3    Introduction to the Nicholson data

3.1 Background

3.2 Transactions costs, co-operatives and milk market development

3.3 Co-operatives as catalysts

3.4 Experience in Ethiopia

3.5 Survey design

3.6 Data collection procedures

Because each of the applications that follow rely on a data set collected at ILRI in 1997, it seems appropriate to introduce these data, the reasons why they were collected and the topic of primary interest at the outset of each of the independent projects that this report summarises.

3.1 Background

Small-scale dairy production is an important source of cash income for subsistence farmers in the East African highlands. Dairy products are a traditional consumption item with strong demand, and the temperate climate allows crossbreeding of local cows with European dairy breeds to raise productivity. Particularly where infrastructure and expertise in dairy processing exist, such markets allow smallholders to participate in the agro-industrial sub-sector and potentially in regional export markets and beyond. Moreover, growth in dairy demand in sub-Saharan Africa (SSA) is projected to increase over the next 20 years due to expected population and income growth. Milk production and dairy product consumption are expected to grow in the region of 3.8 to 4% annually between 1993 and 2020 (Delgado 1999). Increased domestic dairy production has the potential in much of SSA to generate additional income and employment and thereby improve the welfare of rural populations (Staal et al. 1997). However, there are concerns that the benefits of this expected growth might bypass resource-poor livestock producers unless specific policy actions are taken.

Barriers to smallholder participation in dairy production range from the availability and cost of animals to the labour needed to bring products to market. Despite the potential, smallholder participation in market-led dairy development has not been widespread in SSA outside of Kenya. Even in regions with favourable climates for livestock development, such as the Ethiopian highlands, participation in fluid milk markets by rural smallholders has been limited. Changes in sectoral and macro-economic policies are frequently necessary, but not sufficient, to provide the requisite incentives for smallholders to participate in markets.

Small-scale milk producers face many hidden costs that make it difficult for them to gain access to markets and productive assets (Staal et al. 1997). Among the barriers that may be influenced by policy are transactions costs—the pecuniary and non-pecuniary costs associated with arranging and carrying out an exchange of goods or services. The existence of relatively high marketing costs for fluid milk in Africa, the prevalence of thinness in fluid milk markets and the risks attached to marketing perishables in the tropics suggest that transactions costs play a central role in dairy production and marketing. Under such conditions, producers’ marketing co-operatives that effectively reduce transactions costs may enhance participation. Hence, it is vital to know what governments can do to better support these organisations and their emergence, and determine whether alternative institutions should be encouraged.

3.2 Transactions costs, co-operatives and milk market development

Transaction costs are the embodiment of barriers to access to market participation by resource-poor smallholders. They include the costs of searching for a partner with whom to exchange, screening potential trading partners to ascertain their trustworthiness, bargaining with potential trading partners (and officials) to reach an agreement, transferring the product, monitoring the agreement to see that its conditions are fulfilled, and enforcing the exchange agreement.

The nature of milk and its derivatives in part explains the high transactions costs associated with exchanges of fluid milk. Raw milk is highly perishable and, thus, requires rapid transportation to consumption centres or processing into less perishable forms. Further, bulking of milk from multiple suppliers increases the potential level of losses due to spoilage. These losses limit marketing options for small and remote dairy producers, raise transport costs, and imply greater losses due to spoilage than commodities such as grains. Because milk production typically is a year-round activity, dairy producers often must be concerned with maintaining outlets for their production.

The search for stable market outlets by producers is complicated by significant seasonal variation in milk production and dairy product consumption (Debrah and Berhanu 1991; Jaffee 1994). In part due to high perishability, but also due to natural variation, milk quality is variable. Some of its properties (e.g. bacterial counts) are also not easily ascertained. Although not a perfect proxy, we conjecture that distance between production and purchasing points is highly correlated with quality, which declines rapidly after milking. The lack of easily measurable quality standards may also allow agents purchasing raw milk from producers to reject milk without just cause when they have contracted to purchase more milk than can be profitably sold.

