Innovative Development Model for

Rural Prosperity

Global Young Leaders Programme

Shanxi Project 2009

Table of Contents

I. Executive summary

II. Background

III. Business opportunity

IV. Value proposition

V. Marketing plan

VI. Management

VII. Financial analysis

VIII. Economic, social and environmental benefits

IX. Risk assessment and mitigation

X. Implementation plan

I. Executive Summary

• Shanxi province has high levels of rural poverty where agricultural growth is limited by small scale farming structures and rural-urban migration.

• However, farming associations in the province are keen to embrace new ideas especially for sustainable organic farming to uplift communities.

• The Pohan Farmers Association is the first registered farmers’ association in China comprising 3,800 farmer members and is a successful model of rural entrepreneurship and leadership.

• There is an opportunity for organic cotton due to growing global demand (US$3.2 billion market in 2008), growing green awareness and improvements to community livelihoods through sustainable farming.

Executive Summary (cont’d)

• The value proposition is to set up a JV company leveraging the association’s strategic advantages by moving up the supply chain to process seed cotton into lint cotton and commanding premium prices for branded cotton products. The association will have dedicated land resources certified to international organic standards to supply the JV.

Farming Ginning

Proposed JV

Buyers• Spinning factory

• Retailer

• Domestic/foreign buyers etc.

Trading

Seed Lint Yarn/Fabric

• The JV, which has strong support from the Provincial Government, will brand the cotton to make

it attractive to high end buyers, provide stable market access for the villagers and will transfer

management know-how to the local community.

• A strong branding and marketing strategy will be implemented by keeping the spending low in

early years to manage operating costs and ramping up marketing investments from year four

onwards.

• The recommended structure is a contractual joint venture with limited liability of each party to the

cooperative agreement between the farmers association and the investor. Under CJV

agreement terms, the profit is negotiable i.e. parties can receive different distribution ratios in

different years. The management structure can be self determined rather than by governing

PRC laws.

Executive Summary (cont’d)

• Financial summary:– Total investment cost of ¥2.32 million

– Short payback period of 5 years

– Project IRR (10 years) of 30%

– Strong and consistent cash flows of ¥3.4 million from year 5 onwards (after the organic conversion period)

– Excellent growth potential in the Extended Yellow River Region

• Benefits to community– By converting to organic cotton farming, the farmers will benefit from

organic price premium and increase their income level up to 40%.

– With organic cotton farming, use of harmful chemical fertilizers, pesticides and genetically modified cotton seeds will be eliminated.

– The JV will create more than 30 job opportunities within the JV and related business and retain young talents in the community.

– While the government provides subsidies, with increased funding to the Community Development Fund, there is scope to provide healthcare over and above primary healthcare services.

6

Executive Summary (cont’d)

Initiative Yr 0

Mth 1-3

Yr 0

Mth 4-6

Yr 0

Mth 7-9

Yr 0

Mth 10-12

Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6

onward

Marketing

channels

Set up online

presence (join

B2B portal, own

basic website)

Advertise on

China Textile

Accessories

Magazine

Start joining

trade fairs

Build

interactive

website

Certification Phase 1 land: apply for cert Phase 1 land: conversion period

Phase 1

land:

obtain cert

Phase 2

land: apply

for cert

SPOCTE

Operations

Set up T.E.

office, hire GM,

HR & Finance

heads

Hire other key positions

Ginning

FactoryDesign factory

Construct factory &

purchase machines

Start

ginning

Obtain

organic cert

TrainingDevelop training plan & road

map

1st round of team

training

Finance

Approach

potential

investors

Negotiate &

conclude JV

1st capital

injection:

RMB1.2m

2nd capital

injection:

RMB1.12m

Implementation Timeframe

II. Background

China

Shanxi Province

The Cotton Industry

Pohan Farmers Association

China – Land of Hope and Despair

Rural areas are not realising the

benefits of development

China is a rapidly

developing economy

9

BACKGROUND: CHINA

Rapid economic growth and huge capacity

• 9% annual growth rate in 2008

• 4.4 trillion USD in 2008, No.3 in the world

Low per capita GDP

• USD 3,381 per capita, No. 104 in the world

Huge GAP in per capita income between urban and rural area

• Urban area: RMB 15,481

• Rural area: RMB 4,761

Rural community NOT benefiting enough from China’s robust

and rapid economic growth

BACKGROUND: SHANXI PROVINCE

Demographics:

• Population: 34 million

• 34 minority groups; 0.32% of

population

Economics:• 2.12% of China’s annual GDP

• No.18 out of 34 provinces

• Per capita GDP

• RMB 20,398 (USD 2,985); RMB

2,242 lower than national average

• Annual household income

• Urban: RMB13,119

• Rural: RMB4,097; RMB664 lower

than national average

Challenges and Opportunities in Shanxi

Opportunities

• Converting to organic farming

can make a significant impact on

the environment.

