A case study of price setting mechanisms in the Ecuadorian cocoa market

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Has 'the golden bean' lost its brightness?

A case study of price setting mechanisms in the Ecuadorian cocoa market

Marte Haugerud Moe

Department of environmental and development studies, noragricMaster Thesis 30 credits 2008

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The Department of International Environment and Development Studies, Noragric, is the international gateway for the Norwegian University of Life Sciences (UMB).

Eight departments, associated research institutions and the Norwegian College of Veterinary Medicine in Oslo. Established in 1986, Noragric’s contribution to

international development lies in the interface between research, education (Bachelor, Master and PhD programmes) and assignments.

The Noragric Master theses are the final theses submitted by students in order to fulfil the requirements under the Noragric Master programme “Management of Natural Resources and Sustainable Agriculture” (MNRSA), “Development Studies”

and other Master programmes.

The findings in this thesis do not necessarily reflect the views of Noragric.

Extracts from this publication may only be reproduced after prior consultation with the author and on condition that the source is indicated. For rights of reproduction or translation contact Noragric.

©Marte Haugerud Moe, June 2008 [email protected]

Noragric

Department of International Environment and Development Studies P.O. Box 5003

N-1432 Ås Norway

Tel.: +47 64 96 52 00 Fax: +47 64 96 52 01

Internet: http://www.umb.no/noragric

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Declaration

I, Marte Haugerud Moe, declare that this thesis is a result of my research investigations and findings. Sources of information other than my own have been acknowledged and a reference list has been applied. This work has not previously been submitted to any other university for award of any type of academic degree.

Place and date: Signature:

_________________________________ ______________________________

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Acknowledgement

To my supervisor Arild Vatn - this thesis could never been accomplished without you, To my co-supervisor Simon Pahle for inspiration and actuation,

To José Garcia and the rest of the ACDI/VOCA staff in Quevedo, To Iven Ose and the rest of the ADCI/VOCA staff in Guayaquil, To Frank Blacio and the rest of the Nestlé staff in Guayaquil, To all my respondents for sharing their experiences,

To the Nobel Institute for providing a work space and brilliant assistance, To my family and friends for continuous support and encouragement, To Jostein for always believing in me,

Thank you / Muchas gracias

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Abstract

Despite Ecuador is considered one of the world’s leading providers of fine and aromatic cocoa, the economic reward appears to be absent at producer level. The extended poverty found among Ecuadorian small scale cocoa producers, most studies conclude to be caused by scarce agricultural output. Writing this thesis, my aim was to see whether there were any additional explanatory facts, with the attention directed towards the price received by the producers.

I came to recognize the open market structure, prevailing in Ecuador, to be highly labour intensive and complex. Lack of governmental intervention, neither regulating competition nor ensuring proper quality controls to be carried out, made intermediaries inhabit a dominant position. The existing challenges within the conventional market structure have caused a recent increase of initiatives seeking to break with the traditional structures. In order to answer the main objective: To calculate the producer price received by Ecuadorian small scale cocoa farmers, and furthermore seek explanations for the variations I expect to reveal point of departure was taken in the typology of value chain governance published by Gereffi et al. (2005). By carrying out a comparative case study, a producer price comparison among the participants in the three different marketing chains; 1) open markets 2) contractors with MNCs¹ and 3) direct purchases.

A price analysis revealed producers carrying out direct sales to receive a price more than 25%

higher than the producers within the open market structure. The positive impacts choice of marketing channel has on producer price were confirmed running a regression analysis.

Qualitative research found evidence for organizational commitment and assistance from external contributors (NGOs) to be highly influential to the choice of marketing channel. Additionally, a quantitative analysis identified Geographical location (+/-), Age group (+), Use of Fertilizer/pesticides (-) and Access to information of the legal framework (+) to be of influence.

Based on the findings of my research, I developed four recommendations of how to increase the producer price level among Ecuadorian small scale producers of cocoa: 1) Governmental attention should increase 2) Producers to carry out direct sales (in order to easier succeed, form FOs and seek assistance from NGOs) 3) Obtain certifications, and finally 4) Transfer quality incentives to producer level.

1 Due to unforeseen occurrences, this group had to be eliminated. The study was carried out with the remaining two.

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List of figures

Figure 2.1 FOB prices cocoa in grain 2006……….……. 5

Figure 2.2 The vicious circle within the Ecuadorian cocoa sector………...……… 6

Figure 2.3 National vs. international prices for cocoa in grain 2005 and 2006……… 9

Figure 3.1 Four links in a simple value chain……….………… 11

Figure 3.2 Five global value chain governance types……….… 13

Figure 3.3 The Organization of Producer-driven Commodity Chains……… 15

Figure 3.4 The Organization of Buyer-driven Commodity Chains ……….…….. 15

Figure 3.5 NGOs: diversity in the crowd……… 20

Figure 3.6 Framework for analysis of factors influencing choice of marketing channel and price received among Ecuadorian small scale producers of cocoa……… 22

Figure 5.1 The epistemological model of diagnostic reasoning……….… 30

Figure 6.1 Cocoa producing areas in Ecuador………...……. 38

Figure 6.2 Size of plantation in hectares……….………… 41

Figure 6.3 Global production of cocoa beans, in thousand tons……….…… 44

Figure 6.4 The conventional cocoa value chain………..…… 45

Figure 6.5 The national cocoa chain………...…… 46

Figure 6.6 Marketing chain participants……….… 47

Figure 6.7 Adjusted version of the national cocoa chain……… 48

Figure 6.8 Influencing factors for choice of purchaser among my respondents……….…… 49

Figure 6.9 Central problem - low level of competitiveness in the chain of fine and aromatic cocoa……….………..… 51

Figure 6.10 The process of measurement and quality certification at Nestlé, Guayaquil…… 55

Figure 6.11 Cultivation- and post-harvest practices in the organization Unión y Progresso... 58

Figure 6.12 FAO Food Price Index………...… 60

Figure 6.13 Average global cocoa prices ($/qq) 1998 – 2007………..…… 60

Figure 6.14 Perception (in %) of prices to vary according to quality………...… 71

Figure 6.15 Level of satisfaction with price offered for the cocoa (in %)……… 71

Figure 6.16 Revised for analysis of factors influencing choice of marketing channel and price received among Ecuadorian small scale producers of cocoa……….… 89

