working paper

Integration of Developing Countries in the Global Supply Chain

A Global Buyers and Producers Perspective

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Integration of Developing Countries in the Global Supply Chain: A Global Buyers and Producers Perspective
by Ronald E. Berenbeim and Mallika Shakya 4 11 24 37 48 65 76 78 81 82 86 Chapter 1: Introduction and Overview Chapter 2: Cocoa Operations in Ghana and Cte dIvoire Chapter 3: TEAM Foods Colombia: Research, Development, and Diversification for Moving the Value Chain Chapter 4: CPGco Inputs to Personal Care Products Chapter 5: Hindustan Unilever Mobilizing Unlikely Partners for Supply Chain Development Chapter 6: Structural Change During the Time of Crises The Global Recession and the Energy Price Crisis Chapter 7: Conclusions and Ways Forward Bibliography Methodology and Interview Protocol Appendix: Interview Protocol and Case Study Outline About the Authors

Chapter 1: Introduction and Overview

Global buyers and their production networks The nature of trade has been radically altered in the past few decades by the emergence of global production networks, and the rise of inter- and intra-firm trade within these networks. The challenges faced by developing countries are daunting, not least because global competition is intensifying and international trade is taking new forms, which is making it more difficult than ever to break into new markets. Rapid technological change and dramatic improvement in transportation and logistics have given rise to newly organized global production networks and value chains which require sophisticated skills, capabilities, and strategies at all levelseven for manufactured goods as simple as Tshirts. There is a growing body of literature on global production networks and global value chains. Embedded within these are the specific dynamics of inter- and intra-firm relationships, of which relatively less is said or written. This document is an effort to fill in the knowledge gap in this area, and it will deal with the questions relating to the strategies employed by global producers and buyers in selection and operations of their production bases in different parts of the world. Often bundled with financial, management, and technical skills as well as broader logistical and distributional relevance, these strategies look increasingly similar for several of the small and least developed countries who are often on the farthest end of the global supply chain and compete with each other to attract the same group of global buyers and producers. Key questions for developing countries Large and small developing countries have emerged as the new frontiers of the structural change ushered in by the rise of global production networks. Policy makers from these countries must focus more than ever before on understanding the way firms in their countries are linked with their global counterparts, not only in exchange and distribution, but throughout the overall organization of production. Within each country, it is more and more likely that multinationals location decisions depend as much on the availability of necessary public goods and sophistication of local partner firms as on sheer location advantages. As global production networks advance, multinationals are increasingly engaging central and regional governments regarding infrastructure, connectivity, innovation, regulation, and revenue management issues. Global buyers and producers are no longer passive beneficiaries but are becoming active partners in all stages of industrial development: identification of industrial operations bottlenecks, formulation of policy measures to address them, and collaboration in taking necessary actions. For these reasons, policy makers in developing countries can gain a better understanding of global buyer and producer decision making through description and analysis of their supply chain, selection of partners, and country choices for sourcing, distribution, and sale. A better understanding of global buyer and producer priorities when operating and

trading in middle- and low-income countries (MIC, LIC) will address key infrastructure and policy questions that companies ask in making location decisions: How does the business decision maker balance geographic and economic considerations, such as a countrys public policy and its institutional and private sector capacity? What are some of the company- or industry-specific strategies employed by global buyers in dealing with MIC and LIC government and market failures? What lessons can be learned from best practices in these challenging markets? What are the policy and institutional reforms that maximize the role of global buyers to the benefit of the least developed countries (LDC)? What public-private sector collaborative efforts can lead to reforms that maximize buyer, seller, and LDC benefits? How can the bottlenecks related to transportation, logistics, innovation, and quality be overcome? How should the decision-making criteria of global buyers and sellers be taken into account in the design of national policies and assistance strategies by international organizations, including the World Bank? In exploring these questions, the basic premise of this undertaking is that international trade is less and less a random phenomenon where anonymous producers and buyers engage in exchange of what they produce and consume. Increasingly, trade is based on relational contracting in which the local and global counterparts enter into long-term business negotiations, often facilitated by relevant public sector organizations, and value is created beyond the immediate transaction. There is a growing tendency for global buyer and producer location and business strategy decisions to rely on concerted public support that harnesses new technology and production methods and improvements in logistical models. These factors add up to a better business-enabling environment. A broad conceptual framework on competitiveness Better integration into global production networks can accelerate the process of knowledge transfer and firm sophistication in developing countries. But more is needed beyond passive LDC hosting of global buyers and producers in their domestic economies. The kind of minimal effort found in many countries has not improved LDC competitiveness. Recent research demonstrates surprisingly little success on the part of the lowest income countries to move up the value chainparticularly in commodity trade, light manufacturing, and distribution. 1 Instead, where there has been a successful
1

See World Bank Country Economic Memorandums for Cte DIvoire, Cameroon, Sierra Leone, Ghana, and Nigeria who have large or emerging agricultural sectors that have not necessarily led to value chain upgrades or closer integration into global supply chains.

local adaptation to global knowledge, innovation, and capacity increases, it has been linked to domestic public policies and private efforts that in concert have built a successful competitiveness framework. 2 Figure 1: Understanding global buyers perspective on competitiveness

Source: The Conference Board and The World Bank Competitiveness is a widely accepted but often misinterpreted concept. Those who argue that competitiveness is a countrys share of exports into the global market reduce competitiveness to a zero-sum game. Rather, competitiveness needs to be viewed as the path to prosperity and it should be equated with the productivity of an economy per unit of the nations human, capital, and natural resources. Although competitiveness is founded on a country or regions natural endowments, overall security, and a stable macroeconomic regime, it also draws on the multiple dynamics of: firm sophistication; the state of cluster development, which involves greater coordination among firms, their suppliers and service providers, and associated public and private institutions; and the quality of the business environment including factor and demand conditions as well as the rules for competition (Porter, 2008). There is no set formula as to what a countrys path to competitiveness should be at a given point in time but it is now widely accepted that competitiveness entails building a policy and institutional environment in which firms are able and encouraged to surpass rent-seeking and overcome government and market failures. 3 In this regard,

