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International Food and Agribusiness Management Association

20th Annual World Forum and Symposium

Boston, Massachusetts, USA. June 19-22nd

“Navigating the Global Food System in a New Era”

A FRAMEWORK FOR UNDERSTANDING THE ARTICULATION OF THE

ARGENTINE DAIRY AGRIBUSINESS SYSTEM FROM A NEW

INSTITUTIONAL ECONOMICS AND DISTRIBUTION CHANNELS

APPROACH

Authors: Barilatti M.M., Senesi S. I.., Pérez San Martín, R. G.

Corresponding authors:

María Mercedes Barilatti. Food and Agribusiness Program, School of Agronomy, UBA-Argentina.. Av. San Martín 4453, Buenos Aires (PS: 1417), Argentina. email: barilatt@agro.uba.ar

Sebastián Ignacio Senesi. Food and Agribusiness Program, School of Agronomy, UBA-Argentina. Av. San Martín 4453, Buenos Aires (PS: 1417), Argentina. email: ssenesi@agro.uba.ar

Raúl Guillermo Pérez San Martín. Food and Agribusiness Program, School of Agronomy, UBA-Argentina. Av. San Martín 4453, Buenos Aires (PS: 1417), Argentina. email: rpsm@yayabu.com.ar

Fernando Vilella. Food and Agribusiness Program, School of Agronomy, UBA-Argentina. Av. San Martín 4453, Buenos Aires (PS: 1417), Argentina. email: vilella@agro.uba.ar

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International Food and Agribusiness Management Association

20th Annual World Forum and Symposium

Boston, Massachusetts, USA. June 19-22nd

“Navigating the Global Food System in a New Era”

A FRAMEWORK FOR UNDERSTANDING THE ARTICULATION OF THE

ARGENTINE DAIRY AGRIBUSINESS SYSTEM FROM A NEW

INSTITUTIONAL ECONOMICS AND DISTRIBUTION CHANNELS

APPROACH

Abstract

This study seeks to describe and understand the current organizational behavior and institutional environment of the Argentine Dairy Agribusiness System (Dairy ABS). A research framework is developed incorporating two different perspectives: Transaction Cost Economics (TCE) and literature on Distribution Channels (DC). It is applied to two key transactions of the of the Dairy ABS: farmer-processor and processor-large retailer. It is observed that existing relationships of power and dependency, a weak contractual framework low alignment of the transactions and determine high transaction costs at both stages threatening the performance of the system as a whole. This scenario has worsened due to heavy state intervention since 2005. It is expected that the scope of this study will broaden existing diagnoses of Argentina’s Dairy ABS for decision-making at the public and private management stages.

Keywords: dairy agribusiness system, power, dependency, governance structure, transaction alignment

1. Problem statement

Dairy agribusiness in Argentina has been going through a stagnation of production levels for the past ten years. Despite its comparative advantages, Argentina has maintained its production since 1995 between 8 and 10 thousand million annual liters, reducing 0.8% its participation in worldwide bovine milk production in ten years (SAGPyA, FAOSTAT).

When studying the Argentine dairy ABS dynamics and its connection with these tendencies, it can be observed that, historically, there have been conflicts within the interfaces between its links, outcome of the contractual inefficiencies, which generates ex-ante and ex-post transaction costs. The assets’ specificity involved—in particular, milk and dairy products, given their perishable nature—determines, in several cases, coordination mechanisms existing between chain links to be inefficient, due to the markets’ unsuitability to handle adaptations in

view of external shocks (Zylbersztajn, 1996).

Institutional changes result in agents of the chain facing a more complex and uncertain environment, which aggravates the conflict levels among them, as the dynamics of the contractual relations (already conflictive themselves) have been affected. This situation influences the transactions alignment degree, with respect to the terms in which these develop: specific assets involved, prices, terms and safeguards (Pérez San Martín, 2003). Agents evidence a disparate ability to adapt to this new institutional framework, which can be related to their power, dependency level (Coughlan et al, 2002), their structural characteristics and capacity to access, and management of information for decision-making.

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By analyzing Argentine dairy ABS it is noted that the existing contractual mechanisms reflect this insufficiency more intensely during periods of crises, along with the risk of opportunism, given the perishability nature mentioned above. This has led to a longstanding high conflict level between the different links in the Argentine Dairy ABS, whose origins (according to Szabó and Bárdos, 2005) could be located in the inefficiency of the coordination mechanisms set by the dynamics and turbulence that characterize the business and the institutional environment in which it develops (Williamson, 1985; North, 1990) as a result of:

The market structure—characterized by a significant concentration in which few industrial enterprises and large retailer chains participate in a major part of the business—and the product properties—highly perishable, determine that the competence will be flawed given the negotiating power of certain agents within the chain.

Total or partial lack or weakness of cooperatives and/or farmers groups promoting organizations that effectively represent their interests.

Consecutive state interventions in a turbulent institutional atmosphere with frequent changes in the rules of the game, leading to a low ability to guarantee property rights and asymmetrical appropriation of generated incomes (Pérez San Martín, 2003).

