Sourcing decisions on price should be a function of value and risk 

There is a clear incentive for businesses dependent on smallholder farmer production to ensure smallholders have a business case for investing in farm production. An obvious entry point is the revenue side of the farm business. Buyers must ensure farmers are paid rewarding farmgate prices, regardless of where the company is situated in the supply chain, to motivate farmers to continue producing and trading in their supply chain.

As brought forward in an earlier opinion article ‘Real talk: prices and profits for all businesses’, improving sourcing relationships and practices has many benefits to food,  beverage and textiles companies. Only, how can we make this work when farmgate prices are influenced by market pricing mechanisms such as commodity exchanges and minimum price regulations?

Below we offer 3 entry-points for companies to deliver higher and stable farmgate prices by factoring in value and risk in sourcing decisions.

  1. Re-distribute value

Higher farmgate prices can be achieved through a fairer allocation of value across the supply chain channelled through higher farmgate prices, compensation for unrecognised value creation, and upstream investments. But what is a fair allocation of value to farmers? And don’t we rely on the market to determine that price based on supply and demand?

In short, traditional price discovery and price-setting practices need reimagining.

With variation across products and supply chains, farmgate prices are often de-linked from physical realities like cost of production and are influenced by trading mechanisms and financial speculation rather than physical trade.

Cost-plus and open-book pricing is a price discovery and price setting approach where buyers pay a price that covers the cost of production and a margin on a product. These are not novel pricing strategies in business practice; but in food, beverage and textile supply chains it is up to buyers to offer this option since smallholders are highly fragmented price takers. Multiple businesses do this already: food, textile and FMCG retailer Costco is doing so in their San Francisco Bay Coffee sourcing program as are respective clothing, dairy and chocolate brands Everlane, Danone and  Tony’s Chocolonely, to name a few. The latter company actually offers multiple price premia to cover sustainable production, costs of living, and producer group management fees – all costs they utilise in their price discovery and setting practices.

Additional compensation, for example for farmer-centric marketing materials and farmer-delivered ecosystem services, can also be paid. Any price increase or additional compensation should be verified to ensure the full increase in price is received at farmgate rather than leaked across intermediaries. In traceable, short and/or digitised supply chains, direct payments to farmers may be possible even by brands and retailers.

  1. Prioritise maximum price delivery at farmgate

Sometimes farmers can’t secure the maximum farmgate price available. Reasons for this range from long and opaque supply chains to information and resource deficiencies in production contexts, and even unscrupulous and untransparent behaviour of their direct buyers.

All procurement departments, especially those operating at origin, can commit to shorten supply chains and prioritize direct trade with farmers so fewer intermediaries share the total export and end-product value. This should translate into higher farmgate prices. More direct trade with farmers enables better relationships and information exchange between parties, increasing opportunities for smallholders to change their production, storage and/or processing procedures to deliver their produce in accordance with different quality and product specifications to reach the highest available farmgate price.

Transparency and consistency in transactions with smallholders is also crucial for direct buyers to enable smallholders to access the maximum farmgate price available. Basic practices like using precision and updated weighing scales, clear quality specifications and corresponding prices, farmer-observed quality sampling and reporting, and documentation of transactions, are all essential and yet not standard practice.

Downstream buyers can use their market leverage, supplier benchmarking and supplier incentive strategies to encourage suppliers to adopt such practices.

  1. Reduce and offset farmgate price-risk exposure and price volatility

Higher and stable farmgate prices can be achieved through a fairer allocation of risks and risk-mitigation costs across the value chain.

Most actors have mechanisms for risk management, from hedging on financial markets to strategic inventory and financial reserves, to using supply or market leverage in negotiations with trade partners. Meanwhile, farmers have no such risk-mitigation equivalents, or they do not have the resources to use them. Buying commitments and contracts are still rare between smallholders and their buyers, even in supply chains where purchase contracts with balanced terms for both buyers and seller are common further downstream.

Procurement teams can apply common practices with other partners to their sourcing approach with smallholders. Formalising and guaranteeing orders and transactions is a start. Procurement teams can offer contracts that guarantee purchase volumes of varying product specifications, including corresponding prices for different product specs, and relevant payment terms such as reducing time between product delivery and payment. This eliminates significant price and market risk for farmers. Long-term contracts that are balanced between parties are preferred.

Downstream actors can require their trade partners to formalise sourcing relationships with farmers through their own purchase agreements or through supplier incentives and benchmarking practices.

Investing in risk mitigation on behalf of farmers is also possible. Farmers can utilise physical risk-mitigation strategies such as product sorting and strategic inventory management, or financial risk-mitigation strategies such as hedging and insurance – but they need financial and other resources to do so.

Front line of sourcing

Procurement teams are on the front lines of smallholder sourcing. Making a business case for smallholders is an essential function for all procurement teams, and more broadly for all supply chain companies who are dependent on smallholders for their own success. Luckily, numerous untapped resources and strategies exist to improve relationships with and outcomes for smallholder producers regardless of dominant market mechanisms. These opportunities simply need to shift from marketing and CSR narratives, or sustainability siloes, into procurement practice to make all businesses in supply chains grow.

This article follows an earlier piece about distributing value and risk more fairly