See Sun and Zhang (2009), which discusses the usefulness of various frameworks on global integration of developing countries for policy dialogues. Sun and Zhang argue that owing to technological and institutional backwardness, developing countries have made little progress on both accounts of governance and upgrading. The World Bank (2009) handbook on industrial clusters demonstrates the importance of public-private collaboration for enhancing local knowledge, technology adaptation, and

competitiveness is a kind of continued filtration process through which better performing industries, processes and practices, and markets can be singled out from the lesser performing ones. An evaluation of the operations of global buyers and producers may offer developing countries a kind of search engine through which such a filtration process can be facilitated on an ongoing basis. 4 Global buyers and producers are often large in size and resilient to crises, and command advanced organizational structures and operations that can be documented as global best practices. Global buyers and producers operations are not dependent on local public goods in the way those of local firms are; yet their investment and expansion decisions depend largely on the competitive policy framework and business environment offered by host countries. Thus, global buyers experiences can be used as a control group to assess related policies and institutions for possible scrutiny or reward. Selection of the case studies Three key industriesagribusiness, apparel, and retail distribution (fast-moving consumer goods, or FMCG)were chosen for study because these sectors have emerged in many industrial countries as the launching pads for further industrialization. Global buyers and producers were invited to discuss their success with innovative approaches in their developing country operations. Global buyers and producers were encouraged to highlight these efforts within the context of hard and soft infrastructure strengths and limitations, and the degree of direct enterprise incentives and support from host governments. Nine case studies were compiled altogether of related products, sectors, and buyers. These were eventually condensed into the four case study chapters presented in this document. Two of the case studies discussed involve the import of global buyers from developing countries while the remaining two are about the global producers retail distribution strategies in emerging markets. The purpose is to explore the multiple dimensions of institutional structuresboth in the private and public sectorsthat allowed countries to acquire and adapt the sophisticated business models that global buyers and producers require. Stable macroeconomic, political, and social environments supported by sound infrastructure and supporting institutions are vital to both national and firm competitiveness. Beyond the national and top-management level, policies and provisions have context-specific nuances. Although the macro fundamentals of competitiveness remain more or less the same in most

governance for achieving export competitiveness. Beyond macroeconomic reforms and piecemeal efforts on export promotion, it calls for a paradigm change in the way public and private sectors have interacted with each other on policy- and industry-specific issues.
4

See Sabel (2007) for a detailed discussion on the return of the industrial policy. He argues that competitiveness is a joint effort between governments and private sectors but that each has a distinct role within such an initiative. He argues that industrial policy has been unjustly vilified but he acknowledges that governments should not pick winners for extending public support for industries but work towards an objective and rigorous filtration process.

countries, national industrial policies cannot be set in isolation. In fact, competitiveness strategies have worked best where they have sufficiently taken into account global production network developments. This is especially true when countries are hit by exogenous shocks such as the global financial crisis in 2008-2009 or the unexpected fuel price rise in 2008. Two cases focus on middle-income countries (Colombia and India) and two examine business activities in low-income countries: Cte dIvoire and Ghana. These choices comprise a wide spectrum of strengths and weaknesses in political and physical security, macroeconomic stability, economic liberalization, firm and institutional sophistication, technology, scale, and natural endowments. Until fairly recently, the economies reviewed in this document were comparable to todays struggling countries. By seeking direct engagement with global buyers and producers, most of these countries have capitalized on their natural endowments of geography, scale, and human resources to become more competitive. These case studies also shed light on those recurrent political and economic problems that continue to threaten the growth and competitiveness in many countries. The global buyers and producers chosen for participation have a long history of engagement in frontier locations. They are acknowledged trend setters in their respective industrial sectors with respect to global integration and corporate social responsibility. The innovativeness and sustainability of their collaboration with a diverse set of local institutions made them attractive candidates for this study. Some buyers made substantial efforts to bring on board unlikely collaborators like grassroots-level development NGOs (e.g., Hindustan Unilever); others forged partnerships with local and global knowledge institutions (e.g., CPGco and TEAM Foods); and still others patiently collaborated with host governments for local infrastructural and institutional reforms (e.g., the cocoa processing multinational in Chapter 2). The messages from the case studiesespecially on key issues of supply chain structure and trade financeare further validated through two broader surveys of global buyers that collectively covered 90 respondents from diverse industrial sectors, sizes, and geographic locations. Summary and key messages The case studies in this collection suggest that many of the factors that allow local subsidiaries to attain parity with their parent global buyers and producers are the same as those that produce overall competitiveness in these countries. The fundamental issues of political and physical security, economic stability, and basic infrastructure cannot be ignored. However, several other factors are key: coordination among firms, sophistication of supporting industries and associated institutions, and efficiency in physical and virtual movement of goods. In varying degrees, such factors become takeoff points for local private sector growth and sophistication. Political and physical security is fundamental to efficiency in the physical and virtual movement of goods. As such, it is the first requirement and as important as macroeconomic fundamentals. For example, one multinational downsized its cocoa growing operations in Cte dIvoire and consolidated the investment in neighboring Ghana because of Cte dIvoires deteriorating political situation and the Ghana governments active and meaningful engagement in overcoming some of the policy and

institutional constraints for the companys future investment in a new cocoa processing plant. Cte dIvoires position as the largest cocoa producer in the world and its more liberalized cocoa industry were of little benefit in its competition with Ghana when compared with Ghanas proactive policies that contributed to efficiency in carrying out core functions (e.g., collection, storage) and in maintaining quality standards. In Colombia, oil palm and retail distribution supply chain security concerns were overcome through closer public-private coordination that effectively heightened security measures for plantations, depots, offices, and trucking routes of both global and local firms. Transport and logistics are a strategic source of competitiveness, highlighted by the increase in global production sharing and the shortening of product life cycles. The TEAM Foods, CPGco, and Hindustan Lever (HUL) cases underscore the need for national transport and logistics services reform so that competition can result in a natural evolution to a quality-based selection process. Indeed, where logistical bottlenecks remained, global buyers sought to develop especially aggressive market penetration strategiesas seen in HULs tendency to compensate for logistics inefficiencies through collaboration with NGOs to train rural women to be social entrepreneurs. With their ties to local communities these women were able to raise the personal hygiene awareness that was a key element in HULs detergent marketing effort. In a different approach, TEAM Foods invested heavily in internal supply chain management systems like sales and operations planning (S&OP) to ensure that inputs from local trade policy and market intelligence specialists are directly fed into the S&OP process on a periodic basis. Product quality is another area where competition takes place. Quality development is a complex process because several of its elements are embedded into other related aspects of competitiveness: innovation and diversification. Breaking the frontier in product quality requires innovation and deliberate building of human and material resources. Upgrading quality is what allows companies to begin to differentiate their products from one another, and it is a platform on which a sustainable business strategy of diversification can be built. Upgrading quality often requires capabilities that are more tacit than explicitthey a part of the firms invisible assets (Amsden, 2001) and they impinge on a whole set of public goods that can be achieved only through contributions from multiple public and private sector actors. Labor standards and standards for safety and quality are generally necessary to protect consumers from unsafe and inferior goods, but virtual barriers arising from deficiencies in these areas often inflict serious costs on international trade. While global buyers make genuine efforts to ensure that these standards are met, they also have to develop advanced procurement and logistical technologies to ensure that less time and money are spent in clearing standards-related bureaucracies. The cases of TEAM Foods and CPGco both highlight the importance of advanced procurement and coding technologies for meeting these demands. In these areas, the advantages of large over small firms cannot be ignored. Large global buyers and their subsidiaries may have easier and affordable access to technologies that smaller firms lack. While macroeconomic policies receive much attention and have the ability to influence

nations competitiveness-building at a broad scale, most barriers to competitiveness lie at the microeconomic level. Interventions on issues such as trade logistics, technology, and quality standards and innovation require precision policies and better coordination between firms, service providers, regulating bodies, and support institutions. Such measures may sometimes be best developed and implemented at sub-national or cluster levels. Nevertheless, the eclectic nature of issues such as transport, technology, and standards demands that all or most competitiveness interventions may need simultaneous engagement with a wide range of industrial sectors, line ministries, and research disciplines.