It is, then, necessary to study the chain in depth, especially regarding institutional and organizational aspects, in order to identify misalignments that restrain the effective articulation between chain links and subsequently its performance with the purpose of designing alternatives capable of remedying this situation.

2. Objectives

The goal of this paper is to describe and understand current organizational behavior and institutional environment of the Argentine Dairy Agribusiness System from a systemic point of view.

In order to do so, two specific objectives are proposed:

a) To develop a research framework incorporating two different perspectives: Transaction Cost Economics (TCE) and literature on Distribution Channels (DC),

b) To apply the framework to the study of two key transactions of the system: farmer-processor and processor – large retailer (supermarket).

3. Methodology

A qualitative research approach is adopted to accommodate the complexity and multi-dimensionality of the research topic. Applied research is carried out, since it depends on knowledge developed by pure research, but whose interest is knowledge application and practical consequences. The research has an explanatory level, taking into account that it seeks to develop, clarify and modify concepts and ideas, with a view to formulating more precise problems or hypotheses that can be researched in further studies, besides having a less rigid planning, not applying quantitative techniques and being carried out with more practical concerns (Gil, 1994).

Between May 2008 and December 2009 ten semi-structured in-depth interviews were carried out with farmers, representatives for farmer’s unions, managers of processing enterprises,

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specialized journalists and public sector representatives. Main method for data collection was recording and posterior transcript. This was complemented by secondary sources of information1 both qualitative as quantitative, such as official and private-source statistics, newspaper articles, and the attendance to conferences and events specifically related to the matter.

4. Theoretical and research framework

The theoretical framework used in this study, which provides the focus and boundaries to the research, was designed to integrate three different perspectives: The Agribusiness System approach, New Institutional Economics and literature on Distribution Channels (DC).

The Agribusiness Systems approach (ABS) has its origin in two different conceptualizations, developed at different places and times but showing similarities with respect to the structure of productive systems (Neves (2007) based on Zylbersztajn and Neves (2000); Batalha (2001)): Davis and Goldberg (1957) and Goldberg (1968) concept of “Agribusiness” and the

concept of “filiere” originated in the French school of industrial organization.

In relation to this, according to Zylbersztajn and Neves (2000) ABSs contain the following fundamental elements for their descriptive analysis: agents, relations between them, sectors, support organizations and an institutional environment. Based on these, the authors define the business network theoretical model. In this sense, the process consists in analyzing a business and its group of suppliers and distributors, the relationships that exist among them and the relation to the environment. In essence, it is an interaction and relations approach (Neves, 2007) (Figure 1).

Figure 1: Agribusiness System from TCE perspective

FarmersCommodity

Industries

Food, fiber

and fuel

industries

Wholesalers Retailers

CO

NS

UM

ER

S

T 1 T 2 T 3 T 5T 4

INSTITUTIONAL ENVIRONMENT:

culture, tradition, education, legal framework

ORGANIZATIONAL ENVIRONMENT:

public and private organizations, information, cooperatives, firms

T: Transactions

Source: Zylberstajn, 1996

Distribution channels or marketing channels can be defined as “a set of involved

interdependent organizations in the process to make the product or service of the available company for consumption or use” (Coughlan et al, 2002). Rosenbloom (2002), highlights an important feature of distribution channels: the fact that they exist beyond the firm limits, that is, that they do not belong to the internal organizational structure of any of the firms involved in the negotiation. This feature leads to the need to understand distribution channels as interorganizational forms, managed by more that one form that necessarily leads to the existence of direct relationships between agents.

1 As in Argentina available research on retailers’ competition is scarce, in order to better identify and describe existing purchasing practices, a literature review was carried out, particularly on the UK and EU whose Competition Commissions have conducted studies regarding these issues. These documents are further referenced at the bottom of this document.

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New institutional Economics approach is adopted at two levels of analysis– macro and micro analytical. The macro level deals with the institutional environment, or the rules of the game, which affect the behavior and performance of economic actors and in which organizational forms and transactions are embedded. Williamson (1993) describes it as the set of fundamental political, social, and legal ground rules that establish the basis for production, exchange and distribution. At micro-analytic perspective, the Transaction Cost Economics approach is employed in order to study the dynamics of contractual and institutional arrangements (firms, hybrid forms or markets), within the dairy ABS, and ex-ante or ex-post transaction costs originated in the relationships under study.