• Growing global demand for

organic products

• Farming associations are already

established in the region and are

keen to embrace new ideas for

sustainable organic farming.

Challenges• High levels of rural poverty

• Small scale farming structures limit agricultural growth

• Rural-urban migration

• Environmental deterioration.

Shanxi Province can benefit widely from

improvements in farming techniques.

Cotton Industry

Worldwide:

• 31 million ha (465 million mu) or 2.4 % of global arable land used for cotton production.

• 50 million farmers employed in over 100 countries

• Production of cotton in 2008 = 23.3 million metric tons.

World Lint Cotton Production Distribution in 2008

U.S.A ; 3.2

China; 7.8

India; 5.1

Pakistan; 2

Brazil; 1.4

Uzbekistan;

1.1

Others; 5.1

30%

20%

12%

20%

8%

5%

4%

Million Tons

1mu = 0.06 ha

China:• The biggest cotton producer and consumer

• Producing 7.8 million metric tons and consuming 9.9 million metric tons in 2008.

• About 14 million Chinese farmers directly involved in cotton production in regions as above.

Organic cotton is the way forward

Cotton Industry

Organic Cotton Farming

• Land Management

• No Pesticides

• No Herbicides

• No Genetically

Modified Seeds

Organic cotton farming uses the earth’s

natural resources for sustainability

• Natural Fertilisers

• Fair Treatment of

workers

• Water

management

Organic agriculture combines tradition, innovation and

science to benefit the shared environment and promote fair

relationships and a good quality of life for all involved.—International Federation of Organic Agriculture Movements[4]

Organic Cotton Benefits

• Elimination of toxic

chemicals

• Water savings

• Elimination of genetically

modified seeds

• Long term soil fertility

• Organic certification

requires fair working

conditions for all worker

along

Pohan Farmers’ Association (PFA)

• 1st registered farmers’ association in China in 2004

• Membership: approx. 3,800 farmers

(Average income: 2,400RMB/mu/yr)

• Established in 1998 by Ms. Zheng Bin(Nominated for the 1000

Global Women Nobel Peace Prize 2005,

Top 10 rural entrepreneurs in China in 2008)

• Current Status

- Well organized farmers’ association with a mission to uplift rural

livelihoods today and providing 28 full-time jobs

Ms. Zheng: Visionary Leader

Organic Farming &

Trading Association

Women’s Handicraft

cooperative

Rural retail chains

Green Family GroupFarmers’ school

Youth Organic

Farming Group

Application of

Farming technique,

Hands-on

experiences

Fertilizers

based on

Chinese

tradition

medicine

Growing

& Selling

of Cotton

Fertilizers

based on

Chinese

traditional

medicine

PFA Key Projects

Transfer of

Experience &

Track Record

Basic

education,

vocational

skills,

transfer of

farming

know-how

Vision and Inspiration: Harmonious Society

PFA’s Vision

Strategic Goals:

• Promote entrepreneurship

and organic farming

• Strengthen bargaining power

• Improve quality of life

• Enhance community welfare

• Promote sustainable

• development

Promoting Sustainable Development and better MARKET ACCESS

Implementation:

• Selling products

• Provide information

• Adult education

• Engaging youth

Business Opportunity

Organic Cotton Opportunity

International Certification

Organic Cotton Opportunity

Demand55%

Supply45%

Source: Organic Exchange

Global Organic Cotton Supply/Demand Mismatch

Strong & Increasing Global Demand

IRR of 30% within 10 years

30% Price Premium over conventional cotton

Growing Awareness of Green Movement

Great Social Impact & Improve Community Livelihoods

Global Organic Cotton

Production

26% 18%

14%42%

Global Production 2007

India Turkey China Others

Source: Organic Exchange, ‘Textile Information Weekly’

China ranked 3rd producer globally amongst 24 countries in 2008

with Xinjiang dominating China’s production market

Xinjiang95%

Others5%

Domestic Production2007

Organic Cotton in the World Growing Demand & Internationally-Driven

Growing demand from retail drives the global production

A 25 – 55% annual growth rate of organic cotton products in next 5 years

forecasted by Organic Trade Association.

Source : Organic Exchange & International Federation of Organic

Agriculture Movements

0

0.5

1

1.5

2

2.5

3

3.5

2005 2006 2007 2008

Global Retail Sales of

Organic Cotton Products

Sales Value

($billion)

23

Organic Cotton in the World Growing Demand & Internationally-Driven

Major Consumer Countries (2006) Metric Tons

1) United States 9,500

2) Switzerland 2,500

3) Germany 1,500

4) United Kingdom 750

5) France 650

6) Sweden 350

7) Japan 350

8) Italy 250

9) Netherlands 100

Organic Cotton in the World Growing Demand & Internationally-Driven

Brand Demand for Organic Cotton is on

the rise

2007 2008 2009

74,839MT

92,998MT

173,272MT

33% 25%

Source: Organic Exchange, Nike & Wal-Mart Company

Website

2008 Green Initiatives of two of

the global largest users:

Purchased more than

12.7 thousand tons of

organic cotton and an

additional 5.5 tons of

transitional cotton from

1000 farmers at certified

organic prices.