Chapter 2: Cocoa Operations in Ghana and Cte dIvoire

One multinational companys Ghana and Cte dIvoire cocoa operations demonstrate that the nature of economic and political regimes, quality of backbone services, and direct enterprise support in the growth and sophistication of the West African cocoa industry are key factors in purchase and sourcing decisions. 5 In making its choices, the companys experience also shows how companies can find themselves weighing the relative costs and benefits of two very different business environmentsin this case the advantages of Cte dIvoires liberal economic regime against the benefits of Ghanas political and social stability. Since they expanded their cocoa production in the early 1970s, Ghana and Cte dIvoire have had different degrees of political stabilityespecially since the 1990s when the global supply chain for cocoa achieved a new level of integration. In the 1990s, Cte dIvoire undertook a major economic liberalization program by deregulating its cocoa production, pricing, and distribution. At the same time, its political stability declined resulting in major deterioration of the business-enabling environment. In contrast, Ghana kept its cocoa production, pricing, and distribution centralized and highly regulated through establishment of a government-owned Cocoa Board, while maintaining its overall political stability. This competitive advantage as opposed to Cte dIvoire helped Ghana to achieve significant improvements in its business-enabling environment. As a consequence, global producers, such as this particular multinational studied for this report, now prefer Ghana to Cte dIvoire for longer term investments such as the establishment and upgrade of cocoa processing plants. As a result, Ghana has moved up the global value chain. The Companys Operations in West Africa This multinational company is one of the largest agricultural processors in the world. Serving as a vital link between farmers and consumers, it trades, transports, stores, and processes cropssuch as corn, wheat, soybeans, canola, and cocoainto food ingredients, feed for animals, renewable fuels, and industrial products. The company distributes these products to its customers, primarily large food and energy companies and industrial firms, throughout the world. With a global network of more than 200 processing plants and more than 25,000 employees, the company operates in 60 countries. In 2007, it recorded net sales of over $40 billion and net earnings of over $2 billion. The company operates one of the largest and most advanced origination, transportation, and logistics networks in the world. Through a fleet of trucks, railcars, barges, and ship charters, it is able to take grains from anywhere they are produced, process them into a diverse slate of products, and move these products to any destination worldwide.

The company name and specifics were redacted on request.

Currently, the company trades and processes about 15 percent of the global cocoa crop, or 500,000 tons (in 2007), selling mostly intermediate products to confectionary and food companies. The cocoa division of this company was started in 1998 with the acquisition of the cocoa operations of a large American and a large European multinational. In 2000, the cocoa division of a large diversified private agri-business company in Cte dIvoire was added to these operations. Recently, the company has also produced significant amounts of industrial chocolate to sell to high-end confectioners. Its cocoa operations include about 3,000 employees in Europe, North America (for processing and selling), West Africa, Brazil (for sourcing and processing), and Southeast Asiaparticularly Singapore (processing) and Indonesia and Malaysia (both sourcing). There are three categories of cocoa beans: (1) criollo (the native or the beans with premium organoleptic quality); (2) forastero (the stranger or the basic quality); and (3) trinitario (the blend). Criollo accounts for only 1 percent of the worlds cocoa production and is almost fully concentrated in Venezuela. The other two varieties are grown in other tropical rainforests and found in West Africa, tropical Asia, and South America with a varying degree of refinement. Before 2000, the involvement of exporters such as this company in the higher ends of the supply chain was minimal in Africa, since all trade was government controlled for both price and quality. In the late 1990s, the World Bank strongly encouraged countries to abolish the state-controlled trading and marketing firms to create a more efficient, free market-based system in which farmers were expected to receive more money for their crop, because competition should reduce the cost of the collection, sorting, grading, logistics, and sales services performed by the mostly non-transparent government monopolies. Cte dIvoire, Cameroon, and Nigeria did liberalize their state monopolies: Cte dIvoire replaced them with a complex set of agencies for regulation and promotion of the industry that are described in detail in the next section; Cameroon and Nigeria developed lighter regulatory frameworks. Ghana was the only country in West Africa that went for partial liberalization instead of full liberalization. It liberalized the logistics services but maintained the public monopoly over cocoa collection and price determination. Instead of full liberalization, the government focused on improving transparency in state governance. The companys cocoa involvement in Africa varies by country. The soil and the climate needed for cocoa production is geographically restricted within Cte dIvoire, Ghana, Nigeria, Cameroon, and Sierra Leone. Within West Africa, so the company made decisions to invest in cocoa processing plants in Cte dIvoire and Ghana while remaining mere marginal purchasers in Cameroon and Nigeria. Cte dIvoire is the largest cocoa producer and was the first of this companys cocoa investments in Africa. However, the company is rapidly curtailing its investments in Cte dIvoire while expanding in neighboring Ghana. This case study is an attempt to understand the policy and institutional rationale on the host countries that are behind this particular corporate decision.

Industrial Organization: West Africa and Global Cocoa Production

West Africa produces almost 2.5 million tons of cocoa beans per year. This makes the continent the main cocoa growing region in the world with a share of over 70 percent in the total world cocoa production of around 3.5 million tons per annum. Since final consumption in Africa is very limited, its relative share in world exports is even larger. More than 95 percent of the African cocoa production originates from Cte dIvoire, Ghana, Nigeria, and Cameroon. Cte dIvoire is by far the largest producer in the world, with a production level of 1.3 million tons or 37 percent of global Source: International Cocoa Organization (ICCO) cocoa production per year which was Figure 3: World cocoa bean production, grindings, and valued in 2005/06 at 1.5 billion U.S. surplus/deficit dollars. Ghana is the second largest producer, with an annual production of about 700,000 tons or 18 percent which was valued at 810,000 U.S. dollars. Overall cocoa has a rapidly growing market and the production often falls short of demand (see Figure 3).a Cocoa production in West Africa is characterized by a very high share of smallholders in total production; by a very small average farm size; and by low yields. It is estimated that about 95 percent of the West African cocoa production originates from small farms. There are virtually no plantations and only a small number of middle-sized or larger farms. A farm size of about 3 hectare is typical for smallholder cocoa farms in West Africa, with most farms in the size group of 2 to 5 hectare.