Neves et al (2001) integrate these concepts for developing a model for distribution channel planning. Their work is used as basis for the research framework developed in this study, which was subsequently adapted to the developing line of reasoning, as research findings are interpreted. In that sense, components of the research framework are introduced in Figure 1 and addressed following:

Figure 2: AGRIBUSINESS SYSTEM ANALYSIS - TCE AND DC APPROACH

FRAMEWORK

1. ABS Description,

its agents and their

strategies

2. Analysis of the Institutional Environment

3.a. Identification of

dependency

sources

3b. Identification of

power-bases

5. Analysis of

transaction

alignment and

transaction costs

6. Management

implications and

formulating

recommendations

4. Description of

transaction

attributes and

Identification of

Prevailing

Governance

Structure

Source: The authors

1. ABS Description, its agents and their strategies

The analysis begins with a description of the Agribusiness System under study. This should be done implementing a box-design, focused on the agents and transactions involved in it. Information about product and capital flows, market share of companies and any details considered to be fundamental for the analysis should be provided. It is important to present and discuss results with representatives and experts of the ABS (based on Neves, 2007).

2. Analysis of the Institutional Environment

The goal of this stage is to understand the rules of the game where the ABS under study takes place, pointing out key issues related to the transactions in which the research focuses. It is important to understand formal constraints (such as rules, laws, constitutions), informal constraints (such as norms of behavior, conventions, self-imposed codes of conduct), and their enforcement characteristics (North, 1994).

3. Power and dependency relationships in the transaction

At this phase of the research, the goal is to understand the dynamics of existing relationships between agents in terms of power and dependency. These are important facts to be considered in the analysis, as they provide a broader view of how the ABS structure can influence the

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performance of the relationship between agents. Therefore, these two concepts and key aspects to identify in those relationships are presented next:

a. Identification of dependency sources

The definition of dependency is summarized by Coughlan et al (2002), who state that dependency is “the obtained profit multiplied by the lack of alternatives.” That is, the

greater the profit an agent (B) obtains from another one (A), and the fewer the

alternatives B has to substitute it, the more B depends on A and vice versa. Frazier et al. (1989) state that there exist three approaches to study dependency:

sales and profits: being both of these objectives so important for organizations, the dependency of A with respect to B will be greater when the percentage of sales and profits that A gets from the relation with B increase (El-Ansary y Stern, 1972; Bucklin, 1973).

performance of assigned roles: firm A will be more motivated to preserve the relation with B the higher the performance level of functions that B carries out and benefit A’s

objectives. Consequently, A will perceive that B is more relevant in order to achieve its goals, which will originate an increase of its dependency.

specific assets investments and compensatory investments: the dependency of A with respect to B increases with the investments in specific assets realized by A within the relation, and decreases with A’s compensatory investments that protect it from possible B’s opportunistic behaviors. As the specific investments become less-employable outside the relation—due to their high specialization, the party that has generated it increases its dependency (Williamson, 1975; Heide and John, 1988).

b. Identification of power-bases

The following definition of power is widely accepted: power is the possibility to make a person do something, that he or she would otherwise not have done (Visser et al, 2000). Applied to this framework, power can be considered as the possibility to influence the decision variables of another party at another level of the ABS (based on El Ansary and Stern, 1972). Power is based on sources, which are called power-bases. Taking this into account, at this stage, existing power-bases in the transaction have to be recognized and described (based on French and Raven, 1959; Stern and El-Ansary, 1977):

Reward Power, which is based on the perceived ability to give positive consequences or remove negative ones. Rewards can also be used to punish, such as when they are withheld.

Coercive Power, based on the perceived ability to punish those who do not conform to ideas or demands.

Legitimate Power: related to organizational authority, it is based on the perception that someone has the right to prescribe behavior due to election or appointment to a position of responsibility; it has been split up in legal legitimate power and traditional legitimate

power

Referent Power, through association with others who possess power

Expert Power, based on having distinctive knowledge, expertness, ability or skills,

Information Power, based on controlling the information needed by others in order to reach an important goal.

Persuasion power: Rational appeals based on size, financial position, knowledge and concentration. Refers to the role as a leader that a channel member plays.

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4. Description of transaction attributes and Identification of Prevailing Governance

Structure

At this phase of the analysis it is important to focus on the goods being transacted and to describe the three dimensions of the transaction: asset specificity, frequency and uncertainty. These transaction attributes determine the adaptation of agents on the transaction: they will use the different governance structures so that the less possible transaction costs are generated there. In that sense, the next step is to identify the explicit or implicit contractual framework within which the transaction is located: Market, Hybrids or Hierarchies (Williamson 1981, Furubotn and Richter, 1997).

5. Analysis of transaction alignment and transaction costs

After the identification of the prevailing governance structures, and in order to understand the alignment degree of the transaction, the following matters must be considered (based on Williamson 2002; Perez San Martín, 2003):

Price: pricing mechanisms and their transparency.

Payment Terms: their impact in relation to the success of the business and the economic environment.

Existing safeguards, and their ability to prevent from damages, opportunistic behaviors in the transaction.

Asset specificity: The degree of protection and retribution of the specific assets involved in the productive process and the transaction.

In that sense, in order to assess existing transaction costs at the organizational level, matters related to bounded rationality and opportunism of individuals—in particular regarding quasi-rent appropriation (Williamson, 1975, Klein et al, 1978), should be identified and described.