Figure 6.17 Open market structure in the Ecuadorian context……….… 90

Figure 6.18 Collective sales to direct purchasers………..… 90

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List of tables

Table 6.1 Age, sex and geographical division of the respondents answering the survey... 40

Table 6.2 List of interviewees………...……… 42

Table 6.3 UNOCACE associates and their levels of production………...… 56

Table 6.4 Ecuadorian reference prices FOB ($/qq) for cocoa in grain, 1998 – 2007……… 65

Table 6.5 Producer prices for cocoa in grain……….… 67

Table 6.6 Producer shares of FOB prices 2003 – 2006……….… 67

Table 6.7 Cocoa Prices 2007 – Average prices received among Ecuadorian cocoa producers compared to the global stock exchange prices…..……… 69

Table 6.8 Measurements and explications of the independent variables applied in the regressions……….……… 79

Table 6.9 Multiple linear regression: Producer price………..………..… 81

Table 6.10 Binary Logistic regression: Marketing channel……….…… 85

List of appendices

Appendix 1 ICCO forecast on global cocoa production and consumption………...i

Appendix 2 The 3 botanic varieties of cocoa trees worldwide………ii

Appendix 3 The 3 different stages of the harvest season………iv

Appendix 4 Quality classification system of Ecuadorian cocoa……….vi

Appendix 5 Original questionnaire in Spanish………..vii

Appendix 6 English version of questionnaire………...xvi

Appendix 7 Total exportations of cocoa in grain 2003 – 2007………...….xxv

Appendix 8 Collinearity diagnostics – producer price………xxvi

Appendix 9 Multiple linear regression – producer price (1^st & 5^th run)………...xxviii

Appendix 10 Collinearity diagnostics – Marketing channel………..xxx

Appendix 11 Binary logistic regression – Marketing channel (1^st & 4^th run)………..xxxii

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List of abbreviations

ANECACAO Asociacíon Nacional de Exportadores de Cacao

(The Ecuadorian national association of cocoa exporters)

CC Commodity Chain

CCA Commodity Chain Analysis

CORPEI Corporación de Promoción de Exportaciones y Inversiones Ecuadorian organ for the promotion of export and innovations)

FFS Farmer Field School

FO Farmer Organisation

FOB Free On Board

BCS BCS Öko-Garantie GmbH

(A Germany based international organic certifier and controlling agency)

FAO Food and Agriculture Organization of the United Nations

GCC Global Commodity Chains

GDP Gross Domestic Product

GTZ Deutche Gesellschaft für Technische Zusammenarbeit (A Germany based international cooperation enterprise for sustainable development with worldwide operations)

GVC Global Value Chain

ha Hectares

ICCO International Cocoa Organization ICE Intercontinental Exchange

IICA Instituto Interamericano de Cooperación para la Agrícultura (Inter-American institute for agricultural cooperation) IMF International Monetary Fund

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INIAP Instituto Nacional Autónomo de Investigaciones Agropecuarias (The Ecuadorian national autonomous institute for

agricultural research)

LA Latin America

LCA Latent Content Analysis

LDC Low Developed Country

LIFFE London International Financial Futures Exchange

MAG Ministerio de Agricultura, Ganadería, Acuacultura y Pesca (the Ecuadorian Ministry of Agriculture and Livestock) MCA Manifest Content Analysis

MIC Ministerio de Industrias y Competitividad

(the Ecuadorian Ministry of Industrialisation and Competitiveness)

MNC Multi National Company

MT Metric tons. Unit of measurement equivalent to 1000 kilograms NBR National Bureau of Economic Research

NGO Non-Governmental Organisation NRI Natural Research Institute NYBOT New York Board of Trade

PP Producer price

qq Quintales. 1 quintal = 100 Spanish libras. Unit of measurement equivalent to 45,36 kilograms

TNC Trans National Company

UDENOR Unión de Enxeñerías do Noroeste, S. A.

Union of Engineers in the south-western part of South America) UNOCACE La Unión de Organizaciones Campesinas Cacaoteras del Ecuador

(Union of Ecuadorian cocoa producer organizations)

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‘[Value] is adjusted… Not by any accurate measure, but by the haggling and bargaining of the market, according to that sort of rough equality which, though not exact, is sufficient for carrying on the business of common life’

Adam Smith

²

2 In The Wealth of Nations, book 1, chapter V.

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1. Introduction

1.1 Global production systems

Increased globalization has made a variety of services offered in all corners of the world available to the ‘global client’. The international trading pattern is frequently expanded through factors like extended division of labour and global dispersion of production. A recent trend is outsourcing of labour, which has been proved to be a very efficient way to conduct business. To comply with the demands of a fastidious group of clients, improvements must be carried out continuously. The high levels of expertise required in various fields have resulted in extended specialization. This development of ‘knowledge clusters’ corresponds to Adam Smith’s ideas of an advanced economy best to be achieved through specialization and detailed division of labour (Todaro and Smith 2003). As a consequence, it is not longer sufficient for an industry to maintain an efficient production in order to enter the global market and allow for sustained income growth. As well, an overall understanding of the existing dynamics of the entire value chain is required to take advantage of the new global production system (Kaplinsky and Morris 2002).

Unfortunately, it is still apparent that the appointment of winners cannot happen without losers.

Prebish and Singer presented in 1950 evidence for a tendency of relative prices of raw materials (including agricultural products), when compared with the price of manufactured goods, to experience a steady decline in the long term (Todaro and Smith 2003). As most production of primary goods is located in Low Developed Countries (LDCs), their inhabitants tend to account for the losers within the global trade pattern.

Tracing a global value chain of agricultural commodities reveals the ‘losers’ often to be found at the very bottom; the farm level. This tendency being apparent in the world’s cocoa trade is demonstrated by farmers struggling with low return of investments, despite the global cocoa consumption³ is reaching new peaks annually (ICCO 2007a). Cocoa, being a buyer-driven commodity whose value is set by the global produce exchange, is extremely vulnerable to price fluctuation. When prices are low, it is easily observed within all levels of the value chain. But is

3 For further details, see ICCO forecast for global cocoa production and consumption in Appendix 1.

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this the case as well when the prices are increasing? Or is some of the surplus likely to disappear within the chain before reaching producer level? How can it else be explained that most Ecuadorian farmers are living in poverty when the global market seems never to get enough of the fine and aromatic cocoa of which Ecuador is the world’s leading producer?