Figure 2: Trade flows of cocoa beans from and to cocoa producing and consuming countries, 2006

Source: ICCO, 2008. Although over one million families are engaged in cocoa farming in West Africa, average yields are low on the smallholder cocoa farms and they have not changed much over the past three decades. A typical yield is about 650 kg of dry cocoa beans per hectare. Over time, yields have increased to some extent by the planting of hybrid trees. On the other hand, in a number of areas yields have been going down, as the age of the trees has increased. (contd)

(contd) Historically, cocoa processing has been done closer to where the final markets are because this helps keep cocoa inputs fresh for making final products. This practice continues to date for higher quality cocoa. But increasingly, some of the cocoaproducing countries in Asia and West Africa are now processing cocoa beans (often lower quality cocoa) within their territories. It is often the global buyers of cocoa who own such processing facilities in cocoa-growing countries, and the intermediate products they develop are cocoa butter, cocoa liquor, and cocoa powder.
See Assessment of the Movements of Global Supply and Demand, ICCO 136th Executive Meeting report, Berlin, 2728 May, 2008 (EX/136/6, 3 April 2008), www.icco.org
a

The Companys Operations in Cte dIvoire and Ghana This multinationals supply chain starts with the farmers. Unlike other agricultural products, cocoa is not planted in commercial plantations but by smallholders in small scales often mixed randomly with other crops. 6 While cocoa trees grow steadily in the fields, there are two distinct cocoa harvest periods: a large one between January and March and a smaller one of lower quality between April and June. In Cte dIvoire, the major share of the crop is bought from the farmers by some 5,000 small traders/transporters (or pisteurs) who buy, transport, and dry the beans. Dry beans are then sold to wholesalers, or traitants, who blend and bag the beans, which are then sold to exporters. Bigger pisteurs may combine the two steps and sell to exporters directly. Exporters debag once again, check for quality, perform a second round of cleaning and blending of the beans, then re-bag and ship out.

Clarence-Smith (1996) has argued that smallholder plantations (as in Latin America) were discouraged in African and Asian plantations up until the First World War and the colonizers introduced large-scale and more scientific production methods even when they required high and rigid costs. However, in the 1950s, it appears that plantations went back to being smallholder plantations, largely organized in the form of cooperatives.

Figure 4

Domestic Cocoa Supply Chain in Ivory Coast

Farmers (800,000) Pisteurs (5000) Traitants (400) Up-Country Buying Stations Local Grinders (4-6) Local Chocolate Manufacturers
Securing bean supply For exporters and grinders

Cooperatives
120 Large, 500 Total

Exporters (50) Inspection Agency

(e.g.SGS, Cornelder)

Shipping Lines (4-6) Bean Export Chocolate Liquor, Butter and Powder Export

Ivory Coast
Ports: Abidjan, San Pedro

Europe/USA Other Raw Materials: Milk, Sugar, Packaging

Note: Highlighted functions are carried out under government supervision.

Source: The Conference Board and The World Bank based on information collected in company interviews. As far as pricing, the government had been setting the prices for the sale of beans at all steps of the domestic supply chain until the 1990s. As part of its structural adjustment program, the government of Cte dIvoire removed price control mechanisms and deregulated the prices in 1998. Contrary to earlier studies that had assured that deregulation would increase farmers share of the proceeds by developing a more competitive distribution system, in reality, the farmers rates decreased. What deregulation did was encourage foreign companies to invest in more extensive operations within Cte dIvoire. This was the point when the company entered Cte dIvoire. It was soon followed by three other multinationals, and a local private company, Pronibex. Instead of simply buying cocoa beans from Cte dIvoire, former importers now began to invest in processing and quality improvement within Cte dIvoire. The company set up a cocoa division in Abidjan to work more closely with cooperatives as well as traitants on issues such as training, pre-shipment and pre-harvest financing, and incentives for quality enhancement.

Figure 5

Ghana Supply Chain

Farmers Primary Society-QCD- check/rate Licensed Buyer(23) Government Quality Inspection Regional Warehouses and Ports Gov. Inspection Agency Shipping Lines (4-6) Exporters Cocoa Marketing Co Local Grinders (4-6)

Local Chocolate Manufacturers

Ghana

Ports:Tema, Takoradi

Bean Exports

Cocoa Liquor, Butter and Powder Exports

Europe/USA
Other Raw Materials: Milk, sugar, Packaging

Note: Government entities oversee the functions highlighted in green boxes

Source: The Conference Board and The World Bank based on information collected in company interviews. The main difference between the Ghana and Cte dIvoire supply chains is the continued government regulation of Ghanas cocoa industry. Ghana has a state monopoly that sets the prices paid to farmers and controls the quality of beans traded at three points in the supply chain. The price is set once a year and after it is fixed, fluctuations in the world price cause some fluctuations in the quantity of the bean supply in Ghana. This is caused by diversion of the supply to and from neighboring Cte dIvoire and Togo, which become attractive if there is a large difference between the national and the world market price. Since Ghana sells a major portion of its crop in futures markets, these shifts can lead to some shortages if the national price is significantly lower than the world price. The supply chain starts when the farmer brings his crop to a primary society nearby, where a government quality controller checks and grades the beans and seals the bags. The farmer is paid by a clerk from a licensed buyer based upon quality grade as well as quantity. The licensed buyer delivers the bags to a regional warehouse or port storage facility, where the beans are again checked upon entry by a government quality inspector. The beans are then sold by the Ghana Cocoa Marketing Company to an exporter, a local grinder, or a foreign buyer. The beans pass a government inspection before they are delivered to a local grinder or to the shipping line chosen by the exporter.