For every cotton-

containing apparel

product to contain

at least 5 percent

organic cotton by

2011.

• Growing global demand for organic

cotton (2008: US$3.2 billion vs. 2007:

US$1.9 billion)

• Increasing demand for organic cotton

from brand-name buyers

• Growing awareness of the green

movement

• Environmentally friendly: eliminating the

misuse of pesticide and fertilizer

• Improve community livelihoods with

sustainable farming system

• Sales may be susceptible to economic

cycle

• Currently in the start-up phase and

testing land-conversion

• High certification-associated fees and

lengthy implementation process

• Less credibility in the domestic

certification process -> gives rise to many

potential entrants in the organic market

25

Organic Cotton:

Opportunities & Challenges

Opportunities Challenges

Why International Organic Certification is

Required

26

1) Certified products command organic cotton premium

2) Most end-buyers require international certification

3) Certification from China is typically not recognized in the international market

4) Largest organic cotton end-consumers are US, EU & Japan

Main Market Standards: 1) US NOP, 2) EU 2091/2, 3) Japan JAS

• Certain brand-name retailers may have other sets of requirements

International Certification

• Standards need to be applied across the value-chain down to the farm & ginning factory

• Need to engage a accredited certification company for the application process

• Certifies both the land & specified product

• Annual inspection & renewal

Organic Certification Process

Timeframe: 6 months

Validity Period: 1

year

Inspection required

every year

85,000RMB /year

Engage

Certification company

Engage certification

company which are

accredited by the

standards bodies

Pre-Conversion

Certification company

execute first inspection:

1.Farming standard

2.Requirement

1.Application form

2.Documentation etc.

Certification company

inspect conversion

process

Required Conversion

Period

US: 3 years

EU: 2 years

JPN: 2 years

2 months to complete

certification process

Cost: 25,000 RMB /year 85,000RMB /year

2.5-3.5 years

Conversion

PeriodYearly

Renewal

Certification Process Requires

4 Years

Value Proposition

Value Proposition

JV Vision

Business Model

Rationale

Competitive Advantage

Value Proposition

• The value proposition is to set up a JV company leveraging OFTA’s strategic advantages and moving up the supply chain to process seed cotton into lint cotton.

• The JV company will focus on organic cotton with a dedicated ginning factory for organic lint cotton production.

• Through its trading arm, the JV will command premium prices for its branded organic lint cotton.

• The OFTA will have dedicated land resources certified to international organic standards to supply organic seed cotton to the JV

By trading directly with the JV, farmers will avoid being exploited by the middlemen and obtain fair prices for their products.

Farming Ginning

Proposed JV

Buyers• Spinning factory

• Retailer

• Domestic/foreign buyers etc.

Trading

Seed Lint Yarn/Fabric

JV Vision

1. China’s Leading Organic Lint Cotton Producer– Provide branded organic lint cotton, which will be certified to

international standards and sold at a competitive price to high end buyers

2. Future Growth – To achieve annual compounded sales growth of 30% over 10 years

3. Opportunities for the Community– To provide economic opportunities for the community through

employment of young farmers as well as nurturing local talent, management capabilities and leadership skills

4. Sustainable development– To promote sustainable development in Shanxi Province and the rest of

China through the elimination of chemical fertilizers, pesticides, herbicides and genetically modified cotton seeds as well as reduced water usage.

The Business Model

JV

Consists of

• Ginning Factory

• Sales and Marketing

OFTA Investors

Purchases

seed cotton

Sales of

Excess

Seed

Cotton

Jointly Owned

Other Ginning

Factories

• Spinning Factories

• Domestic Buyers for

international Market

Sales of Organic

Lint Cotton

Other Organic

Cotton Growers

Buyers

Sales of Cotton

Seed

Relationship Between OFTA and the JV

OFTA

• Facilitates organic conversion of land

• Provides technical support to farmers on organic farming

• Part ownership of JV

JV

• Ownership of ginning factory

• Buys organic seed cotton from

farmers through OFTA

• Converts seed cotton into lint

cotton

• Branding of organic lint cotton

(西 厢 棉)

• Markets and sells lint cotton to

high-end buyers

• Sells by-product cotton seeds

• Profits distributed to OFTA

Rationale

• The JV will brand the organic lint cotton to make it attractive to high end buyers such as buyers for brand retailers (e.g. Muji, Walmart, C&A, Nike, Hugo Boss etc.) and as such obtain a 30% higher premium

• The JV will also provide stable market access for the villagers, which will encourage them to make long term planning and be more responsive to market changes.

• The JV has strong support from the Commerce Administration Department of the Provincial Government who wish to stimulate development of rural enterprises.