1.2 Purpose of the study including its objectives

Low agricultural output has been uttered by numerous (Ramírez 2006, 2007, Collinson and Leon 2000) to be the main explanation to the extended problem of poverty among actors operating at the lower levels within the Ecuadorian cocoa sector. This is a well-documented and acknowledged fact. The purpose of this study is to reveal whether there are any other explanations to the existing poverty among Ecuadorian cocoa producers, with special attention drawn to the price disbursed at farm level. With the goal set, I defined my main objective to be:

To calculate the producer price received by Ecuadorian small scale cocoa farmers, and furthermore seek explanations for the variations I expect to reveal.

As I assume participation in alternative marketing channels to be of considerable importance to the price received by the individual farmer, generating a general overview of the organization of the national cocoa industry early in the research process will be crucial. Holding the motivation of acquiring a profound understanding of both the design and structure of the commodity chain constituted for the design of the first of my three sub-objectives:

Q1: How is the production and marketing of cocoa organized in Ecuador?

After having recognized its main components, my aim is to move all the way down to the very bottom of the chain. Here I am to investigate the average price paid to producers participating in the various marketing channels. In addition, I seek to reveal whether the price paid to the producers is influenced by the quality of the product they offer.

Q2: What is the average price ($/qq) offered to the producers within the various marketing channels and how does this price correlate with the quality of the cocoa purchased?

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Expecting to find variations in the price offered to the producers within the different marketing channels, I now seek to know why it is so. What characteristics do the farmers participating in the commodity chain offering the highest/lowest prices inhabit, and how can they be differentiated from the other cocoa producers?

Q3: How can the variation in the producer prices be explained?

In order to give an answer to the third sub-objective, the structural advantages as well as disadvantages of each particular marketing chain must be given account for. Asking how come farmers are better off participating in one commodity chain, may help reveal weaknesses or limitations within the other chains, seen from the farmers’ perspective.

1.3 Limitations of the thesis

As indicated in the previous section, the focus of this thesis is to trace the commodity chain of Ecuadorian cocoa. Due to time constrains and vast amount of information in need to be gathered, the limitation is set by the marketing of cocoa in grain. My sample will be gathered within the region of Los Rios with the respondents selected randomly. Cocoa producers giving their answers to my survey will constitute for the main sample, but additional information will be extracted through semi-structured and observations of actors found at all level of the commodity chain.

1.4 Chapter outline

The outline of the thesis will be as follows: With the purpose of providing the reader with basic information of the functions, mechanisms and challenges within the Ecuadorian cocoa market, I will in the following chapter (2) give a presentation of the national production system. Chapter 3 is used to present the theory, resulting in a framework to be applied in the analysis. For the reader to obtain a better insight of the existing studies within the field, Chapter 4 will give account for some of the previous research conducted. In Chapter 5 the methods applied in this study are presented. Chapter 6 contain findings, analyses and discussions. With basis in the prior analyses, I conclusions are drawn in Chapter 7.

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2. Background

2.1 Ecuadorian cocoa production

Ecuador is said to be the birthplace of cocoa (The Success Alliance 2007), and the country’s history of cocoa cultivation can be traced back to the 17^th century. Ecuador experienced a rapid economic growth at the very start of the 20^th century, with cocoa as the dominant export commodity. When the Panama Canal opened in 1914, Ecuador was brought to the position as the world’s main cocoa exporter, accounting for 20% of the global market (UN 1994). A historical peak was reached in the years 1914 and 1916, when exports amounted for approximately $ 77 millions. In the latter period of the cocoa cycle (1926 – 1930), the structure of Ecuadorian exports diversified, now accounting for coffee and rice as well. This transformation brought the shares of cocoa exports to account for less than 50% of the total national exports (ibid). Despite the fact that cocoa maintained the position as one of Ecuador’s most important export commodities throughout big parts of the 20^th century, the country’s share of the world’s total cocoa production fell from 18% at the very start of the century, to 2% in 1945 (UNCTAD 1991).

Ecuador, producing the two types of cocoa; Nacional and CCN51, is world famous for its high quality products. The variety Nacional, being a unique Ecuadorian product, has experienced a widespread global demand for decades. Nacional, being the traditional variety cultivated for centuries, does still dominate the national cocoa production, covering 95% of all the land areas applied for cocoa production (SICA 2007a). Despite having its origin from the Forastero⁴ family Nacional is considered being a fine and aromatic cocoa. Due to its characteristics, it has been described as Pepa del Oro (‘Golden bean’) for decades. Its large sized seeds are developed by light brown cotillions. The aroma of chocolate which is delicately accompanied by a floral flavour characterizes its taste, is known as Arriba (ANECACAO 2007). The extraordinary flavour is developed due to the quick fermentation⁵ of the cocoa seeds. In contrast to most other types of cocoa which seeds in about six days, the Ecuadorian only needs three or four (Shared interests 2007).

4 See Appendix 2 for further information about the different cocoa varieties.

5 See Appendix 3 for further information about the different stages of the harvest season.

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CCN51 was introduced to Ecuador in the 1970s and is the only sort of cocoa produced in the country not considered as fine and aromatic. Currently there exists more than 20 000 hectares (ha) (out of total of 400 000) of this variety on a national level (SICA 2007a). CCN51 gives a considerably higher yield than the Nacional, with an agricultural output exceeding 40 quintales (qq) per hectare annually (compared to 5-6 qq/ha). The fine and aromatic cocoa produced in Ecuador is exported under four different names; ASE, ASS, ASSS and ASSPS⁶ (ibid). These varieties of Nacional are generally priced higher than CCN51 (demand dependent), something which is illustrated in Figure 2.1 below.

55 60 65 70 75 80 85 90 95 100 105

JanuaryFebruar y

March

April May

June July Aug

ust Septem

ber Octobe

r

November Decembe

r

Month

US$/qq

CCN51 ASE ASS ASSS ASSPS

Figure 2.1 FOB prices cocoa in grain 2006 Source: Based on data from ANECACAO (2007)

Note that the prices given in the Figure 2.1 is Free On Board (FOB) prices. Free on Board is a term implying both who holds the duty of the loading and shipping costs and at what time the responsibility of a good passes from the buyer to the seller. In the case of Ecuadorian cocoa, the buyer tends both the duties and responsibilities pass over from the purchaser to the buyer when the goods are loaded on board the vessel (most often) in Guayaquil.