6. Management implications and formulating recommendations

As stated in the beginning of this paper, the purpose of establishing this framework is to study deeply the relations between agents that interact in an ABS, from a systemic point of view. As many transactions of the ABS are studied under this framework, it should be easier to assess from a broader point of view where the constraints and limitations of its articulation rely. A summary and key-findings of the previous stages must be presented. Therefore, results obtained at each stage, and critical points identified along the analysis, should serve as an input to formulate strategies either to overcome, diminish or promote such aspects.

Though, from a long term perspective, and in order to implement a superior design of the current ABS, strategic planning is essential to face changes in the local and global business environment (Neves, 2007).

5. Results: The application of the agribusiness system analysis from TCE and DC

approach framework to Argentine Dairy Agribusiness System

5.1. The Argentine Dairy ABS

Argentina possesses important comparative advantages in terms of agroecological conditions for dairy production; in fact, several studies of IFCN have placed the country as a world cost leader. Nevertheless, the Dairy ABS is strongly oriented to the domestic market: exports never represented more than 30% of production (currently 15%), and has been historically an exporter of production surpluses. Since 1999 there has been a stagnation of production levels: production has oscillated around 10,000 million liters, not increasing at all.

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A schematic overview of the Dairy ABS is provided in the figure below. Agents and transactions in which this study focuses are showed in capital letters and highlighted:

Figure 3: Argentine Dairy ABS schema

Source: The authors

The arrows show product flow across the Dairy ABS. There are a great number of organizations that influence the Dairy ABS, which are mentioned in the bottom boxes of figure 1. The most important features of key involved agents are presented next:

Table 1: Main attributes of key Agents in the Argentine Dairy ABS

Fa

rmers

Milk farms are organized regionally, in basins, concentrated in the provinces of Buenos Aires (29.6%), Santa Fe (31.9%), and Cordoba (32.1%), and in a smaller proportion, Entre Ríos (5.5%), and La Pampa (1%).

The number of dairy farms has decreased by 75% between 1983 and 2010, going from 40,000 to 10,000 dairy farms during the period.

Farming systems are mainly pasture-based which means that production increases in spring and autumn, and is heavily reduced in winter and summer.

Some farmers have gathered in groups known as raw milk sale pools in order to gain more bargaining power.

Pro

cess

ors

There exist approximately 1200 processors, which employ around 30,000 people. Similarly, to farmers, the industry has been settling in the more favorable areas for milk production in the provinces above mentioned.

64% of the total dairy production is conducted by 20 dairy processors, of what two largest concentrate around 30%.

61% of the dairy plants are within the smaller operative scale, ranging from 5,000 to 20,000 liters per day, and constituting the so-called dairy SMEs. The milk companies that can operate more than 250,000 liters per day only represent 4% of the total.

Large processors hold the leading brands and have a wide variety of products: their portfolio includes from fluid milk and cheese to high value added products. Three of these processors concentrate 90% of fluid milk and yoghurt domestic market

SMEs processors portfolio is mainly composed by the cheese.

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Ret

ail

ers

Dairy products sales are distributed as follows o Large retailers (Supermarkets) account for 37.3% of sales. Six retail chains explain 82% of total food and beverage supermarket sales. o Small supermarkets 35% (10% are from the Asian community). o Convenience stores 27.7%.

It can be said that indirectly large retailers account for more than 50% of dairy products’ sales: convenience stores in general are supplied by large wholesalers. The Asian small supermarkets have developed a collective bulk buying system through their chamber.

Large retail chains have been experiencing a process of fusions and acquisitions since the mid ‘90s that have led to greater concentration at this stage.

It is also important to point out that large retailers’ price strategies and trends –as they are leaders of the industry- are followed by the rest of the retailers.

Co

nsu

mer

s Consumers are increasingly searching for dairy products regarding healthiness, and also convenience.

Though, dairy consumption habits are below standards: teenagers and adults are 25% below recommended intake.

Dairy consumption is negatively affected by economic crisis: in 2002 crisis it decreased more than 10% in a year.

Source: designed by authors, based on Lacelli 2006, AC Nielsen, SAGPyA, personal communications with

experts.

From a general point of view, it is observed that Argentina Dairy production has stabilized at levels around 10,000 million liters per year, while there has been a reduction in the number of farms (75%) in the last 27 years. There are more than 1,200 processors, but milk purchases are concentrated in 20 companies. The largest processors - which own the leading dairy brands - hold 30% of the share. Large retailers, supermarkets and wholesalers, when considered together, hold more than 50% of dairy products’ sales.

5.2. The institutional environment in the Argentine Dairy Agribusiness System

The Dairy ABS has not been exempt from the institutional environment in which food and agribusiness take places in Argentina. Historically, the agri-food sector has received very little direct government support. The agricultural export taxes, quotas and trade restrictions have been used extensively to dampen internal prices and encourage domestic processing (Ordóñez and Nichols, 2003).