• Working with an investor partner, OFTA will benefit from financial support and management know-how (which will be eventually transferred to the local community).

Model is consistent with worldwide organic fair trade best practice

Competitive Advantage of JV

• International Certification in Organic Cotton Production

– aimed to achieve in 4 years time to command a higher price

• Geographical advantages

– Suitable weather in growing organic cotton

– Possesses land reserve which can expand to larger scale production to meet

demand from larger buyers

– Possesses transportation, utilities and production infrastructures (one of the 5

conventional cotton production bases in China.)

• Integrated process controlled by PFA

– includes a ginning factory to provide more value-added products and eliminate

middlemen

• Early Mover

– strategically positioned for early market entry with strong presence and brand

recognition among handful of established producers

34

Local but Global

Organic Cotton – Goods of the Future

35

Marketing Plan

Objectives/Strategies

Branding

Logo

Product Channels

Pricing Strategy

Marketing Objective

37

Become the Most

Respected, Ethically

& Socially

Responsible Organic

Cotton Producer in

China

Branding Objectives

• Delivers a clear message

• Confirms credibility

• Connects with target customers

• Motivates the buyer

• Concretes User Loyalty

Objectives of branding the

trading the entity

•Name of the JV Company Shanxi Pohan Organic Cotton

Trading Enterprise (SPOCTE) signifying the province, name

of the farmers association, product and business.

Branding Signifies

A Social Enterprise for the Pohan Farmers Association

39

Branding Strategy and Positioning

Economy Penetration

Skimming Premium

• Creating a distinctive Brand Image

• Differentiate product

• Top Organic cotton product in China

• Green and environment friendly Product (Organic cotton)

• Top Organic cotton product in China

Brand Positioning

• Key Themes – going green, Organic and local significanceLogo

• XiXiang Mian（西厢棉）Brand name

• Xixiang Ji （西厢记）is one of the most well known classic love stories in China, which

happened in Yongji City (Location of SPOCTE)

• The brand identity indicates green farming, healthy and environmental friendly product and

local significance

Brand identity

Brand Positioning:

- Premium Organic Cotton

Branding Strategy

西 厢 棉

Chinese No.1 organic cotton

西厢棉

Chinese No.1 organic cotton

西 厢 棉Chinese No.1 organic cotton

西 厢 棉

Chinese No.1 organic cotton

Recommended Brand logos for SPOCTE

Marketing Campaign Plan will align with

Production Ramp-Up

Year 1

Year 2

Year 3

Year 4

Year 5 Onwards

• Creating a static content website for SPOCTE

• Advertising in the textile magazine with two insertions per year.

• Listing SPOCTE on B2B website’s (e.g. Alibaba)

• Register SPOCTE with the nearest cotton exchange

• Advertising in the textile magazine with two insertions per year.

• Advertising in the textile magazine with two insertions per year.

• Advertising in the textile magazine with two insertions per year.

• Upgrade website to an interactive with e-marketing website

• Participate in trade fairs

• Advertising in the textile magazine with four insertions per year

• Advertising in Textile Newspaper

• Participate in trade fairs

Scenario 1: Utilizing the 80,000 mu available in Pohan

Scenario 2: Utilizing 300,000 mu available in Yellow River Region

Available Land for Cotton Production

-

5,000

10,000

15,000

20,000

25,000

30,000

Year

0

Year

1

Year

2

Year

3

Year

4

Year

5

Year

6

Year

7

Year

8

Year

9

Year

10

mu

Scenario 1

Scenario 2

TOTAL mu

Marketing Campaign Plan will align with

Production Ramp-Up

1mu = 0.06 ha

Breakup of Marketing Spends

Assumption: inflation rate is 7% YOY

Marketing spends and intensity ramps up with increase in production.

Marketing Strategy

Advertising in textile magazine: Niche targeted magazine to ensure higher

reach in the most cost effective way.

Advertising in Textile Newspaper: Niche and cost effective.

•Creating the static content website in year 1; Upgrade to an interactive e-

marketing website in year four

•List SPOCTE on B2B website's (e.g. Alibaba) to get access to the online

fraternity

•Register SPOCTE with the nearest cotton exchange.

•SPOCTE takes part in trade fair’s since that will provide direct access to

interested buyers.

Media Plan

Online

plan

On ground

plan

Strategy: keep the spends low in early years to manage operating costs and

ramp up marketing investments from year four onwards.