6 See Appendix 4 for further information about the quality rankings.

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2.2 Causes of change

Cocoa Nacional has made Ecuador an important and demanded actor in the global cocoa market.

For several years, Ecuador produced more than 50% of the global share of fine and aromatic cocoa and was considered the most important producer worldwide (ANECACAO 2007). Despite prices being set higher for the variety Nacional, this does not compensate for the low agricultural output extracted. The ripple effects of holding limited access to a valuable product have occurred in two levels: 1) Farmers seeking short cuts cause frequent neglections within the post harvest practices. 2) Middlemen, traders and exporters mixing together the two varieties. In 1994 the International Cocoa Organization (ICCO) punished the fraud taking place by adjusting Ecuadorian cocoa 25% down, now being considered a nation producing 75% fine and aromatic cocoa (ibid).

Figure 2.2 The vicious circle within the Ecuadorian cocoa sector

In Figure 2.2 I have tried to illustrate the vicious circle currently appearing in Ecuadorian cocoa sector.

Another link could have been added in between the stages Diminished yield and Lack of satisfactory economic profit, namely Extended mixture of the two varieties. Despite having great economical impacts at farm level,

mixture most often take place above producer level and is therefore left out of the original model.

The results of farmers loosing interest can be identified both through their cultivation and post- harvest practices. The most apparent tendencies to be tracked are poor planning and crop management, lack of pruning and tree shaping, irregular tree spacing, no plasticizing and weed control, fungal diseases and lack of sufficient fermentation of the cocoa beans (The Success Alliance 2007). Low agricultural yield is, as earlier mentioned, considered the major cause for the

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extended poverty among Ecuadorian cocoa producers and a range of studies and projects have been carried out holding the aim of increase the agricultural output extracted. However, there are factors above actor level which should be brought up, discussing influences for Ecuador gradually to loose its position in the global cocoa market.

Rough and unpredictable weather conditions make farming in Ecuador a continuous struggle. The country has been a victim of natural hazards as drought and floods over the years, most severe in the years 1975, 1983, 1995 and 1998, as well as earthquakes (1987) and volcano eruptions (1999) (ICG 2007). Secondly, unstable relations to their neighbouring countries have made Ecuador suffer from lack of foreign investment initiatives. The Colombian guerrilla movements in the north and brief wars with Peru in the south (1981, 1995) have contributed to undermine the nation’s economic environment (ibid). Furthermore, the nation’s economy has suffered from governmental mismanagement (rent-seeking and corruption) throughout the last decades. U.S.

Department of State utters Ecuador's political parties to “... have historically been small, loose organizations that depend more on populist, often charismatic, leaders to retain support than on programs or ideology” (U.S. Department of State 2007). Years of governmental mismanagement has made the population loose faith in the political system, as there has been a tendency of Ecuadorian politicians to prioritize western interest (as well as self interests) rather than the national. As a consequence of natural disasters (among others El Niño) and a sharp decline in the world’s petroleum prices, Ecuador experienced a major banking crisis and recession in 1999 (CIA 2007). As the real GDP contracted with more then 6% and the banking system collapsed, Ecuador had no choice but to adopt U.S. dollars as a legal tender in 2000 (ibid).

During the decades of 1950s, ‘60s and ‘70s, import substitution policies were pursued in most Latin American (LA) countries (Stiglitz & Charlton 2005). Despite experiencing a rapid growth in their economies during the period, a turning point was met in the early 1980s when none of the LA countries experienced much economic growth. A regional average of 6% growth during the 1970s felt to almost zero in the 80s. Professionals have argued against one another for the causes of this stagnation. While the neo-liberal view, favoured by IMF and the World Bank, put the blame on import substitution combined with an excessively degree of state intervention, an alternative view has put more emphasis on Latin America’s open capital markets. This view

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claims Latin America’s reliance on foreign direct investments and external flows of capital to be the factor most influential for the area being so vulnerable of global economic shocks. The heavy loans the LA nations undertook during the ‘70s enabled them, for some while, to avoid the global recession which followed the oil price shock. Finally, the Latin American debt crisis became a crude fact in the early 1980s, when the US Federal Reserve augmented the interest rates of these loans to level unmanageable for most of the nations to handle (ibid).

According to a report from The Natural Resource Institute (NRI) Ecuadorian cocoa is marketed without governmental interference, meaning local prices are calculated taking point of departure in international prices and local supply and demand (Collinson and Leon 2000). This leads local prices occasionally to move out-of-sympathy with the New York⁷ and London prices (where the world’s cocoa exchange are situated) as they are determined by the demand from the nations own cocoa processing industry and neighbouring countries (ibid). The report identifies other hallmarks in the Ecuadorian cocoa sector to be lack of competition laws, absence of monopolies and cartels, minimal governmental interference, low levels of vertical and horizontal integration and finally no existence of barriers to entry (ibid). Figure 2.3, on the following page, illustrates the divergence between national and international cocoa prices in 2005 and 2006.

Cocoa being a product highly vulnerable to price volatility has motivated many cocoa producing countries to establish ways of protecting the farmers economically. Primarily, this is done by setting fixed producer prices. Setting fixed producer prices does not only imply economic security for the producers, but as well for the government. In addition to work as an incentive for the expansion or contraction of production, a set price pattern makes the collection of general revenue and taxation of the producers easier for the government (UNCTAD 1991). As pointed out by Collinson and Leon (2000), not all cocoa producing countries experience governmental interference. This is specially being the case within the countries in Latin America and in Asia where the marketing of cocoa is left to the private producers, as the governmental agencies are overseeing a variety of aspects (UNCTAD 1991).

7 Corresponding to the overall Ecuadorian practices, point of departure will primarily be taken in the NYBOT (New York Board of Trade) prices in this paper.