Since the trade is controlled through government regulations, it took longer for Ghana to adopt the efficiencies of bulk handling for export. However, since the government board (COCOBOD) recently invested in bulk facilities for loading ships, Ghana has surpassed Cte dIvoire by replacing the harbor storage in large bags, as used in Cte dIvoire, with pure bulk storage facilities without using packaging materials. Cocoa growing countries would like to extend the supply chain in their countries by including cocoa processing, and thus add value and economic activity before export. During processing, 20 percent of the cocoa bean is not converted into an intermediate product; therefore processing near the source provides a reduction in freight tonnage of 20 percent for exporta major cost saving involved in local processing. However, the producers of final cocoa products would much prefer to have cocoa processed closer to their own plants because semi-finished cocoa products are difficult to preserve in taste and freshness for a longer time and through variety of climates. In fact, it is only the lower quality cocoa beans that are processed within producer countries, while the higher quality beans are processed closer to the plants where final cocoa products will be produced. The decision to process the beans within producer countries is extremely complicated. The companys experience has shown that this decision is underpinned by a diverse set of considerations involving overall political stability, market openness, and supporting policies and institutions that are industry specific. Countries often tend to rely on tariff preferences for locally processed beans and tariff penalties for exported beans in proportion to the quantity processed locally. But these are short-term measures and have their limitations. This case study shows that the overall corporate decision for long-term investment on the part of the global buyers depends less on tariff-based rivalries but more on longer term visions of policy and political stability as well as the efficiency of supporting institutions that work for better organization of the industry. Cocoa bean processing uses heavy presses and grinders to produce three intermediate products: cocoa liquor, cocoa butter, and cocoa powder. The overall capital required for such a processing plant may range between 5 and 20 million dollars and because the process is capital intensive, it is important to run the equipment continuously over the year, despite the fact that the two main harvesting periods comprise only six months total. Keeping in mind such a dual cycle, inventories need to be maintained throughout the year to bridge the gap and produce consistent quality. Most cocoa products are not made from beans of one origin, but from a blend of different beans. This usually requires importing beans to allow for a blending of cocoa varieties. Cocoa bean inventories slowly deteriorate, due to oxidation color and flavor that are affected over time. In a moderate climate, inventories can be kept for about ten years, in a tropical climate for about only nine months. This limits operational flexibility, and requires investment in climate conditioning for bean storage in tropical climates.

In making the investment decision, the company will typically look at the following factors: Overall long-term stability to ensure positive cash flow The investment horizon used to make the discounted cash flow calculation to evaluate projected results against a hurdle rate for investing capital is fixed for stable economies where clear laws and regulations are consistently applied. The company uses eight to ten years in this case. For less stable situations, or those with less transparency and judiciary independence, the period is shortened to five years or less, and/or the hurdle rate is increased by a risk factor. Capital account convertibility Availability of a stable currency, interest rates, and convertibility of the local currency are important considerations for any corporate decision to be taken by the company. Optimum trade policies Higher export tax on cocoa beans releases larger volumes of beans for local processing, hence creating a bigger stake for processing companies in cocoa bean acquisition. In fact, this multinational and other cocoa processing companies often administer some of these taxes in both Cte dIvoire and Ghana and handover revenues to the government at no additional charge. Supporting institutions for industry organization Since cocoa processing plants are capital intensive, they require smooth operations throughout the year without having any production disruptions. For this, an effective system needs to be in place that ensures regular retail collection of beans, storage, quality control, and price stability. Because cocoa growing is predominantly done by smallholders, this is an elaborate task for West Africa and requires an additional facilitating role from the public sector compared to other industries where basic functionalities of market forces may have been sufficient. Key competitiveness issues Cocoa processing requires an effective system for collection, distribution, storage, and pricing of cocoa so as to link smallholders with global buyers. Political, social, and economic stability are needed for the process to work, so public goods as well as private goods are vital to effective commerce. In addition, because cocoa growing in West Africa has been done by smallholders since the 1950s, the company believes that there is a clear need for the public sector to lead in facilitating a smooth linkage between growers and buyers within the national market. West African states have historically held a monopoly over price determination, quality control, and training of farmers and traders at various levels, although some have relinquished these roles over time. Some of these feature prominently in the discussion of key competitiveness issues in cocoa operations for this company in West Africa. Political and social stability When the company made its cocoa industry investment, Cte dIvoires stable government was one of Africas success stories. Unfortunately, the countrys political situation began to deteriorate just after the company had made its

business commitment in 1998. The 1999 coup, intertwined to a certain degree with cocoa farmers resistance, led to a complicated saga of resistance and counter-resistance which gave rise to serious ethnic tensions. Ethnically biased laws dispossessed northern Ivoirians land holdings and limited the Northerners from political participation. Since mid-2002, the country has been effectively split in two. The northern half of the country with 10 percent of the cocoa crop has been essentially disconnected from the harbors as well as from the southern half. Had the company anticipated these instabilities, its spokesmen say that its investment in this country would have been simply unthinkable. In contrast, Ghana has benefited from a stable and democratic government for the last decade. This has made it by far the most attractive investment opportunity in comparison to other African cocoa sources, even though its government has not significantly liberalized the cocoa trade and continues to monopolize the functions of collection and price determination of cocoa beans. A good economic incentive regime In the 1960s and 1970s, after obtaining independence, many African countries regulated the sale of agricultural products through government marketing boards. In the early 1990s, the IMF and the World Bank urged countriesespecially those suffering from corruption scandalsto undertake substantial economic reforms. Under USD 384m ESAF (1998-2000), Cte dIvoire liberalized its cocoa sector: the old cocoa board CAISTAB was first replaced by a semi-public Nouvelle CAISTAB in 1999 and finally fully deregulated prices in 2000. Prior government commitment to such economic reforms was one of the reasons why the company had made substantial investments in Cte dIvoire. 7 Regrettably, deregulation has not necessarily led to market stability and this has invited disasters for the country. 8 Before liberalization, CAISTAB was paying the local farmers 70 percent of the world market price, which was also calculated to be the optimal producer price level. 9 After the first round of liberalization, however, the prices for farmers in Cte dIvoire were reduced to less than 50 percent of the world market price. In 1995/96, the producer price was as low as 43 percent. Although it increased to 52 percent in 2002/03, more recent data shows that producer share in the export price has

7 8

See World Bank Country Economic Memorandum on Ivory Coast (2005).

Gilbert and Varangis (2006) have argued that liberalization and globalization are two different concepts when discussed in the context of West African cocoa production because the industrial restructuring envisaged on the liberalization program has led to compromise on globalizing potentials of some of the West African countries in the cocoa production, processing, and distribution. See ICCO estimates and analyses on optimum cocoa taxing as well as on the global practices on customs treatment of cocoa beans and semi-processed inputs, Indirect Taxes and Custom Duties on Cocoa Beans and Cocoa Semi-Finished Products, ICCO Consultative Board on The World Cocoa Economy, CB/16/3/Rev.1, 20 August, 2008, (www.icco.org)