Shanxi Pohan Organic Cotton Trading Enterprise

Products and channelsProduct Range: - Cotton Seed, Raw cotton and Lint cotton

Farming

(raw cotton)

Ginning

(Lint cotton)

Local farmers/factories

(ginning / spinning etc )

Direct Sales to

Domestic buyers

Advertising on Online

BtoB market place

(e.g. alibaba)

Web-site

(links to sales team from

Trading company)

Raw

Cotton

Cotton

Seeds

Lint

Cotton

Sales channels

provide“Cotton seeds" and

“Lint cotton”

provide “Raw cotton”

Sales process

Trading

Section

(marketing

/sales)

provide “Raw cotton”

Pricing Strategy

Economy Penetration

Skimming Premium

Quality Low High

L

o

w

h

i

g

h

P

r

i

c

e

Rationale

- Demand exceeds Supply

- Xinjiang is the only dominant producer in domestic market

- Pro-organic cotton and domestic sourcing policy of Chinese government

Objective

Short to medium term

(3 – 5 years)

- To launch the product successfully

- To gain and expand market shares in

target markets

Long term (5+ years)

- Premium product image

- Top Organic cotton producer in China

Notes: 1- Year 1&2

2- Year 3&4

3- Year 5 & onward

4- Prevailing Organic Cotton Market Price

Price = avg. market price4 X 80% (20%

discount)

Price = avg. market price4 X 90% (10%

discount)

Price = Xinjiang product price X 95%

• Conversion Stage I1

Market Entry Pricing

• Conversion Stage II2

Marketing Penetration

Pricing

• Certified Organic3

Steady Stage Pricing

Pricing Strategy (cont’d)

Management &

GovernanceObjective

Structure

Governance

Training and Development

OBJECTIVE

– Structure – clear

organizational chain of command

– Leadership – commitment

towards accountability, efficient

operations & profitability

– Transparency – open and

regular communication with

various stakeholders on key

compliance and financial

indicators

•Assist SPOCTE’s sustainable organic cotton production through:

http://www.wilsenachvanwyk.co.za/images/Management%20Team.jpg

Corporate Structure of SPOCTE

• Creating most favourable partnership between PFA and Investor to ensure SPOCTE as most reliable ethically & socially responsible organic cotton producer in China while sustaining profitable growth.

Recommended structure

– Limits liability of each party to the cooperative agreement

– Established through cooperative agreement between PFA and Investor

– Governed under CJV Agreement terms as negotiated between PFA & Investor rather than governing PRC laws.

– * Profit negotiable; parties can receive different distribution ratios in different years as agreed by PFA and Investor under CJV Agreement

– Investor may receive profit prior to CJV corporate income tax & prior to CJV distribution of profits

– Management Organization Structure can be self determined under CJV Agreement terms rather than governing PRC laws.

N.B. See appendix for Cost & Procedure diagram of incorporating CJV

* Investor receives higher % profit for stated period of time for purposes such as recovering invested capital.

Contractual Joint Venture (CJV) as Limited Liability Company

Organization Structure of SPOCTE

Board of Directors

General Manager

(1)

Company Audit

(1)

Sales & Marketing

(2)

HR, PR & Community

(2)

Financial

Controller and

Deputy Controller

(2)

Production &

Supply Chain

(2)

Factory Workers

(Part-time)

(15)

Technician

(1)

Quality Assurance

(1)

( ) denotes headcount

Leadership Roles & Responsibilities

General

Manager

Sales &

Marketing

Production

& Supply

Chain

Financial

HR, PR &

Community

Company

Audit

Oversees all of the company's sales & marketing as well as the daily operation

of the company, and reports to the Board of Director.

Promoting the product to the market to develop business opportunities for the

company and ensure the implementation of the annual sales target.

To source the raw material for the factory and be responsible for all the

production processes in the factory.

Responsible for the accounting issues, prepare monthly financial report and

prepare budgeting proposal to the General Manager as well as the Board.

Responsible for the management, training and development of the organization,

and liaising with relevant parties, such as government & certification companies.

Responsible for management, training & development of CJV, liaise with relevant

parties such as governmental department, certified agents.

Ensure governance of CJV in meeting Financial, CSR and Organic

Production commitments, reporting directly to Board of Directors.

Members in Board of Directors

• It is advised that the Board of Directors contain executive & non-

executive members as follows:

Independent

Director

(Accounting

background)

Independent

Director

(Agricultural

background)

Related NGO

Representative

(e.g. FuPing)

Local

Government

Representative

NON-EXECUTIVEEXECUTIVE

PFA

Representative

Investor

Representative

General

Manager

Governance Challenge

Several predictable challenges:

• To recruit competent audit talent, who possess the knowledge and skills for

finance, CSR and Organic cotton farming and ginning in local;

• Governance should be strengthened because some the farmers with small

plots can potentially damage the credibility of the organic cotton due to

some of their practices;

• To raise the awareness on health, safety, and labor issues in the Ginning

factory and seek compliance with the overall mission to be ethically and

socially responsible;

• Meet the international and domestic standard on Health, Safety &

Environment

• Meet the international and domestic standard on labor

54

Governance - CSR check list

Labor

• What is the local minimum hiring age?

• What system is in the factory to prevent child labor hiring?

• What is the local minimum wage?

• What is the lowest basic salary in the factory?

• How does the factory pay Saturday and Sunday work?

Environmental, Health & Safety

• Is the noise level monitored in the workshop?