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2005

0 10 20 30 40 50 60 70 80

US$/qq

January March May July September November

Month

National International

2006

0 10 20 30 40 50 60 70 80 90 100

US$/qq

January March May July September November

Month

National International

Figure 2.3 National vs. international prices for cocoa in grain 2005 and 2006 Source: Based on data from SICA (2007b & 2007c)

2.3 Profoundness of the problem

Despite cocoa being one of Ecuador’s major agricultural export commodities, its earnings does not account for a huge percentage of the country’s GDP. In 2004, cocoa accounted for 0,52% of the national GDP (total $ 18 956 513 000) and 6,2 % of its agricultural share (total $ 1 599 650 000) (SICA 2007d). The profoundness of the problem is rather the fact that 85 to 90 percent of the national cocoa industry is sustained by approximately 100 000 smallholders (The Success Alliance 2007). Taking into account all the persons operating at the various levels of the chain, the national cocoa sector employs about 800 000 Ecuadorians (Ecuadorcocoaarriba 2005a). As the official Ecuadorian unemployment rate is calculated to 9,8% (CIA 2007) and the (unofficial) underemployment rate is by various voices claimed to be reaching as high as 47%, it is crucial for the national economy to sustain the productivity within the sectors still contributing with employment

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3. Theory

Holding the motive of producing a theoretical framework to guide the further analysis, various theories are introduced throughout this chapter. By gradually filling in pieces to the puzzle, the final goal is to develop an overall theoretical basis contributing to ease the analysis of my third research objective, factors influencing the prices received by Ecuadorian cocoa producers.

3.1 Commodity Chains

In order to present the action taking place between actors operating at the various levels in the Ecuadorian cocoa sector, and furthermore identify which impacts these interactions have on the producer price received by the farmers located at the very bottom of the chain, theories concerned with the functions of commodity chains (CCs) can contribute with beneficial information.

Different methodologies and theories have been developed in order to analyse commodity chains.

In this thesis the focus will be directed towards the most significant approaches found in literature, Commodity Chain Analysis/French Filière (CCA), Global Value Chains (GVC) and Global Commodity Chains (GCC). Assuming participation in alternative marketing channels to be of great impact to the price received by the Ecuadorian cocoa producers, their structure and agents (‘requirements of admission’) are important to reveal. Directing their focus towards the different practices taking place within the single chain, each of the above listed commodity chain approaches can make useful contributions to my research.

3.1.1 Commodity Chain Analysis (CCA)

The Commodity Chain Analysis (CCA) was developed by the French Research Institution (French Filière) dealing with local production systems and consumptions in the 1960’s in order to achieve “… a neutral, value-free technique applied to analyze existing marketing chains for agricultural commodities assessing how public policies, investments and institutions affect local production systems”, and is composed of “… a quantitative analysis of inputs and outputs, prices and value added along a commodity chain through agents accounts” (Tallec and Bockel 2005:3).

The term is used referring to a general group of economic agents, and their activities, making a direct contribution to the determination of a final product. The chain of production includes all

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processes taking place from the transformation until delivery to the final market of one particular agricultural product (ibid). The empirical research tradition has been dominant since the rise of the filière analysis. Throughout its development the main objective has always been to map out the abovementioned commodity flows and to identify the agents (typically done through the design of flow-charts of commodities and transformations) (Raikes et al. 2000). Launched almost half a century ago, the CCA has provided the basis for the development of the GVC and GCC approaches. Due to their common origin, similarities are easily traced and differentiation can sometimes be hard.

3.1.2 Global Value Chains (GVCs)

“In its most basic form, a value-added chain is the process by which technology is combined with material and labor inputs, and then processed inputs are assembled, marketed, and distributed”

(Kogut quoted in Gereffi et al. 2005:79). Its purpose is to give account for the activities firms and their workers go through when bringing a product or a service from its conception to its end use (Global Value Chains Initiative 2007). In order to illustrate the process of bringing a product, or a service, from its conception, throughout the different production stages until it reaches the final consumers, and at the very last, to final disposal after it is used (Kaplinsky and Morris 2002), the value chain has to include a full range of different activities. These activities include elements such as design, production, marketing and distribution (Global Value Chains Initiative 2007).

The four fundamental steps included in a basic value chain, and their interlinkages, are illustrated by Kaplinsky and Morris (2002) in Figure 3.1.

Design and product development

Production - Inward

logistics - Transforming - Inputs

- Packaging - Etc.

Marketing Consumption / recycling

Figure 3.1: Four links in a simple value chain Source: Kaplinsky and Morris (2002)

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Moving away from theory and into the real world, you are not likely to come across such a simple structure within the value chain of any product or service (Kaplinsky and Morris 2002).

The reality is normally much more complex. One of the most apparent differences is the number of linkages in the chain; there tend to be many more. Taking the complexity of the real world into account makes it a comprehensive task to conduct research on global value chains. Examples of areas you are dependent of obtaining sufficient knowledge about are job details, technologies, standards, regulations, products, processes and markets valid for the specific product and the region under investigation (Global Value Chains Initiative 2007).

To explain the binary view of how global production is to be organized - either through markets or within transnational firms, Gereffi et al. (2005) address the issue of transaction costs. They furthermore claim the global value chains to be found in different forms, as they display a range of different characteristics and have a multiplicity of impacts on diverse communities. The issue of governance is central in the global value chain approach, as “… a chain without governance would just be a string of market relations” according to Humphrey and Schmitz (2001:2). With information gathered from global case studies, Gereffi et al. (2005) are proposing a complete typology of value chain governance, where the aim is to reveal five basic (analytical) varieties within this process of administration (illustrated in Figure 3.2).

1. Markets represent the simplest form of GVC governance, as firms and individuals, beyond exchanging goods and services with one another, do not interact in a large degree.

Partners can be switched frequently, as it does not involve huge costs for neither of the parties involved.

2. Within the modular value chains, services are offered to a customer’s specification (more of less detailed). Suppliers are the ones holding the entire responsibility for the process technology, when offering such ‘turn-key services’. As a consequence of suppliers tending to apply generic machinery to spread their investments within a broader customer base, the transaction-specific investments are limited and the prices are switched low.

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3. Relational value chains are built upon complex relationships between buyers and sellers, frequently resulting in mutual dependence and a high level of assets specificity. The relationship can either be based upon family or ethnic ties, reputation, social or spatial proximity.

4. In the captive value chains small scale suppliers tend to be dependent on larger, dominant buyers. These networks are often characterized by asymmetric power relations with high degree of monitoring and control by the lead firm, as the suppliers are relying on their cooperation.

5. Vertical integration is the characteristic of hierarchy, where the dominant form of governance is managerial (top-down) control (Gereffi et al. 2005).

