.
    • Contrary to the comments of the supply chain manager for MACERCAFE, small farmers in Rwanda do not have the luxury of doing the same. Their coffee trees are sometimes their only source of cash the entire year, so they invest everything they can into them, no matter what the price is. Maybe "small" has a different meaning in Rwanda than Nicaragua? For Rwandan standards, a small farmer has less than 400 trees. 500 - 1000 trees is a medium sized farm, and 1000+ trees is large (1000 trees still being less than half a hectare).
The AGLC program produced a helpful typology for understanding the spectrum of small to large farmers. See figure below. This typology highlights an important aspect driving whether farms are profitable or not - farmer motivation.  The SCA's report doesn't mention it and neither does Mr. Kraft. Yet a farmer's motivation for growing coffee cannot be assumed to always be profit maximization. In Rwanda, at least, some farmers are growing coffee out of necessity - it is their only source of cash. The typology also highlights the other factor that greatly impacts profitability, that is capacity. Capacity includes things like whether the farmer has an education, other adults in the household, a large farm and access to credit.

[Typology diagram credit: Dan Clay, 2016]

The punchline of the typology is that large farmers in Rwanda own over half of Rwanda's trees. Seems like they are similar to MACERCAFE in Nicaragua. They have capacity and their motivation is commercial - profit maximization. So price is a key driver. If the price they receive for their cherry does not cover costs, with a margin that matches their opportunities elsewhere, you can train them and talk to them all day, but do not expect their coffee trees to be well-attended. Their focus will remain on the crops and businesses that are paying the highest return on their investment.

The fact is, it is helpful to be having these discussions so that the gaps in our knowledge are recognized, which allows researchers to focus and fill the gaps. There is a lot of new research since the time that the SCA's report was written in 2015, especially from the AGLC project. Click here for the project description and scroll down to see the list of publications and resources.