Smallholder farmers are still finding themselves substantively behind commercial farming standards and often are far from operating as self sustainable thriving entities. Even if they have graduated through IDH’s or others’ training programs, successfully adopted good agricultural practices (GAP) and achieved solid improvements in their yields (between (10-40%), there is a large gap to bridge. To make a jump, they need the full “productivity package” of agro-inputs, fertilizer and improved seeds and planting materials. Often, they also require rehabilitation and/or replanting of their crops to maximize the full potential of their farm.
However, these productivity input and rehabilitation services require a much larger financing facility than can be provided by IDH grant funding – being both substantive in amount but also cyclical in nature. GAP training costs roughly USD 100 to 150 per farmer (and often a once-off sunk cost) but a simple fertilizer composite could be as much as USD 500 per farmer per season.
The role supply chain managers can play
Supply chain managers (SCMs) are in many cases, the most suitable provider for delivering the services to the smallholders. They have a network in place, the lowest cost structure, in the long-term benefit from such investment (increased off-take and better quality crop with lower reputational risk) and are thus often the most willing participant.
The largest impediment for the SCM to move into this type of engagement with smallholder farmers is their capacity to handle the much higher levels of risk associated with such an investment. Smallholder farmers typically have no track record on repayment of loans, and side-selling and other farmer loyalty issues are a significant deterred. The front-runner SCM’s are able to provide short-term crop pre-financing for short term risk, but medium-term and longer-term financing requires a risk tolerance beyond the scope of even the largest SCMs’.
Financial institutions in this space
Its also typically still too early for local or international commercial financial institutions to invest, due to the rather high risk levels associated with medium and longer-term financing. For financiers, funding is not the issue at this stage, but rather farmer risk (i.e. taking direct risk on farmers defaulting) remains a black box for all financiers with only a very few willing to share some (limited) risks directly on these farmers. This risk comes from:
- a knowledge and relationship gap (significant information asymmetry between the SCM and the 3rd party investor (e.g. a development finance institution (DFI),
- perceived and real risks of agriculture and producer country risk,
- lack of infrastructure to administer finance in the rural areas from which these SCM’s source,
- requirements to achieve financial returns relative to the risk deployed – i.e. these projects do not typically sit on the market risk-return graph.
Opportunity for IDH and partners
There is a clear opportunity for IDH to act as a catalyst for the financial industry as well as the supply chain. Therefore, IDH has engaged with development banks (e.g. FMO, the Dutch development bank, IFC, the International Finance Corporation, etc.) and impact investors (e.g.. Root Capital, AgDevco, etc.) to develop ways to support this style of farmer financing.
IDH is well-positioned as a public good provider in this process, as it has built up a reputation with the SCM and has experience in funding the transition of smallholder farmers. (from A to B see diagram below). Through IDH’s supply chain networks and field-level projects, DFIs are willing to invest in these projects and the prototyping of this process of farmer upgrading can take place. IDH is responsible for the impact monitoring and evaluation – but also uses its grant-funding as an effective catalyst to drive success through the actual financing (DFI + the SCM) of the project. This all ultimately provides much needed examples of farmer-level financing.
Grant funding as a catalyst
Through well structured conditional grants (‘first-loss funding’) IDH is able to share risk with supply chain actors on the highest risk portion of a smallholder portfolio. This in turn catalyzes the DFI’s and potentially some larger commercial banks to step in and share risk on the remainder of the portfolio.
IDH also invests in a parallel process with local financial institutions (“FI’s”) in the region of the projects, in order to familiarize them with the farmers and agriculture finance. This process paves the way for IDH’s gradual exit. Furthermore, local FI’s are able to enter these risk-sharing projects at the beginning phase by offering savings/deposit accounts for the farmers and thus build their internal comfort levels to take over the portfolio from the SCM-IDH-(D)FI partnership. This often suits the SCM, who is not looking to act as a financial entity for longer than is required.