Figure 3.2 Five global value chain governance types Source: Gereffi et al. (2005)

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3.1.3 Global Commodity Chains (GCCs)

While the Global Value Chains has its focus directed towards the value added to a product while it moves upwards the chain, the GCC approach is more interested in revealing the processes taking place between the different stages.

Despite being defined by Hopkins and Wallerstein already in 1986 as “… a network of labour and production processes whose end result is a finished commodity” (Gereffi and Korzeniewicz 1994:2), the concept of Global Commodity Chains became first well-known after being introduced to the literature by Gary Gereffi in the mid-1990’s, referring to GCCs as the whole range of activities involved in the design, production and marketing of a product (ibid). The global Commodity Chain has as its primary focus “… to analyse the international trading system and the increasing economic integration of international production and marketing chains”

(Tallec and Bockel 2005:3). Hopkins and Wallerstein indicate its greatest virtue to be its emphasis on the process (Gereffi and Korzeniewicz 1994). Originally the concept of GCC was created to analyse the impact of globalization on industrial commodity chains. Moreover, GCCs were to emphasize the embedded power relations in value chain analyses, by unveiling the dominant party (parties) determining the overall characteristic of the chain. Gereffi and Korzeniewicz apply the term network referring to the overall configuration of relations in the network or its parts. By using these properties in their analyses of commodity chains, they claim to include the ‘length’ of the chain and the ‘density’ of interactions in a particular segment, as well as the ‘depth’ or number of levels occurring at different stages of a GCC (ibid).

The form for governance conducted in a GCC, Gereffi (1999) argues either to be producer- or buyer driven. The producer-driven commodity chain he characterizes to contain huge firms playing central roles in the coordination of the production networks. The archetypal actors are technology- and capital intensive manufacturers, including the industry of cars, aircrafts and other heavy machineries (ibid). One of the major differences between the producer- and buyer driven commodity chains is the control being exercised by the administrative headquarters of Transnational Companies (TNCs) in producer-driven production systems (Gereffi and Korzeniewicz 1994). Figure 3.3 illustrates the structure of a simple producer-driven commodity chain.

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Figure 3.3 The Organization of Producer-driven Commodity Chains Source: Gereffi and Korzeniewicz (1994)

In Figure 3.4, illustrating a buyer-driven commodity chain, the arrows have increased in number and changed direction. The number of actors is higher and there are made a distinction of whether they are located in the foreign or domestic market. The relationship existing between the various actors operating in this sort of chain, Gereffi and Korzeniewicz (1994) define either as primary or secondary. In order to

illustrate the different relationships they apply solid (primary) and dashed (secondary) arrows.

Figure 3.4 The Organization of Buyer-driven Commodity Chains Source: Gereffi and Korzeniewicz (1994)

In contrast to the producer- driven, the buyer-driven commodity chains include more labour intensive industries, such as footwear,

toys and handicrafts (Gereffi 1999). In these kinds of industries there are the great merchants, dealers and branded manufacturers who hold the leading parts in creating decentralised production networks in a range of exporting nations. As the motivation factor is to keep the production costs down, favourable locations are often found in developing countries (ibid). The core company’s main task in a buyer-driven chain is to administer the production and trade networks within the chain and additionally to make sure all the pieces of the business come together as a integrated whole (Gereffi and Korzeniewicz 1994).

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3.2 Organization and participation

As already mentioned, the national cocoa sector employs a rather large share (6%) of the Ecuadorian population, accounting for about 13.9 millions inhabitants (CIA 2007). The 100 000 producers alone represent about 0,7% of the total population. Taking into account the national underemployment rate (47%) and the age structure (62,7% being between 15 – 64 years), cocoa farmers constitute for 2,2% of the working (fulltime) share of the population.

Despite being part of such a large occupational group, the Ecuadorian cocoa producers hold an extreme limited market power. One of the explanations could be found in the structure of the commodity chain in which the farmers participate; the individual producer being just one out of numerous actors in the labour intensive buyer-driven commodity chain. Stimulating to collective action and enhanced level of participation through the creation of Farmer Organizations (FOs) could be one alternative way of breaking down the existing (hierarchical) power pattern within the cocoa chain.

3.2.1 Organization and its obstacles

The occurrence of Farmer Organisations in developing countries (both at local and higher levels), became for real triggered in the 1980’s and 1990’s. FOs ought to fulfill numerous roles and functions. Denis Pesche (2002) has identified the major ones to be; 1) provide services to their members (technical or economic), 2) represent the interests of both their members and the other farmers situated in the area, and 3) be involved in local development by providing different sorts of social investments. Furthermore, Pesche makes a division between the internal and the external work done by the FOs. While the internal work takes basis in the strengthening of their functions and fulfilling the needs of their members, the external work is primarily focused on extending their networks (external partners) and to achieve overall recognition of their work (ibid).

With basis in his wide experiences working with farmer organizations in Ecuador and several other countries in Latin America, Anthony Bebbington (1991) utters FOs being able to help strengthen the market power among agriculturalists holding scarce resources. Collective sales are often mentioned as one of the major benefits of being part of a larger union. Not only are prices often set higher when larger quantities are purchased, also competition is likely to be reduced

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when the farmers collaborate rather than compete. Finally, Bebbington utters farmers being easier detected by the other participants within the chain to be of crucial importance when combating the existing power structures in the general commodity chain.

According to Bebbington (1991), FOs can furthermore, by actively adapt and disseminate agricultural technologies in programs they themselves control and administer, contribute to build sustainable livelihood for the rural poor. In addition, farmer organizations can act as a ‘user constituency’ for the rural poor, pressuring public sector and non-governmental agricultural agencies to orient their work to the needs of the rural poor. Lastly, farmer organizations is claimed by Bebbington to act as an ‘interface’ between the research and extension worlds of development agencies and the livelihood conditions of the resource poor farmer population (ibid).

With the current recognition of the benefits attached to the creation of farmer organization, how come the phenomena are not better splayed on a global scale? The Norwegian sociologist, author and politician Gudmund Hernes (1975) lists five circumstances, under which the possibilities for people organizing are reduced. The first obstacle in order to organize, Hernes claims to be the possible deprivation of freedom of speech and organization among the citizens within a nation.