In particular, since 2005, a growing awareness of rising food prices led to the implementation of policies with the purpose of curbing the dairy product prices for consumers, blaming raw material prices for the increase of the ones at supermarkets (Dulce et al, 2009). In that sense, government intervention has developed basically under three mechanisms:

Control of domestic prices, by setting agreements with different agents within the Dairy ABS, mainly with leading processors, and farmers associations. These agreements were set in high conflictive environments and, in general, did not represent equally the interests of agents involved.

Regulations that affected resource allocation between the different agents of the

Dairy ABS, the main mechanisms implemented were direct subsidies, cross subsidies and export duties: ad valorem taxes and maximum export prices.

Export regulations, by implementing licensing requirements that represented high bureaucracy in the exporting process.

These interventions had an adverse effect in both transactions under study. In the case of farmers and processors, government sectoral agreements on the matter have favored large processors, as they set maximum prices for raw-milk purchasing and were also benefited by subsidies: between 2007 and 2009, approximately 60% of a U$S300 million-total subsidies

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were destined to processors. Around 65% of this amount was destined to the largest two processors, and 40 % between 11 processors (ONCCA, AACREA).

In the case of processors and retailers, retailers were benefited, as result of increasing competition between processors (especially of SMEs) who at the same time had to deal with price controls and export restrictions which forced oversupply scenarios. In

At both stages it is observed that state intervention also affected price transparency and information asymmetries, as price information mechanisms for raw milk and processed products were eliminated or heavily distorted.

It can be said that policies restricting exports and controlling prices, which were set with the purpose of curbing dairy product prices for consumers, lacked of effectiveness. When international prices decreased after skyrocketing in 2007, domestic market consumer prices for basic products continued to increase. This occurred despite the decrease of farmgate milk prices in the second semester of 2008 and the first trimester of 2009.

Figure 2: shows how the process adjusts on farmers: they were not able to benefit from increasing domestic prices as their share on final products sales income decreased. It is also important to highlight the heavy tax pressure on the product (21%).

Figure 4: Evolution of share on sales income of por salut cheese of farmers, processors, retailers and taxes.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1 2 3 4 5 6 7 8 9

10

11

12 1 2 3 4 5 6 7 8 9

10

11

12 1 2 3 4 5 6 7 8 9

10

11

12 1 2 3

2006 2007 2008 2009

Farmer share processing cost Processor margin + retailer share TAX

Source: The authors based on data from ADELCO, CAPROLECOBA and interviews with experts.

Note: Por salut cheese was selected in this analysis as is it a basic representative product of the processing

industry. It was not possible to distinguish retailers share from processors as the available data on wholesale

price is scarce. To make a better approach to this matter, a calculation on the processing cost was included in

the analysis.

As a synthesis, it is observed that state intervention through mechanisms such as price controls, cross subsidies and export restrictions lead to a high uncertain environment in the Dairy ABS that has encouraged asymmetries and conflicts between agents.

5.3. Dependency origin and Power-bases relationships between farmers, suppliers

and retailers

Taking into account the previously described structure of the market and the institutional environment, where the activity takes place, the following tables 2 and 3 present the sources of dependency and power bases identified at Farmer-Processor and Processor-Retailer dyads:

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Table 2: Identification of sources of dependency

Farmer – Processor Processor – Retailer

Sales and Profits

Although at national level there are many processors and farmers, at regional level there are never more than two or three large buyers of raw milk per basin. In that sense, farmers tend to deliver their production to one processor, which makes the former very dependent on the latter.

Collusive behavior is observed between processors in raw milk purchasing: they agree on criteria to accept farmers in their supply network that delivered before to another processor. Otherwise, this is seen as a “stealing act”. This

reduces even more the farmer’s alternatives to

obtain better commercial conditions, as processors´ supply networks are very rigid structures.

In the case of raw milk sale pools, they

increase their dependency on processors when their output is sold to only one or two of them, in particular in oversupply scenarios (spring). This situation is partly compensated in undersupply scenarios (winter-summer) when processors need to reduce idle capacity.

Processors find in the supermarkets a good distribution channel alternative as they allow to sell great volumes, diminishing logistic costs, and there is also less risk of lack of payment. This dependency is not symmetric: a supermarket may sell 20,000 or 30,000 products, which may come from a large number of suppliers, while processors may sell 20 to 70% of their output to a few retailers.

Investment in asset specificity and compensatory investments

It is observed that at farming and processing stages investment in specific assets that have low alternative uses are required (milking cows, machinery, human resources and processing facilities). These high levels of asset specificity also represent high barriers to exit the activity.

Processors invest in product development, brands, product positioning. Supermarkets positioning -their brands- and their geographical location determine processors dependency on them to effectively sell their products and obtain expected turnovers. Processors may also invest (or relocating existing investments) in product development for supermarkets private labels, which makes the former more dependent on the latter.

Role Performance

During favorable periods in dairy agribusiness, processors are more willing to maintain fluent relationships with farmers. Though, in periods of crisis, or like the current market distortion due to state intervention, farmers become more dependent on the processors´ performance and its policy towards farmers in terms of prices and terms of payment.