fallen again to 41 percent. Contrary to popular expectations, farmers prices decreased further because the government set up four new organizations to perform functions that CAISTAB was doing before. In the meantime, EU audits have encouraged suspicions that some of the cocoa revenues were being siphoned off to finance some of the state costs of fighting the insurgency. This discontent led to a farmers strike in 1999. At roughly the same time, an army mutiny resulted in a military coup. The interests of processing companies are seriously compromised where government bureaucratic expenses increase so much that the welfare of cocoa investors and farmers are compromised. For example, the Cte dIvoire export tax for cocoa (or DUS droit unique de sortie) was approximately 20 percent of the export value in 2002-03. When combined with the registration tax, cocoa institutions levies, and other burdens, a cocoa farmer had to pay up to 52 cents per kilogram of cocoa exported (see box). A history of cocoa tax, tariffs, and levies in Cte dIvoire The total burden of taxes and levies introduced after liberalization was expected to be less than the difference of about 30 percent between the government-paid price for beans and the world market price. However, in the Cte dIvoire during some of the conflict years, this burden has exceeded 50 percent of the world market price, reducing net payments to farmers. In August 2000, a decree on the mission of the state in the commercialization of coffee and cocoa was passed by the government. This decree envisaged the creation of two new structures to govern the cocoa and coffee trades after liberalization: the Autorit de Rgulation du Caf et du Cacao (ARCC) and the Bourse du Caf et Cacao (BCC). A subsequent government then set up three other institutions by July-August 2001: the Fonds de Rgulation et de Contrle du Caf et Cacao (FRC), the Fonds de Dveloppement et de Promotion des activits des Producteurs de Caf et de Cacao (FDPCC), and the Fonds de Garantie des Coopratives Caf et Cacao (FGCCC). The institutions main roles are to regulate the cocoa trade and support cocoa farmers. The multiplication of cocoa institutions has affected the number of levies paid by exporters. In order to fund the new institutions, the agriculture and finance ministers introduced new levies on each kilogram of exported cocoa and coffee. These levies, financing the ARCC, BCC, FRC, and FDPCC, reached their peak in January-March 2003, totaling 141.9 CFA (27 U.S. cents)/kg. In 1999, levies were just 15.5 CFA (3 U.S. cents)/kg. For the 20062007 harvest, the levies, financing the same four institutions but with a slightly different breakdown, amounted to 49.1 CFA (10 U.S. cents)/kg. The proliferation of levies has had a direct impact on the price paid by exporters to cocoa farmers, as exporters, who have to respect global prices, have transferred the cost of levies to the farmers. An EU financial audit noted that the levies more than covered the cost of running the cocoa institutions and recommended that they be reduced.a In addition to levies for cocoa institutions, the government has imposed separate export taxes on cocoa. These taxes have been an important source of revenue for the Ivoirian government. After 2001, the export tax known as the droit unique de sortie (DUS)

increased from 120 CFA (23 U.S. cents)/kg to 220 CFA (40 U.S. cents)/kg within three years, and the registration tax rose from 2.3 percent to 5 percent of the cost insurance freight price. In 1999, the combined total of the DUS, registration tax, tax for the Nouvelle CAISTAB, and the Sacherie-Brousse (a levy to provide bush bags to farmers), amounted to 135.5 CFA (26 U.S. cents)/kg. In January-March 2003, before the reconciliation government was operational, this combined levy and tax reached a peak of 361.9 CFA (70 U.S. cents/kg). For the main harvest in 2005-2006, collections from the DUS amounted to 178.7 billion CFA (US$343 million) and registration taxes amounted to 35.7 billion CFA (US$68.5 million). For 2006-2007, the combined total of the DUS, the registration tax, and the cocoa institutions levies amounts to 310.4 CFA (60 U.S. cents)/kg, which in many cases exceeds the price per kilogram paid to the cocoa producer. The combination of the DUS and the registration tax means that exporters pay 261.3 CFA (52 U.S. cents) into the Treasury for each kilogram of cocoa exported.
a

Source: Global Witness, Hot Chocolate report, 1998.

In contrast, Ghana has emerged as one of the most successful cocoa-producing countries in West Africa. According to data from the Federal Accounting Office, export earnings for Ghana from existing cocoa already amounted to US$102 million (2002-04); these exports increased three-fold over the previous decade. Ghana followed a different set of trade policy for cocoa than Cte dIvoire. From levying an average of 16 percent export tax in the 1960s and 12 percent in the 1990s, Ghana has levied only about 5 percent export tax since 2005. Correspondingly, in 2003 it processed only about 15 percent of its total cocoa beans locally; the rest are exported directly. Permission for processing capacity is restricted to about one-fifth of current production. Despite these restrictions, the company has made a corporate decision to favor Ghana over Cte dIvoire for its investment in cocoa processing plants. Although it heeded substantial elements of the IMF calls for reform, Ghana maintained its Cocoa Control Board, which regulates both prices and export supplies. 10 This action was not without risk. It is widely assumed that farmers smuggle out cocoa crops when world market price is higher than what is offered by the government. Removal of price control would have prevented such crop diversion but the Ghanaian government chose to retain price control to ensure that farmers get a stable and guaranteed pricing for their

Haque (2007) argued that neoliberal economic principles have added challenges to those already faced by primary commodity producers, and cocoa is a prime example. Wilcox and Abbott (2004) have argued that the economic liberalization program has had serious implications for West African governments: on the one hand, complete price deregulation exposed the farmers to global price volatilities thereby adding challenges of income distribution between cocoa producers and buyers. On the other hand, institutional deregulation offered far more space to multinationals for enhancing their backward linkages while in some cases draining sources of public tax revenue.

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crops. And for these reasons, until recently, the company kept its distance from Ghana, even though it is the second largest supplier of cocoa in the world. Since the early 2000s, their corporate position on Ghana has significantly changed. The company now acknowledges that Ghana has the best investment climate in all of West Africa and adds that its stability and governance transparency is especially supportive for large multinational businesses. In 2005, it established a cocoa-processing plant in Ghana and agreed to collaborate with the Ghanaian government in undertaking national reforms of transport logistics and customs clearance for cocoa. 11 Essentially, the companys stance on Ghana has been significantly reversed thanks to the countrys overall political and economic stability. Transport logistics and backbone services are key to competitiveness The company greatly values its access to efficiently produced critical backbone services. Although the Cte dIvoire and Ghana have comparable hard infrastructure, Ghanas soft infrastructure has overtaken that of the Cte dIvoire within the past six years. When the company first invested in Cte dIvoire, the country had a good road network but that has changed since 2002 when a coup attempt cut the country in two and militias started to roam in both areas. As a result, the 300km expressway from San Pedro to Abidjan quickly deteriorated. Electricity, though 50 to 100 percent more expensive than in Europe, is available and fairly reliable in Cte dIvoire. Water and gas are available with a certain degree of compromises. The use of mobile phones has taken off, largely replacing fixed telephone lines, and has led to greater degree of price transparency among farmers. By comparison, Ghana has developed an acceptable road networkincluding two toll roads connecting Accra with Tema and Takoradi. Electricity is as costly as in Cte dIvoire, but it is not fully reliable because its hydropower plants have not been able to prevent seasonal fluctuations. This compels the company to use somewhat less automated equipment in addition to having a bigger back-up power system. Water and gas remain problems in Ghana. The use of mobile phones has increased, but since pricing is fixed, its role in determination of the market priceas in Cte dIvoireis minimal. Beyond the local road connection and backbone services, what is especially important for the cocoa business is the port-to-port connection with the final market. The company has introduced efficiencies into shipping between Africa and Europe by using large bags with ten times the storage capacity of standard bags and by using mass bulk storage where possible in the harbors. This requires the installation of cranes with five-ton lift capacity. The use of these improvements can reduce the time it takes to load and unload a shipment by several days and makes the process less labor intensive. The net effect is a significant reduction in costs. In Cte dIvoire, the company has supported the introduction of the large bags and it was