The second obstacle he identifies to involve costs. Namely, that the ones with the highest advantages of joining such an organization are in some cases unable of handling the costs of establishment, something often resulting in insufficient representation of interests. In his third point, Hernes emphasizes the problem of solidarity. He claims the possibilities for organization to be reduced when the actors with common interest within one field, are affected in different degrees of resolutions made within other fields. His fourth point is touching upon more concrete barriers. Even though actors have democratic freedom and permanent interests which are shared with others, they can meet problems in terms of organization due to physical barriers (i.e. large distances, poor infrastructure, etc.). In his final point, Hernes underlines despite overcoming all the abovementioned factors, actors can still meet difficulties in the case of organization due to their personal terms of action. The problem of free riders is to be found within the field of organization as well as most other places in the society. When the services offered by an organization are not limited only to its members, but to all members of the society, it is difficult

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to encourage organizational commitment (ibid). Despite being presented more than 30 years ago, the problematic brought up by Hernes do still prevail, especially within the context of LDCs.

3.2.2 Participation

Holding the common goal of increased development for the global poor, the importance of participation is commonly agreed. Organizing farmers is one way to encourage involvement, and the history provides us with numerous evidences of the close connection existing between NGOs, FOs and the level of participation.

The era of aid and development was up to the late 1970’s dominated by top-down approaches, concerned by implementing western ideas and knowledge rather than to encourage participation.

Throughout history agricultural projects have tended to be (at least to some degree) participatory, as farmers often have been included in discussions about their challenges and needs. Anyhow, it is not until recently that the necessity of more formal participation has been recognized within most disciplines, including the agricultural (Oakley et al. 1991). A common understanding does now exist among most professionals, namely that in order to better ensure the success of a project farmers’ participation has to be developed more formally (ibid).

In addition to recognize how to best ensure an agricultural project’s efficiency and effectiveness, Oakley et al. (1991:26) address a range of benefits that can be gained from formal participation of farmers. In areas containing low level of farmers with access and active contact with agricultural services, formal participation can make the farmers (or clients) more visible and thereby contribute to increase the coverage and extension of such services (individual farmers easier ignored or ‘failed to see’). Furthermore, formal participation of farmers can help breaking down the inherent resistance to change often apparent in farming communities, and as well assist dispel any mistrust of external ideas by ensuring the farmers that their ideas will be taken into consideration and built into the objectives of any given projects. By formal participation it is easier to guarantee the needs of the farmers to be covered rather than only depend of the ideas of the outside professionals. Finally, formal participation can make contributions to ensure projects to benefit the groups of smaller and more marginal farmers, not only the ones better off (ibid).

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3.3 The role of NGOs

NGOs, or non-governmental organizations, have experienced a steady increase of their activities throughout the twentieth century, with a particular acceleration within the last couple of decades.

A recent estimate has claimed it to be between fifteen and twenty five thousand NGOs operating on a global scale (Eade 2000). The primary geopolitical focus is concentrated on the ‘Third World’ of former European colonies and the ‘Second World” of former (and some still remaining) communist states (DeMars 2005). Their activities cover a spectre of issues, “…from feeding famine victims and protecting endangered species, to eliminating nuclear weapons and AIDS, to democratizing Russia and the Arab world” (ibid:1). Farrington, Bebbington et al.

(1993) claim NGOs to constitute for a promising, but not yet firmly established ‘third sector’.

Hence, it is a sector which is contrasting itself from the practices of both the public (state) and private (for-profit), due to its frequent interaction with both.

But what is to be included in the expression NGO? All organizations without any governmental interference, as the name implies? Bebbington, Thiele et al. (1993) claim the term NGOs to traditionally been applied describing both national and international organizations, based either in North or South. Clark is being criticized by Farrington, Bebbington et al. (1993) to be all inclusive when applying the term. Despite distinguishing between the six categories relief and welfare agencies, technical innovation organizations, public service contractors, popular development organizations, grassroots development organizations and advocacy groups and networks, Clark consider them all as NGOs. These classifications made by Clark do not make any sense according to Farrington, Bebbington et al, claiming they are not being able to distinguish the work by Oxfam with the work of a local neighbourhood organization when applying his system. Instead they are presenting their own figure (3.5), where classifications in accordance to location, scale ownership, orientation, approach and operational dimensions are made (ibid).

Having the complexity of the term presented, I will throughout the remaining parts of the thesis refer to NGOs as organizations giving support to grassroots organizations, rather than themselves being one.

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Figure 3.5 NGOs: diversity in the crowd Source: Farrington, Bebbington et al. (1993)

By holding on to a belief of future changes not being foremost dependent on intellectual breakthroughs, a big share of the NGO workers are committed to the idea of making a practical contribution in order to create a better world. By this action-oriented approach they contrast themselves to academics who concentrate their efforts on reflections, analyses and criticism (Eade 2000). On a global level “… many NGOs saw [and still see] themselves as a ‘missing link’

not simply to develop participatory methods, but, equally importantly, to empower the rural poor to contribute to technical change from their own resources, and to articulate demands on government services more effectively” (Farrington, Bebbington et al. 1993: xvii).

Past state performance, including its economical and political impacts, is according to Farrington, Bebbington et al. (1993) the factor most apparent to generate the interest of NGOs. Economic concerns have been raised on the basis of inefficiencies as the outcome of state interventions in the economy. Additionally, political concerns occur due to the belief of the state to govern on the basis of own interests, rather than responding to the need of the society as a whole (ibid). Other common strategies among NGOs are; 1) to work both with and within government structures in order to influence policy and systems, 2) operational expansions, 3) national and international

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lobbying and advocacy, and finally 4) to strength the organization of the poor (including networking and federations) (Eade 2000).

The last point by Eade is of particular interest conducting research at farm level. As mentioned earlier in this chapter, farmers who organize enhance their chances of breaking out of the traditional power structure within a commodity chain. Their odds are further strengthened if their FO receives support from a NGO, as these organizations often constitute a part of an extended network of partners not only holding agricultural knowledge and technology/equipment, but as well political influence and economic resources. Being intercepted by a NGO can be vital for the prosperity among individual farmers or an independent FO. By strengthening the producers in certain areas or within specific organizations, Bebbington (1991) claims the appearance of NGOs is likely cause power asymmetries at the producer level.

3.4 Theoretical framework

One of the aims of this study (Q3) is to reveal the structure of three different types of marketing channels within the Ecuadorian cocoa sector; the open market, direct purchases and contractors with Multinational Companies (MNCs), and furthermore give account for the impacts participation in each and every has on the price paid to the producers. Before initiate the process of analysis, it is essential to give account for the factors expected to most influential for the individual producer’s access to/choice of marketing channel. To be better equipped to analyze this process, a framework for analysis of factors influencing choice of marketing channel and price received among Ecuadorian small scale producers of cocoa was developed (Figure 3.6).

