The Yin and Yang of Value Chain Investment
[This article reflects the opinion of the author and not necessarily that of FAO.]
Sustainable Development Goals (SDG) level impact ultimately implies impact at scale. Impact at scale implies investments of sufficient size to occur at the right place in the system. Two disciplines look at these investments from two complementary perspectives: value chain development experts look at the ‘where to invest’ (finance demand side) while financial design experts look at the ‘how to invest’ (finance supply side). In practice these two disciplines, these two types of practitioners, operate largely in isolation and with little coordination, and as a result, both lose much of their potential effectiveness. Bringing them together in a systemic way is essential for achieving SDG impact. After elaborating on this argument, this article will illustrate it by sharing an ongoing effort for the sustainable development of the pineapple value chain in Suriname.
Bringing value chain analysis and financial mechanism design together
Modern value chain analysis and development is a process that systematically works toward the development of an upgrading plan that implies a set of interrelated investments. The underlying element is the use of a system-based approach that includes not only all the actors along the value chain, but also the various support-providing firms and the enabling and natural environments in which they operate. Two key steps are taken. First, an opportunity is identified for generating value-added that could deliver on the SDG, i.e., there are strong economic, social and environmental impacts. Many such opportunities exist in developing countries. Second, an upgrading strategy and development plan are elaborated that will simultaneously tackle all binding constraints standing in the way of realizing that opportunity. This plan typically implies investments needed to upgrade (or introduce new) business models, governance structures, and enabling environment elements (infrastructure, institutions, organizations). Working with value chain actors, value chain practitioners identify and detail worthy investment opportunities, but then often struggle to find a financing solution.
Modern financial mechanism design for development uses an increasingly broad and innovative set of financial tools and partners to facilitate access to funding for strategic investments. While there is broad agreement that public funds from governments and official development assistance (ODA) fall far below what is needed, there is no shortage of liquidity for financial institutions, investments and impact investors. Neither is there a shortage of financial instruments that can be applied, such as partial credit guarantees, concessional debt or equity along with technical assistance funds, guarantee/risk insurance, matching grants, and voucher programs. The central challenge in designing financial mechanisms lies in finding a match between source and destination of finance in terms of the risk-return profile, typically focused on singular investments (in a particular business, for example). Of particular and growing importance in this regard is blended finance. Blended finance refers to using development finance to mobilize additional (more risk-averse) finance towards sustainable development in developing countries. Working with financial institutions, financial design practitioners identify and detail financing solutions, but then often struggle to find worthy investment opportunities with acceptable risk levels.
Bringing these two disciplines together in a systematic way appears to have clear synergies: they represent two sides of the same coin. The OECD Development Assistance Committee (DAC) principles call for finance to be anchored to a development rationale and to be adapted to local needs. This is exactly what value chain practitioners can bring to the investment table. By focusing not on isolated investments, but rather on investment packages that tackle all critical value chain constraints, the default risks will be far lower, and the SDG impact far greater, than if each of these investments would have taken place on their own. For example, investing in developing a raw material supply will pay off only if accompanied by synchronized investments in the processing of these raw materials and the marketing of the resulting products.
Value chain investment in Suriname
The development of the pineapple value chain in Suriname provides a case in point. Suriname has a unique story to sell through its pineapples. Like coffee from Ethiopia, the pineapple originates from Suriname (or at least from the Guyana highlands which make up a large part of Suriname). That origin is reflected in the many unique pineapple varieties that are cultivated. Furthermore, the indigenous people, who have been cultivating pineapples in Suriname for centuries, are still the main producers. Production is organic by nature and can be certified easily and quickly as such, and there are good and growing markets for fresh and processed organic pineapples from Suriname as long as order specifications are met. In addition, there is a strong interest on both the private and public sector side to develop this value chain. However, the realization of this potential is hampered in three critical ways: lack of knowledge of modern organic pineapple growing, handling and processing practices (traditional growing is currently practiced); lack of access to finance to make the required investments (banks do not know the value chain, do not have good entry points); and lack of organization to make access to knowledge, finance and markets efficient (little to no collective action or structures). The conclusion here is that there is a clear business case for the export of differentiated (high quality, organic, unique variety) pineapples from Suriname, as long as critical hurdles can be overcome.
Under the Accelerator for Agriculture and Agro-Industry Development and Innovation Plus (3ADI+) program, led by the Food and Agriculture Organization of the United Nations (FAO) and the United Nations Industrial Development Organization (UNIDO) and in the case of the Suriname pilot project critically supported by International Labor Organization (ILO) and United Nations Population Fund (UNFPA), value chain practitioners worked with the public and private stakeholders to develop a 2030 vision for the value chain. Apart from critical organizational and institutional upgrades, the strategy to realize this vision implies a set of interconnected investments in modern organic production practices, pack-houses, processing facilities, technical support centers and a digital platform. Each of these investments in and of itself would have little to no impact, and in fact would likely fail. Together, these investments would be transformative and show a strong SDG impact, especially given that social considerations (e.g., indigenous communities, gender, youth) are taken fully into account. This work provided the answers to the ‘where the money needs to go” part of the equation.
To answer the ‘where the money has to comes from’ part of the question, a practical and realistic financial mechanism was designed. This mechanism includes three main parts, each addressing a core need (access to finance, improvement of organization, and access to knowledge).
First, the creation of a blended loan guarantee fund, initially based on donor and international financial institution (IFI) funding that are later complemented with private investment funds, will provide national banks with the de-risking instrument they need to extend loans to pineapple growers and other VC actors such as processors and input suppliers. At first, the fund will cover 100% of the banks’ risk, but as skills and experience on the lender as well as the bank side strengthen over time, other risk management tools will gradually take over, such as the use of pineapples as collateral.
Second, a pineapple value chain company will be set up. This company will be owned by the farmers through village-level cooperatives, engage in outgrower contracts with its farmer-owners, and market the aggregated output.
Third, as the farmers do not (yet) have the required business acumen, the company will outsource its management to a pineapple innovation hub. This hub will take on all the functions that are needed: setting up the production contracts, assessing the credit-worthiness of farmers in collaboration with national banks, arranging the overall financing, implementing a voucher program for the inputs, providing agronomic advise, doing quality control for the pineapples, operating a pack-house, setting up sales contracts and maintaining a digital platform on actors and transactions. As it grows in size over time, the company can internalize some or all of the hub’s functions.
Seed funding will be needed to bridge the initial set up period. Profit margins at the company level are sufficient to pay for the costs of the fund, the loans, and the hub, making the entire model sustainable once a certain volume of production and sales has been achieved (after three years). To fill the funding gap during these first years and provide the first-loss tranche for the guarantee fund, funding through a development grant will be needed. This catalytic funding was requested through the UN SDG Fund, with a decision expected by February 2021.
The Suriname example shows the potential of, and need for, bringing the financial mechanism and value chain streams closer together. At the international level, establishing long-term partnerships between financial institutions (such as IFIs and investment funds) and UN organizations that promote value chain development implies a perhaps not entirely new, but increasingly essential modus operandi for the realization of the SDGs. Any investment made implies that two questions were answered: where the money came from (the yin) and where it went (the yang). The realization of successful investments, i.e., investments with real SDG impact, cannot emerge without simultaneously finding the most effective answers to these two questions. Financial mechanism design and value chain analysis are complementary streams that impact dynamic systems such as food systems in far greater ways when combined from the start than when applied separately.