11

See World Bank Country Economic Memorandum on Ghana, 2008.

accomplished quickly and efficiently. The use of these improvements reduced the time it takes to load and unload by several days and made the process easier on both sides of the ocean. This has not only reduced material costs but also significantly curtailed rentseeking. It has been widely acknowledged that bribing and profiteering has significantly decreased after the logistical reform. In Ghana, the government controls the bean handling in the harbor. Until five years ago, it took much longer in Ghana than in Cte dIvoire to load containers onto the ships because bulk bagging systems had not been in place. However, the government made significant progress in its port system and today Ghana has true bulk storage facilities in its Takoradi harbor, even eliminating the need for large bags and thus surpassing the efficiencies reached in Cte dIvoire. Summary and lessons learned Despite its government cocoa pricing monopoly and lack of quality differentiation in cocoa beans, Ghana ranks higher overall than Cte dIvoire because of its political and macroeconomic stability, level of government support, and a strong track record of improvements in backbone services for connectivity and the overall business environment. Ghana can further improve its ranking in the supply chain hierarchy if its economic incentive regime allows price deregulation so that higher quality cocoa beans can be differentiated from mediocre quality beans. Despite its early advantages, it is Cte dIvoire that now needs to improve its overall investment climate and business enabling environment to compete effectively with Ghana. Although the countrys domestic cocoa market and its international trade are more deregulated than Ghanasand it has a far greater production capacity than its neighbors and the advantage of early investments from some of the largest global buyers of cocoaFDI, transportation, and other backbone services as well as the production trends are declining in Cte dIvoire. The country may need additional efforts to ensure that effective cocoa collection, quality assurance, regulatory system, and transport logistics are in place. 12 Evidently, from this companys perspective and that of other global buyers as well, political, economic, and social stability are the essential factors to developing long-term business strategies that can link local production with the global supply chain.

Whether an economic liberalization program fully reinforces the overall industry competitiveness has been a point of debate among economists studying the West African cocoa industry. For example, Gilbert and Varangis (2003) have argued that, rather than expediting the process of global integration, economic liberalization has forced price deregulation so much so that the farmers have been unnecessarily exposed to price volatilities, leading to local resistance against further globalization of this industry.

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Chapter 3: TEAM Foods Colombia Research, Development, and Diversification for Moving the Value Chain
Earlier theories on global commodity chains argued that commercial plantations in developing countries were controlled by decisions of firms in advanced countries. TEAM Foods faces serious challenges in its raw materials supply chain in Colombia and its finished product distribution network. Yet as an experienced firm in a developing country, TEAM Foods was in many ways better positioned than firms in advanced countries to make the right choicesin this case to move up the value chain ladder by consolidating its economies of scale, diversifying its products and markets, and developing an eclectic package of products and services that enhanced its research capability. TEAM Foods (Tecnologa Empresarial de AliMentos, or Food Business Technology SA) headquartered in Bogota, Colombia, produces and markets products derived from edible vegetable fats and oils. Palm oil is a primary raw material for TEAM Foods products and the company sources most of it from producers in Colombia although it processes palm oil in Colombia, Chile, and Mexico. Manufacturing plants in South and Central America make a range of food ingredients from the palm oil, which TEAM Foods supplies to food manufacturers and wholesalers in the Latin American region as well as in Europe and the United States. The company also sells its own margarine directly to consumers. TEAM Foods is one of Latin Americas top manufacturers of products derived from vegetable oils. Its customers include well-known food manufacturers such as Kraft, Hersheys, Unilever, small bakeries in Latin America, and consumers. TEAM Foods 2008 total annual revenues were US$385 million, which comprises approximately 10 percent of the Latin American market. Most of the revenue is generated from its Colombian manufacturing facility (82 percent) followed by Mxico (12.4 percent) and Chile (5 percent). Much of TEAM Foods business depends on the supply of palm oil, a raw material that is subject to the vagaries of commodity price fluctuations and the changing fortunes of the agricultural industry. TEAM closely integrates its growing and extraction phases of palm oil production in Colombia. In addition to supplying the American market with biofuels, TEAM also processes palm extracts to produce special ingredients (SI) which are used as inputs to a wide range of processed foods and personal care products. TEAM was founded in 1999 to focus on the development, distribution, and manufacture of vegetable oil-derived products. The companys main investors are leading oil palm growers in Colombia that used to be vertically integrated. These players formerly owned both palm growing and manufacturing enterprises. When TEAM Foods was formed the grower investors contributed their manufacturing plants to the venture, and maintained their palm-growing interests as separate businesses. Four plants were consolidated under the TEAM Foods umbrella.

Each of these facilities has a long history in the industry, as follows: Bogota (originally ACEGRASAS SA): Founded in Bogota in 1959; specializes in the manufacture of margarine for baking, kitchen use industrial products, special fats, oils, and creamy solids; Buga (originally FATS SA): Founded in Buga in 1952; manufactures sunflower, soybean, and canola oils in both bottled and bulk forms as well as soybean meal; Barranquilla (originally FAGRAVE SA): Founded in Barranquilla in 1946; responsible for the production of bottled and bulk liquid oils used in the production of soaps and detergents; and Caloto (originally GRASYPLAST SA): Founded in Caloto (Cauca) in 1996; makes packaging for TEAM products. The primary supplier for TEAM Foods is Palmar del Oriente, which manages commercial palm oil plantations. TEAM has expanded internationally and now has manufacturing operations in Chile and Mxico. In 2006, TEAM acquired a plant in Santiago, Chile, which now produces and markets dairy products such as margarine and cream. In 2007 TEAM acquired Tron Brothers, a company with more than 100 years of tradition in the market, enabling it to strengthen its presence in the oils and margarine markets. Figure 6: TEAM Foods operations in Colombia and beyond