The framework, which aim is to give an answer to the third sub-objective, is principally build up on three assumptions. The first is, as already indicated, choice of marketing channel to affect the producer prices. The second assumption is, farmers with organizational commitment being more likely to gain access to alternative⁸ marketing channels. And finally, external contributors to accelerate contact between the different actors in the commodity chain; in this case enhance the chances of a FO to be included in an alternative marketing channel.

8 By alternative marketing channel I indicate alternatives to the open market structure.

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Figure 3.6 Framework for analysis of factors influencing choice of marketing channel and price received among Ecuadorian small scale producers of cocoa

With basis in the five types of global value chain governance sketched out by Gereffi et al.

(2005) in Figure 3.2, I wanted to see if this was a system I came to recognize in the Ecuadorian context. Furthermore, I aspired to investigate whether there are factors holding the force to brake with the power asymmetry Gereffi is describing to be at its lowest in the open market and is escalating until it reaches the hierarchical structure of an integrated firm. The measurement applied to calculate the power asymmetries is the average price the participants in the various marketing chains receive for their cocoa.

Applying abduction⁹ as my research strategy allowed me to develop the framework through combining theory extracted from previous studies with my own field experiences. The above listed assumptions, as well as the other variables presented in the framework, are all selected on

9 Abduction will be further described in Chapter 5.

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basis of first and secondary information and experiences of which determinants to be influential to the price setting mechanisms within the Ecuadorian cocoa sector.

The uncertainties were many in the initial part of the research process as I neither held much knowledge about the global, nor the Ecuadorian cocoa sector before start writing this thesis. Not knowing exactly ‘where to start searching’ resulted in a rather comprehensive questionnaire¹⁰. The survey was divided into five subsections, each one constituting for what I considered to be of overall importance in revealing the differences in producer prices.

The first sequence of my questionnaire, cocoa production, was included with the intention to reveal whether cultivation practices had any impacts on the price received by the farmer. As already mentioned, there have been conducted a range of studies demonstrating insufficient effort at producer level to cause low agricultural output (Ramírez 2006, 2007, Collinson and Leon 2000, etc). My motivation was to test whether the agricultural efforts had any impacts on the price offered the farmers as well (through enhanced quality of the product). The second subsection is marketing. Taking basis in the commodity chain theory presented earlier in this chapter, I sought to identify the economical impacts of the individual producer’s sales practices.

Motivated to unveil the advantages obtained by producers participating in different kinds of marketing channels, special attention was given to the five types of value chain governance Gereffi et al. (2005) describe in Figure 3.2. Questions concerning national structures/policy constitute the third part. This group of question was included into the questionnaire to demonstrate the effects of Collinson and Leon (2000) claiming Ecuadorian cocoa to be marketed without governmental interference. The matter of organization is the concern of the fourth subsection, organization and participation theories providing the basis. Here I aspired to figure out whether the motivation factors and outcome of joining an organization among my selection of respondents being organized could be compared to the ones listed by Pesche (2000) and Bebbington et al. (1991). Simultaneously I sought to disclose if it was possible to draw parallels betweens the ideas presented Hernes (1975) and the motivations for not joining organizations among the unorganized share of my respondents. In the last subsection, the respondents of my questionnaire were asked to give account for their background information. These questions

10 See Appendix 5 and 6 for outline of the questionnaires (Spanish and English version)

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worked as control variables, controlling whether any personal characteristics could cause impacts on the producer price.

In the selection of which questions from my survey to transform into independent variables in the framework, two considerations were done. First, I drew advantage of the experiences gained through conducting interviews and observations. Additionally, I got the questionnaires reviewed by professionals within the Ecuadorian cocoa sector, expressing their opinions of the covered issues. The hypotheses developed in this process (presented in Chapter 6), became later on the independent variables presented in Figure 3.6.

The yellow dashed arrows at the very left side of the framework are included in order to illustrate the assumed relationship between the independent variables. Unveiling the relationships between these variables will be a task too comprehensive to include in this study, and they will therefore not be given any further attention.

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4. Previous studies

There exist a range of studies with their attention drawn towards agricultural commodity trade.

While some narrow down their focus to concentrate on one particular link within the commodity chain, others hold motive of mapping the entire chain, including its function and its stakeholders.

These latter kinds of studies can either trace the chain upwards, with point of departure in farm level, or downwards, with a finish product as their starting point. The amount of studies covering the same aspects of cocoa trade, within the similar conditions as in my research area in Ecuador, is however smaller. The absence of identical studies causes a wider range of studies to be referred to in this chapter. Some of the research looks at trade and marketing of cocoa in West African countries, while other is conducted in Ecuador, concentrating on various aspects within the national cocoa sector. Unfortunately, I am a little bit too early in getting my hands on a study currently carried out by the ICCO¹¹ in Ecuador (among several countries), analysing the value chain in cocoa producing countries

4.1 Commodity chain studies in Ecuador

Pilar A. Jano (2007), conducting a study of the marketing chain of Ecuadorian cocoa for her Master degree at Virginia Polytechnic Institute and State University in 2007, brings up the very important issue of incentives to produce quality, in form of price premiums, not to be transmitted efficiently along the marketing chain all the way down to farm level. Among the range of themes she covers in her thesis, a specific attention directed towards the role of the middlemen is to be found. Jano concludes with intermediaries to be weak on transaction transparency, creating transaction costs impediments and reducing the transmission of price incentives to the farmers, with particular respect to incentives to produce high quality cocoa. Additionally, the author advertises for the national standards to approve the cocoa exports (INEN norms) to be modified, resulting in exporters being more demanding with respect to quality from the wholesalers who will transmit these requirements to the local middlemen and finally to the producers.

Conducting a study of the economic viability of ethical cocoa trading in Ecuador, Chris Collinson and Marcelo Leon (2000) take point of departure in Agroexportadora Maquita, an alternative

11 For further project description, see http://www.icco.org/projects/projects1.aspx?id=z2p2766

A case study of price setting mechanisms in the Ecuadorian cocoa market

Has 'the golden bean' lost its brightness?