Supermarkets depend on leading branded products as they are part of the consumer choice: if they de-list them, buyers would look for them –and other products – in a rival store. In the case of private label suppliers and second brands from SMEs (mainly cheese), large retailers are little dependant as they have more facility to switch supplier.

Source: The authors based on interviews with experts, Visser 2000; Garcia Maritano, 2007; UK

Competition Commission; 2008, Commission of the European Communities, 2008.

From the table above it is observed that farmers are dependent on processors to sell their production: in general they operate with the same one, making daily deliveries. Collusive behavior from processors is observed as at regional level there are never more than two or three large buyers of raw milk.

In the case transactions between processors and supermarkets, processors are dependent on them mainly in terms of sales and profits: in many cases they market high percentage of their products through them while supermarkets can switch of suppliers easily. In the case of the relationships between large processors and supermarkets, dependency relationships are somehow more balance as supermarkets need to sell leading branded products because they

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are part of the consumer choice. Interviewed agents have agreed that SMEs have failed to develop brands and consumer fidelity.

Taking these statements into account, the following table presents power relationships in both dyads and how power is exerted.

Table 3: Identification of power-bases

Farmer – Processor Processor - Retailer

Rew

ard

Po

wer

Processors exercise high reward power, as they control payment mechanisms to farmers. They also implement arbitrary payments known as “commercial bonuses” to grant farmers. The

criterion for setting them lacks transparency and depends on the informal relationship between the counterparts.

When processors need to increase raw milk supply, in general they offer prices surplus to farmers in order to encourage them to become part of their supply network. Though, this strategy based on reward power is not maintained in the medium and long term: bonuses are further diminished or eliminated.

Promotional expenditures can be seen as rewards coming from processors (in general, large processors). Rewards are in form of higher sales and higher prices, (in particular for premium products which are not affected by price control policies. Danone, for example, was the second biggest advertiser of Argentina in 2009.

Per

sua

sio

n P

ow

er

Persuasion power is used along with reward power, as processors offer to improve business relationships (follow up) with farmers if they become part of their supply network.

Retailers exercise strong persuasion power in particular with leading processors by imposing

monetary sums for displaying products on key-spaces of shelves. This mechanisms work based on supermarkets channel leadership, developing the ability to manage competition between processors.

Co

erci

ve

Po

wer

As mentioned before, collusive behavior of processors leads to coercive power: farmers base their decision-making process in the risk of being penalized; this means they perceive higher costs for discontinuing operating with the counterpart.

The most common mechanisms associated to this power base are related to contractual weaknesses that allow processors to impose their purchasing practices (payment term, prices, quality payment mechanisms, etc), without farmers consent at all. These aspects are further discussed in the next section.

Retailers exercise strong coercive power by:

Seeking or imposing discounts on previously agreed prices.

Requiring or requesting to “buy back”

unsold products, this is critical considering the perishability of the products and turns to be an undercover discount:

Delaying payments to suppliers beyond the terms of previous agreements

Imposing contributions to special promotions such as “3 for 2” deals.

Supply the shelf space for free, during 5/7 days when a new retailer store is opened, especially when the supplier is highly dependent on the retailer.

Especially in the case of SMEs processors: retailers de-list their products if they don’t consent

with their terms of agreement.

Leg

itim

ate

an

d

Ref

eren

t P

ow

er

Traditional legitimate power and referent power play an important role. Farmers have traditional relationships with processors and identification with their image of “traditional and leaders”.

Retailers may require suppliers to change quantities or product/quality specifications at less than three days’ notice, and without paying compensation to

suppliers (Legitimate power). Retailers need leading brands, as they are part of the consumers´ choice. This gives large processors more power to negotiate prices and products to be sold (Referent power).

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Farmer – Processor Processor - Retailer In

form

ati

on

Po

wer

Processors exercise high information power as there is not a system of reference prices neither at regional nor national levels: state information system was discontinued in September 2008.

In that sense, processors have greater information on prices as they buy at regional level and have also contact with others. This is a disadvantage for the farmer’s decision-making: they learn their final price around 30 days after milk was delivered.

This asymmetry is perceived when comparing farmers who delivered raw-milk to the same processor in equal conditions (quality, volume) but are not paid the same prices.

Information power is one of the most important power-bases for the retail. Retailers are close to the customers and have access to customer data. They also are aware of processors´ costs and sales performance; as such information strengthens their position during negotiations.

Ex

per

t p

ow

er

Farmers lack of marketing –bargaining-- skills. Collective bargaining trough raw milk sale pools

is not usual at all, and still these horizontal forms of coordination negotiating capabilities are in general underdeveloped in comparison to processors, purchasing departments. These have high skilled human resources on the matter, who have developed great abilities for bargaining.

Since the retail chains have deep knowledge of their customers they are able to implement a marketing mix focused on the wishes of the consumers. The retail chains are transformed into professional marketing organizations, possessing a high level of knowledge in the field of consumer behavior and the marketing of products.