• Is the management aware of noise hazard?

• Is the management aware of hazards of dust?

• Are the workers provided with necessary personal protective

equipments（个人保护用品）n the factory

• Are there regular safety and health trainings for the factory workers

Training & Development

Aim• To refresh and upgrade employees’ and farmers’ knowledge and skills, so as to

achieve SPOCTE’s production and sales goals

Focus Areas• Organic agricultural standards and methods

• Health and safety standards and methods

• Business-related concepts and skills e.g. marketing, law

• Leadership and team building

• IT and technical skills

Modes• Classroom workshops (leveraging on farmer school)

• On-site field training

Resources• SPOCTE HR staff

• Farmer school teachers

• OFTA leaders & experts e.g. technical support team, YOTG members

• External experts e.g. agriculture university academics, certification company experts

Training & Development

– Improve farming techniquesInvite external agriculture experts to

improve current farming school’s quality of

training.

– Expand knowledge

Invest resources into current farming

school and educate teachers to expand

and modernize training

Training & Development

Company vision

• Company culture

• Safety awareness

• Employee attitude and behavior

• Company policy

• Organic agriculture and environment

Technical

• Organic cotton planting

• Organic cotton quality control

• Environment (soil, water) for organic

Cotton

• Ginning techniques

• Quality control on ginning

Skill

• How to learn by computer

• How to do business-sell products

• Basic international trading knowledge

• Negotiation skill

Knowledge

• Reading

• Basic English for young leaders

• Communication

• Team building

• Time management

• Effective Supply Chain management

• To be a modern farmer

Financial Analysis

Investment Requirements

Key Assumptions

Financial Projections

Summary

Investment Requirements

• Benefits of SPOCTE funding:

– Higher price premium with more value-added products

– Increased income by dealing directly with buyers

– Both OFTA and SPOCTE will benefit by fair returns

• An upfront ¥2.32 million capital injection to cover the investment

costs, which will be incurred in first 12 months comprising:

– ¥ 2.2 million initial investment for the ginning factory, including:

machinery and installation, land, workshop, office, and initial working

capital

– ¥0.12 million investment for the sales and marketing department to set

up the company’s website

60

Key Financial Assumptions

• The financial model is based on equity

funding for ginning factory with

capacity of 6 tons/day of lint cotton for

10 years.

• The conversion ratio of raw cotton (raw

material) to lint cotton is 3:1.

• 2 sources of revenues are available:

lint cotton and cotton seeds.

• Straight line method is applied for

depreciation.

• 4-year conversion period for organic

certification will be observed.

• The organic cotton enjoys a premium

of 30% after conversion period.

• Relevant expenses contain

certification, maintenance, marketing,

salaries, operation and set up cost.

61

Ginning Factory Assumption

Yield –steady 200kg/mu

Planted area-steady 15867mu

Raw cotton ¥5/kg

Variable operating cost ¥0.3/kg

lint cotton

Fixed operating cost ¥100,000/year

Maintenance cost ¥30,000/year

Pre-operating cost ¥200,000

Training cost ¥30,000/year

Cotton seed ¥2/kg

Organic lint cotton ¥19.5/kg

Certification fee ¥85,000/year

Key Financial Assumptions

62

• The organic conversion process will be carried out in 2 phases:

Phase 1 – Utilizing the 80,000Mu available in the Pohan area

Phase 2 – Utilizing the 300,000Mu available in the Extended Yellow River Region

Land converted to Organic Cotton Production (Mu)

-

5,000

10,000

15,000

20,000

25,000

30,000

Year

0

Year

1

Year

2

Year

3

Year

4

Year

5

Year

6

Year

7

Year

8

Year

9

Year

10

mu Phase 1

Phase 2

TOTAL mu

1mu = 0.06 ha

63

Financial Projections (Net Income)

Steady net income of ¥3.2 million from year 5 onwards (after the

organic conversion period)

1 2 3 4 5 6 7 8 9 10

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

¥ million

1 2 3 4 5 6 7 8 9 10

Year

Net Income Projections

- Phase 1: Current Pohan area

64

Financial Projections (Net Income)

Strong growth potential from the Extended Yellow River Region

1 2 3 4 5 6 7 8 9 10

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

¥ million

1 2 3 4 5 6 7 8 9 10

Year

Net Income Projections- Phase 1 + Phase 2 (Extended Yellow River Region)

Phase 1

Phase 1 + Phase 2

65

Financial Projections (Cash Flows)

Strong positive cash flow of ¥3.4 million from year 5 onwards

Short payback period of 5 years

0 1 2 3 4 5 6 7 8 9 10

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

¥ million

0 1 2 3 4 5 6 7 8 9 10

Year

Free Cash Flow Projections

- Phase 1: Current Pohan area

66

Financial Projections (Cash Flows)