Differential transactions costs among households stem from asymmetries in access to assets, information, services and remunerative markets (Delgado 1999). Handling these access problems requires institutional innovation. First, the problem of resource-poor smallholders is often so great that a net transfer (such as a heifer) is necessary to induce entry. Second, technical and market information for new commercial items is more likely to be useful to individuals with higher levels of schooling, greater work experience, better access to management and technical advice, and better knowledge of market opportunities. Smallholders may require particular support in information and management. Third, access to services is often unequally distributed within communities. Poor infrastructure, low population density, and low effective demand make necessary institutions for risk-sharing and economies of scale in provision of agricultural services, especially in remoter areas. Fourth, better access to remunerative markets for high-value-to-weight items is necessary for promoting growth of smallholder agriculture.

3.3 Co-operatives as catalysts

A common form of collective action to address access problems of this type is a participatory, farmer-led co-operative that handles input purchasing and distribution and output marketing, usually after some form of bulking or processing. Farmers gain the benefit of assured supplies of the right inputs at the right time, frequently, credit against output deliveries, and an assured market for the output at a price that is not always known in advance, but applied equally to all farmers in given location and time period. Extension is sometimes part of the services provided, typically at higher rates (and quality) than state extension services. Co-operatives, by providing bulking and bargaining services, increase outlet market access and help farmers avoid the hazards of being encumbered with a perishable crop with no rural demand. In short, participatory co-operatives are very helpful in overcoming access barriers to assets, information, services, and the markets within which smallholders wish to produce high-value items (Jaffee 1994).

Like contract farming, producer co-operatives can offer processors/marketers the advantage of an assured supply of the commodity at known intervals at a fixed price and a controlled quality. They can also provide the option of making collateralised loans to farmers. For processors or marketers, such arrangements eliminate the principal agent issues faced by collectives and out grower schemes in monitoring effort by the individual producer. The schemes also provide better relations with local communities than large-scale farms, avoiding the expense and risk of investing in such enterprises, sharing production risk with the farmer, and helping ensure that farmers provide produce of a consistent quality (Grosh 1994; Delgado 1999).

Producers’ co-operatives are unlike contract farming schemes, however, with respect to negotiations among different partners. If the issue in contract farming revolves around the power of farmers to negotiate with processors in producers’ co-operatives, the issue in the co-operatives themselves is the power of members, collectively, to hold management accountable. Producers’ co-operatives in Africa have had a generally unhappy history, because of difficulties in holding management accountable to the members (i.e. shirking), leading to inappropriate political activities or financial irregularities in management (de Janvry et al. 1993; Akwabi-Ameyaw 1997), and also due to over-ambitious investment in scale and enterprises beyond management’s capability. The degree of moral hazard seems to be greater if co-operatives are general in their orientations rather than created for specific purposes, such as farmer-run local milk marketing co-operatives in Uganda and Kenya (Staal et al. 1997). In Ethiopia, on the other hand, the perception exists that there may be enormous potential for their role, in concert with production innovations, as market precipitators (Nicholson 1997).

3.4 Experience in Ethiopia

The traditional system of milk production in Ethiopia, comprising small rural and peri-urban farmers, uses local breeds, which produce about 400–680 kg of milk/cow per lactation period (Debrah and Berhanu 1991). More recently, intensive systems as diverse as state enterprises and small and large private farms use exotic breeds and their crosses, which have the potential to produce 1120–2500 litres over a 279-day lactation (Debrah and Berhanu 1991). Fresh milk marketing is channelled through both formal and informal outlets, with informal markets supplying some 85% of total fresh milk in the Addis Ababa area (Staal 1995). The major formal outlets are dominated by a government enterprise called the Dairy Development Enterprise (DDE), which has established numerous collection centres that buy milk at a uniform government controlled price that requires no minimum delivery. In 1992/93, the DDE supplied 12% of total fresh milk sales in Addis Ababa (Staal 1995). The DDE is concerned primarily with fluid milk marketing, although it does make some cheese and yoghurt in its Addis Ababa processing facilities.

The informal fresh milk market involves direct delivery of raw milk by producers to consumers in the immediate neighbourhood and sales to itinerant traders or individuals in nearby towns. Milk is transported to towns on foot, by donkey, by horse or public transport and frequently commands a higher price than in the originating locale (Debrah and Berhanu 1991). In Ethiopia, fresh milk sales by smallholder farmers are important only when they are close to formal milk marketing facilities such as government enterprises or milk groups. Results from a sample of farmers in northern Shewa in 1986 estimated that 96% of the marketable milk was sold to the DDE (Debrah and Berhanu 1991). Farmers far from such formal marketing outlets prefer to produce other dairy products instead, such as cooking butter and cottage cheese. In fact, the vast majority of milk produced outside urban centres in Ethiopia is processed into products by the farm household, and sold to traders or other households in local markets.