Source: The authors based on interviews with experts, Visser 2000; Garcia Maritano, 2007; UK

Competition Commission; 2008, Commission of the European Communities, 2008.

It can be said that there is a parallelism between both dyads where the exercise of coercive power base prevails. Processors exert coercive power by means of imposing payment mechanisms that lack of transparency, which is also enabled by their information power as there is no system of reference prices neither at regional nor national levels:

Between supermarkets and processors, coercive power is of explicit use when they obtain discounts through a wide variety of mechanisms above detailed that are not related to buying in bulk.

5.4. Description of transaction attributes, identification of prevailing governance

structure and analysis of transaction alignment

The following table presents the attributes and governance structure of the transaction of raw milk and processed products.

Table 4: Description of transaction attributes and identification of prevailing governance structure

Farmer – Processor Processor – Retailer (Supermarket)

Asset

Speci

ficity

HIGH: due to the perishable nature of raw milk. HIGH: due to the perishable nature of dairy products. Asset specificity also relies on the investment in product development, being the key asset the brand of the product and positioning in the market.

Freq

uency

HIGH: raw milk deliveries from farmers are daily, usually to the same processor.

HIGH: Dairy products deliveries from processors to supermarkets have a weekly-to-daily frequency.

Unce

rtaint

y

HIGH: There is a context of high uncertainty on the part of the farmers, as they do not know the prices to be paid, or payment terms, or volume, or quality.

MEDIUM: Though trading with supermarkets means less risk of no payment, uncertainty relies on discounts on the product and changes on payment terms.

14

Farmer – Processor Processor – Retailer (Supermarket) G

OV

ER

NA

NC

E

ST

RU

CT

UR

E

Informal contracts prevail. They implicitly state that the farmer has to deliver the production periodically, while the processor commits to receive the totality of it. Though, each processor has standard conditions for raw-milk delivery regarding quality matters.

In general farmers deliver their production to one processor but as previously mentioned, there isn’t a formal “exclusive purchase” contract

stating so.

Formal –written– contracts are not widely adopted in this dyad, especially those specifying quantities or prices of products to be supplied to the supermarkets. However, retailer’s chains do

have standard conditions for delivery arrangements and similar matters.

Source: the authors

Taking these facts into account, the degree of the transaction alignment is analyzed as follows:

Table 5: Analysis of transaction alignment and transaction costs

Farmer – Processor Processor – Retailer (Supermarket)

Pri

ce

It is not usual to pre-set prices or cashing guarantees: processors inform prices to be paid 30 or more days after milk was delivered.

Current payment mechanism lacks transparency as processors use “commercial bonuses” to grant

farmers. These are given in an arbitrary way and may explain up to 20% of the farmer’s income.

There is no public information service on prices: current “official reference prices” set by the

government’s agreements with the sector are not

clear and have a low degree of respect, as there is a local price formation mechanism in every basin.

In general, pre-arranged price is not finally received by processors as the different discount mechanisms are imposed, especially with SMEs processors.

This leads to a global inefficiency of the system as processors end up preventing themselves from this behavior by increasing prices. Though, due to heavy competition among SMEs (which mainly produce cheese) there are fewer margins to doing so.

Pa

ym

ent

Ter

m

Farmers take notice on the price when they receive the payment, at least 30 days from milk delivery. This implies a financial cost, especially considering the current inflationary scenario and lack of credit.

Large farmers incur in longer payment terms because of the larger amount of money they are owed.

Payments terms vary from 30-90 days. As with larger farmers, larger processors incur in longer payment terms.

Long payment term may incur in the risk that terms of payment do not match product turnover, and also represents financial restrictions to pay back farmers

Ass

et S

pec

ific

ity

Diverse aspects concerning quality operate as adjustment mechanisms, but this tends to lead to opportunistic behaviors as the processors themselves conduct quality controls, without general consent regarding reliable organizations and laboratories that can test quality and compare to the processors’ testing.

Moreover, quality payment mechanisms are deteriorated when considering “commercial

bonuses” that end up representing higher

contribution to farmers’ income than milk

quality.

The mechanisms concerning asset specificity and quasi-rent appropriation vary according to the processor involved: large processors -where higher asset specificity is involved- in general obtain better price arrangements in comparison to SMEs, whose negotiations with supermarkets are mainly price-driven and thus there is higher risk of quasi rent appropriation by supermarkets.

15

Sa

feg

ua

rds

As there are no formal contracts, there are no safeguards. Farmers have no mechanisms to discuss the payments they have received and even they are the largest short-term credit lenders to processors (production is paid at least 30 days after delivered), they are the less protected creditors in case of processors bankruptcy. Furthermore, non-payment risk is very high, and occurs frequently in economic and financial crises which, in Argentina, are recurrent. As mentioned before, industries use their raw milk quality standards as safeguarding mechanisms.

Even though non-payment risk with supermarkets is low, there aren’t enough safeguards preventing

from unexpected discounts or penalizations, and there is no “appealing” mechanism regarding these

issues.