Excellent growth potential from the Extended Yellow River Region

0 1 2 3 4 5 6 7 8 9 10

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

¥ million

0 1 2 3 4 5 6 7 8 9 10

Year

Free Cash Flow Projections

- Phase 1 + Phase 2 (Extended Yellow River Region)

Phase 1

Phase 1 + Phase 2

Summary of Key Financials

• Total investment cost of ¥2.32 million

• Short payback period of 5 years

• Project IRR (10 years) of 30%

• Strong and consistent cash flows of ¥3.4 million from

year 5 onwards (after the organic conversion period)

• Excellent growth potential in the Extended Yellow River

Region

67

Economic, Social and Environmental

Benefits

Impacts

Benefits

Empowerment

Sustainability of Community Benefits

Economic

Social

Environment

Increased Income

leads to better

livelihood through

social

development

Knowledge leads to

higher awareness of

action impacting the

environment

Sustainable environment is

fundamental for future economic

growth

Provide continuous

education through Farmers’

School

Invest in Organic FarmingEstablish JV

Economic benefits to community

• Setting up JV

– Create jobs within the community

– Provide a platform for farmers to increase their bargaining power

for organic cotton trading

– Buffer income shocks from crop variability and volatile

commodity prices

– Provide opportunity to take ownership in the company

– Encourage agricultural entrepreneurship

By converting to organic cotton farming, the farmers will benefit from

organic price premium and increase their income level up to 40%.

Economic benefits to community

40% of PFA’s share of overall JV’s profits will be

directly distributed to farmers in form of bonuses.

Environmental impacts

• High usage of chemical fertilizers and pesticides leaking into surrounding ecosystems

• Accounts for 22.5 - 25% of insecticide and 8-10% of pesticide usage worldwide

Every year 20,000 deaths result from pesticide usage worldwide, many of which are due to cotton farming.

Source: World Health Organization (WHO)

Conventional cotton farming has

following impacts:

Environmental impacts

Conventional cotton farming has following impacts:

• Every year 2.6 % of the world’s water is used in cotton production

(20,000 liters of water is used for the production of a T- shirt and a

pair of jeans)

• 73% of global cotton harvest comes from irrigated land

• As cotton farming requires abundant water reserves, low humidity

and long daylight, the existing farm sites often face constraints in

expansion due to lack of water reserves.

Water management is key component of

successful organic cotton farming

Environmental benefits

Two key benefits of converting to organic cotton are:

1. Soil Fertility– With organic cotton farming, use of chemical fertilizers,

pesticides and genetically modified cotton seeds will be eliminated.

– Traditional methods will be used as a substitute (Chinese medicine and use of manure).

2. Water conservation– In the long term, we will introduce Drip Irrigation Systems which

will save about 50% of the water currently being used.

Social impact and benefits

Currently there are limited opportunities in rural China

572,000 people left Shanxi province between 2000- 2005 in search of a better life and higher income

In Out Net

Shanxi 255,000 827,000 -572,000 -1.5%

Rural Urban Migration for Shanxi Province between 2000 - 2005

Source: White Paper: Internal Labor Migration in China (University of Washington, Seattle)

Our plan will create more than 30 job opportunities within the JV and

related business and retain young talents in the community.

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Education

Social impact and benefits

Healthcare Social Wellbeing

Harmonious Society

30% of the Profits of the JV will be allocated for Community Development

Empowerment through education

• Additional Funding will directly benefit the expansion of the Farmers School

and the Community:

�

i) Farmers

• Empower farmers through continuous technical education (organic farming methods including

soil fertility management, technical training on ginning practices)

ii) Women

• Empower women through continuous adult education and increase of self-esteem

• Additional income for women through more job opportunities

iii) Youth

• Empower rural youth with no tertiary education through education especially in IT and

management skills.

• In the long term the School could be expanded to provide specialized

education in organic farming beyond the Shanxi Province .

Education is key to sustainable development

78

– By lessening the exposure to chemical fertilizer and pesticides, we

can improve the health conditions of farmers.

– While the government and PFA provide subsidies, with increased

funding to the Community Development Fund, there is scope to

provide healthcare over and above primary healthcare.

Healthcare benefits

Risk Assessment

Risk Priority Mapping

Mitigation Measures

Risk Priority Mapping

80

Likelihood

Impact

High

Low

HighLow

• Not enough fertile land

• Not enough labor

• Setting up of heavy industry nearby

• Speculative dive in organic cotton prices

• Lower government support

• Currency risks

• Dissatisfaction from farmers due to

unrealized benefits

• Not enough organic-related skills

• Pollution of water, air, soil

• Increased foreign competition (including

lower tariffs)

• Drop in available financing

• Not enough raw materials e.g. non-GM

seeds, organic fertilizers

• Bad weather e.g. floods

• Export restrictions

• Customers unconvinced of organic benefits

• Counter-party risks e.g. buyer non-payment

• Increased local competition

81

Risk dimension Mitigation Measures

• Regular training, monitoring and inspection• Not enough organic-related skills

• Frequent analysis of water, air, soil

• Secure strong investor with long-term, social view

• Increased foreign competition

(including lower tariffs)