The other principal outlets for milk are ‘milk groups’, which are milk marketing co-operatives recently established by the Ethiopian Ministry of Agriculture’s Smallholder Dairy Development Project (SDDP) with the support of the Finnish International Development Association (FINNIDA). The milk groups buy milk from both members and non-members, process it, and sell the derivative products to traders and local consumers. Although the milk groups sometimes sell fluid milk products such as sour milk, skim milk, or buttermilk, most of their revenue is generated by sales of processed dairy products, butter and cottage cheese (Nicholson et al. 2000). The groups do not presently represent a significant source of fresh milk for either rural or urban markets.

3.5 Survey design

The SDDP milk groups purchase raw milk from farmers, then use hand-operated equipment to process the milk into butter, local cottage-type cheese (ayib), and yoghurt-like sour milk (ergo). These dairy products are sold to local households, to traders who market them in turn to major urban centres, and local restauranteurs. Typically, the value added from processing the fluid milk into products (less funds retained for maintenance of the groups’ facilities) is returned as a semi-annual, lump-sum payment to group members and others who have supplied the group during the period since the previous payment.

At the time of data collection four of these milk groups existed, two in the Shewa region north of Addis Ababa and two in the Arsi region near the regional centre, Asella. The activities of these groups are focused exclusively on the processing and selling of dairy products. They provide no additional services (i.e. no credit, feeds, veterinary services etc.) to farmers or to buyers and, therefore, represent the simpler end of the continuum of activities that co-operative organisations might undertake.

Although the number of farmers and the amount of milk received at each group is not a large proportion of regional totals, the formation of these groups has created a new outlet for sales of fluid milk by producers. Prior to the formation of the groups, the households processed nearly all locally produced milk into butter and ayib (a local form of cottage cheese). Even now, most milk produced in these areas is marketed as home- processed dairy products and sold to traders or other households in local markets. Thus, the milk groups can be considered organisational innovations that increase the number of marketing options available to smallholder dairy farmers and mitigate some of the principal transactions costs that retard entry.

3.6 Data collection procedures

In order to respond to questions surrounding the possible impacts of ‘other factors’ on entry, data were collected from four rural communities called peasant associations (PAs) (which are state-designated partitions of rural districts) near two of the four milk groups formed by the SDDP. Preliminary surveys were undertaken in December 1996 and January 1997 to ascertain the extent of crossbred cow ownership. On the basis of the preliminary surveys, the Mirti and Ashebaka PAs in the area of the Lemu Ariya milk group were selected from Arsi region, and the Ilu-Kura and Archo PAs were selected near the Edoro milk group in Shewa region. One PA in each region was close enough to the milk group that co-operative selling occurred; the other was distant enough that sales were precluded. None of the households in the Ashebaka and Archo PAs participated in the milk groups, whereas a proportion of the households in Mirti and Ilu-Kura PAs delivered milk to the groups.

A census of households in these four PAs was conducted for the purpose of developing a sampling frame. Using the census results, a sample of 36 households was selected in each of the PAs, stratified by whether the household owned crossbred cows, participated in the group, and their distance to the group or to another local markets where dairy products could be sold. During June 1997, baseline surveys of household characteristics and current cattle management practices were administered to 144 households. From June 1997 to October 1997, data on milk allocation and marketing, significant events occurring in the cattle herd (births, deaths, purchases, sales, illness etc.), and cow feeding practices were collected every two to three weeks.

In the empirical applications that follow we focus on the 68 households in the Mirti and Ilu-Kura PAs for which samples were observed on milk sales in the seven days prior to three respective visits, yielding a total of 1428 = 68 × 7 × 3 observations. Importantly, only 15% of the observations correspond to participating households. Table 1 summarises the data by market participation status.

Table 1. Selected characteristics of survey households, by market participation status.

Note: t statistics (1426 degrees of freedom) reported for difference between means.