Like with farmers and processors, retailers use their standard delivery conditions as safeguarding mechanisms. Still, processors don’t have any

appealing mechanisms if they don’t agree with imposed discounts under these terms.

Source: the authors

From the configuration of the supply contracts specified above, it is clear that the contractual framework where property rights of raw-milk and processed products are transferred is very poor and there is a low transaction alignment. Systematically, undue elements of commercial risk—that would otherwise rest with the buyers—are transferred to the suppliers.

In the case of farmers and processors, there aren’t any formal agreements neither safeguards for the transaction. High transaction costs and opportunism is observed as price formation is not transparent and there is high non-payment risk.

Between processors and supermarkets, incomplete contracts prevail, with low safeguards of the transaction. This leads to opportunism and transaction costs, reflected in unexpected price discounts, non-agreed extension of payment terms.

5.5. Management implications and formulation of recommendations

Results obtained at each stage of the study show the following critical points:

Argentina’s Dairy production has stabilized at levels around 10,000 million liters per year, while there has been a reduction in the number of farms (77%) in the last 27 years. There are more than 1,200 processors, but milk purchases are concentrated in 20 companies where the two largest- which hold the leading dairy brands - hold 30% of the share. Large retailers, supermarkets and wholesalers, when considered together, hold more than 50% of dairy products’ sales

The Dairy ABS is facing a process of state intervention through mechanisms such as price controls, cross subsidies and export restrictions that lead to a high uncertain environment in the Dairy ABS that has encouraged asymmetries and conflicts between agents involved in both dyads under study: farmer-processor and processor-retailer.

Farmers are dependent on processors to sell their production: in general they operate with the same one, making daily deliveries. Collusive behavior from processors is observed as at regional level there are never more than two or three large buyers of raw milk. Similarly, processors are dependent supermarkets mainly in terms of sales and profits, while supermarkets can switch of suppliers easily. This situation is more balanced for large processors as supermarkets need to sell leading branded products because they are part of the consumer choice.

In both dyads, the exercise of coercive power prevails. Processors exert coercive power by means of imposing payment mechanisms with lack of transparency, which is also enabled by their information power as there is no system of reference prices neither at regional nor national levels. Between supermarkets and processors coercive

16

power is of explicit use when they obtain discounts through a wide variety of mechanisms, mentioned above, that are not related to buying in bulk.

The contractual framework where property rights of raw-milk and processed products are transferred is very poor and there is a low transaction alignment In the case of farmers and processors, there aren’t any formal agreements neither safeguards for the

transaction. High transaction costs and opportunism are observed as price formation is not transparent and there is high non-payment risk. Between processors and supermarkets, incomplete contracts prevail, with low safeguards of the transaction. This leads to opportunism and transaction costs, reflected in unexpected price discounts, or non-agreed extension of payment terms.

Agents find it difficult to adjust to a situation marked by turbulent institutional scenario, an intensely competitive retail market and aggressive competition among processors for rights to supply major retailers. This yields to a situation where, in the end, adjustment relies on the farmers, which have less power and greater dependency downstream.

In that sense, literature review shows that in the long term, the exercise of buyer power can have adverse effects on consumers. UK Competition Commission has found that “the transfer

of excessive risk and unexpected costs by grocery retailers to their suppliers through various supply chain practices if unchecked will have an adverse effect on investment and innovation in the supply chain, and ultimately on consumers” (UK Competition Commission, 2008).

Still, opportunities arise with world demand growth, driven by global food market trends: rising per capita incomes, population growth, urbanization, Westernization of diets, etc. To successfully face these challenges, and to turn comparative advantages into competitive advantages, the Argentine Dairy ABS will have to innovate into a superior design able to balance relationships between agents in the long term.

There are efforts currently taking place in order to implement strategic planning across de ABS. Still that is occurring in a very convulsive environment. In that sense, (based on Vilella et al, 2009; Neves 2007, Neves et al, 2001), following steps for ABS planning after an in-depth internal and external diagnosis should derive into:

the setting of common goals for the ABS—at the long and short terms— with the consensus of the involved agents;

the design and implementation of collective strategies. Actions should be able align institutional, organizational and technological environment, allowing to balance relationships between agents.

Leadership across the ABS will be the key to innovation. This could be achieved through a vertical organization able to represent and harmonize interests as to facilitate the coordination of joint actions (based on Vilella et al, 2009; Neves 2007, Neves et al, 2001),

5.6. Conclusions

The result of this study is as proposal and application of a methodology to analyze the articulation of buisiness relationships in an ABS. Following the proposed steps of analysis it was possible to understand in both dyads under –farmers and processors and processors-relatilers – where major constraints and limitation for articulation rely.

These results are the base for the formulation of strategic actions in order to enable long term relationships between agents. In the turbulent context in which the Dairy ABS develops, it is expected that long-term commitments will enable the reduction of transaction costs,

17

strengthen information flows and work towards achieving common goals (as strategic planning aims).

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