• Build local industry network, ensure consistent

high quality and even production, lock-in buyers

• Pollution of water, air, soil

Mitigation Measures

High Impact, High Likelihood

• Drop in available financing

82

Risk dimension Mitigation Measures

• SPOCTE to source for alternative suppliers,

conduct careful testing before usage

• Seek government support (materials sourced

locally will be assured full supply by provincial

government & incorporated into province plans)

(Provisions for the Encouragement of Foreign Investment in Shanxi)

• Not enough suitable raw materials e.g.

non-GM seeds, organic fertilizers

• Monitor climate and geographical developments

• Use trading facilities e.g. Letter of Credit

• Customers unconvinced of

organic benefits• Build brand in China, build local industry network

and support industry promotion efforts

• Build local industry network, join lobby group if

necessary

• Bad weather e.g. floods

Mitigation Measures

High Impact, Medium Likelihood

• Counter-party risks e.g. buyer

non-payment

• Export restrictions

Implementation

Timeframe

84

Implementation Timeframe

Initiative Yr 0

Mth 1-3

Yr 0

Mth 4-6

Yr 0

Mth 7-9

Yr 0

Mth 10-12

Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6

onward

Marketing

channels

Set up online

presence (join

B2B portal, own

basic website)

Advertise on

China Textile

Accessories

Magazine

Start joining

trade fairs

Build

interactive

website

Certification Phase 1 land: apply for cert Phase 1 land: conversion period

Phase 1

land:

obtain cert

Phase 2

land: apply

for cert

SPOCTE

Operations

Set up T.E.

office, hire GM,

HR & Finance

heads

Hire other key positions

Ginning

FactoryDesign factory

Construct factory &

purchase machines

Start

ginning

Obtain

organic cert

TrainingDevelop training plan & road

map

1st round of team

training

Finance

Approach

potential

investors

Negotiate &

conclude JV

1st capital

injection:

RMB1.2m

2nd capital

injection:

RMB1.12m

APPENDICES

85

Appendix A. List of Organic Cotton

Suppliers

87

88

89

90

91

Appendix B. Preliminary Costs for

incorporating JV

Set Up of Cooperative Joint Venture

Joint Venture Cooperation (JV) in China

PFA / Domestic-investor Foreign-investor (FI)

Obtain Letter of Opinions

Apply Project Application Confirmation Report

Perform JV Name Check

Obtain the Contracts & Articles of Association

1. Acquire Permission reports from county

level or industry authorized dept.

2. Apply foreign-funded enterprise license

3. Obtain feasibility research report

4. Establish foreign enterprise constitution

5. Report the legal person or director candidates

6. Obtain FI legal dox and QC dox

7. Get approvals from local gov’t and related depts.

Handle registration procedures and receive business license

Open Bank AccountApply Customs

RegistrationApply Taxation

RegistrationApply Foreign

Exchange Registration

Preliminary Costs for incorporating JV

Procedures Fee(RMB)

Company name approval 80

Company approval 20

Trademark Registration 1000

*Company registration fee (base on USD$200,000 capital) 1333

Business IC card 280

Company Seal 500

Organization Code license 228

RMB currency a/c IC card 250

Foreign currency a/c IC card 250

Tax registration 100

Custom registration 175

Check capital (base on USD$200,000 capital) 3000

Statistical license 20

Finance license 20

Total: Approx. RMB 6,600

* < RMB 10 million, 1‰ of registered capital

> RMB 10 million, portion over 10mil charged at 0.5‰. Portion > RMB 100 million not charged.

N.B. Figures may fluctuate slightly in accordance with local & central government laws

Appendix C. List of Participants

List of Participants

• Mr. Robert Zhou (Nike Inc.)

• Mr. Hideki Oka (Infotree)

• Ms. Melinda Mears (Meinhardt)

• Mr. Liu Chi On (Meinhardt)

• Mr. Phillip Xiao (Lever Style)

• Ms. Feng Li (Lever Style)

• Ms. Sherin Goh (IMC)

• Mr. Sin-Hong Leong (IMC)

• Mr. Takashi Kumon (JETRO)

• Mr. Rohit Suri (Turner)

• Mr. Zero Sham (Awake Limited)

• Ms. Reimi Imaizumi (CLSA)

• Ms. Marike Jensen (HKUST)

• Ms. Sandy Hsu (HKUST)

• Ms. Janelle Zai (Chinese University of Hong Kong)

• Ms. Jie Zheng (Tsinghua University)

• Ms. Sherry Ma (Tsinghua University)

• Mr. Jeffrey Song (Tsinghua University)

• Ms. Hui -Yi Lin (Tsinghua

University)

Thank you

If you are interested in this investment opportunity, please contact Chandran Nair at GIFT at (852) 3571 8103 or cnair@global-inst.com.