Source: TEAM Foods

Industrial Organization: Profile of the Palm Oil Business Palm oil is derived from the fruit of the oil palm, and is a major agricultural commodity. The material is used widely in Asia as cooking oil, and is also an ingredient in various foods as well as in other products such as soaps, paints and industrial lubricants. More recently, palm oil has attracted the interest of the biofuels industry, which uses vegetable oils as a feedstock. The oil palm is a tropical fruit that requires specific climatic and soil conditions to grow. The equatorial regions are the most suitable for its cultivation. The palm produces fruit in about three years, and reaches maximum production in 7 to 10 years. Palm trees can grow to around 60 ft in height, making it difficult to harvest the fruit from a fully grown tree. The traditional method is to use a long metal pole with a scythe-like blade to cut the fruit from the top of the tree. This is labor-intensive, and workers have to be able to discern when the fruit is ripe enough for cutting. The bundles of berries cut from the trees have to be gathered and transported to an extraction plant. The next step in the palm oil supply chain is the extraction of the oil. The harvested fruit must be delivered to the extraction plants within 6 to 12 hours because the fruit rapidly acidifies after cutting. This is why the extraction plants need to be in close proximity to the growing areas. The fruit is made up of pulp which yields crude palm oil and the nut which produces crude palm kernel oil and palm kernel cake. These products can be marketed nationally or exported. In 2008 world production of palm oil amounted to about 43.2 metric tons according to the U.S. Department of Agriculture. Indonesia and Malaysia are the two largest producers of palm oil; Indonesia produces 19.7 million metric tons and Malaysia 17.7 metric tons. Colombia produces about 550 thousand metric tons and has grown impressively over the past three decades to be the worlds fifth largest producer of palm oil and the leading producer in Latin America, representing close to 40 percent of palm oil production in the region (Chart 1). Ecuador (17 percent), Costa Rica (9.9 percent) and Brazil (7.8 percent) are other important regional producers.

Chart 1: Palm oil production (1000 MT) Comparing Colombia with Latin America and Africa
800 700 600 500 400 300 200 100 0 1975 1980 1985 1990 Colombia Cote D'Ivoire 1995 2000 2005 Cameroon Costa Rica Congo DRC Ecuador

Note: Malayasia and Indonesia are the two largest palm oil producers with the capacity which are not shown here due to difference in scale. Source: IndexMundi database Summary of operations The oil palm crop was introduced in Colombia in 1932. Its large-scale commercialization started in the mid-20th century, mainly due to a policy introduced by the Colombian government to develop farmland and establish a national supply of palm oil. It is estimated that 6 million hectares of land is suitable for oil palm growing in Colombia, and of this total, approximately 3.5 million hectares can be adapted easily to the cultivation of the crop. During the 1980s, the number of hectares of oil palm in Colombia tripled. In 2005, about 275,000 hectares were under cultivation, of which 161,000 hectares were production and 114,000 hectares were in development. Palm oil and palm kernel oil now account for 90 percent of the oils and fats produced domestically in Colombia, and almost 60 percent of all oils consumed in the country. Exports of the raw oil, mainly to Europe, have increased significantly and now make up about two-thirds of production. Like most agricultural commodities the world price and demand for palm oil varies with factors such as crop yields and weather patterns. However, in recent years a number of other factors have complicated the demand and supply of palm oil. For example, palm oil was subject to the soaring food prices that gripped world markets before the current global financial crisis. The rise of the biofuel industrydriven to a great extent by generous government subsidiesis another recent phenomenon. According to the U.S. Department of Agriculture, the Colombian government plans to increase the production of biofuels from palm oil by 5 percent and the use of sugarcane as a feedstock is projected to grow even more. By the end of 2010, biodiesel production was expected to

have reached 720,000 tons per year from nine production facilities in Colombia. Demand for palm oil is expected to increase. In addition to its potential in the biofuels industry, rising incomes in Asias developing countries are expected to stimulate demand for palm oil. Another driver is changing attitudes toward personal health. Palm oil is free of the trans-fats that are thought to be a risk factor in heart disease. TEAMs operations in Colombia are shaped to a great extent by the supply chain for palm oil. Palm plantations and extraction plants have to be located within six to 12 hours of each other; in addition, refiners can gain significant efficiencies by being integrated with extraction plants. It is perhaps not surprising then that the growing and extraction phases of palm oil production are closely integrated in Colombia. The supply chain for palm oil in Colombia draws significantly on long-term relational contracting where production and exchange obligations are developed through bilateral discussions and contracts sustained over the course of years or decades. There seemed to be little role for third party brokers, and production within the chain tends to be traded directly between growers, processors, and refiners. Such close-knit vertical integration in the palm oil business coupled with good prospects for market growth provided the rationale for the creation of leading agents such as TEAM Foods. The combined entity has made significant contributions by enlarging of the scale, more rigorous process synergies, and more effective strategic management of the entire supply chain. Establishment of the lead agent also provides an integrated platform for international expansion of palm oil products, which has largely been the main driver of economic growth for Colombia. As described in more detail later, TEAM Foods has been successful in helping palm oil producers and processers to move up the value chain and diversify their markets and products outside Colombia. The highest value add for palm oil products lies in the business of special ingredients (SI), which has been the key target for TEAM Foods in terms of expansion of its exports. The global market for SI is lucrative, but what is key to competitiveness in this business is deep insights into customer requirements in each of the countries where it chooses to compete. Consumer patterns vary significantly across borders and SI suppliers must not only tailor products to meet the varied tastes but also develop deep collaborations with large producers of final consumer goods in those markets who are going to be the primary buyers of SI from TEAM Foods. A possible gain from such a diversification effort is that establishing bases in other countries widens its sourcing options for palm oil, an important consideration given that the harvesting and processing of the fruit are tightly integrated. Special ingredients are sold primarily to a variety of organizations throughout Latin America and the United States, and the small market in Europe is growing rapidly. TEAM sells US$381 million worth of SI, which represents 45 and 55 percent respectively of the organizations total sales and profits. The organizations customers include major global buyers and producers such as Nestle, Kraft, Unilever, McDonalds, Bimbo, Pepsi, and Noel. Overall, about 70 percent of TEAMs sales are in Colombia and 30 percent in other countries. TEAM set a goal to expand its export markets to 70 percent of its total operations by 2010. In addition to the business of special ingredients, TEAM Foods maintains three other

lines of businesses including bakery products, margarine, and cooking oils. The bakery products are sold to wholesalers in Colombia, Ecuador, and Panama. The wholesalers supply small bakeries in these countries. Margarine and cooking oils are sold directly to retailers. The margarine is also sold directly to consumers in Mexico, Chile, and Colombia, but sold under TEAMs own brand name. Branding requires considerable efforts in all three countries but it also contributes to the value generated for produce. Two important aspects of TEAMs business operations need special mention. First, the issue of transport logistics is key to palm oil operations because palm oil extractions have to be delivered to the processing facilities within six to 12 hours of harvest and the timeliness of the supply chain is crucial for further processing and distribution of the product. Second, oil palm growing is a heavily regulated industry and the price mechanism set by the government as well as the fiscal benefits offered by the government affect the functioning of the industry significantly. Importance of logistics in TEAM supply chain management Logistics costs represent 12 percent of TEAMs revenues. Transportation is outsourced and its cost totals 9 percent of revenue. Product is exported in two forms: bulk (oleinas) and boxes ready to be used in customers plants. Chile and Mexico are served from local plants in those countries, and the North American market is served mostly from Colombia. The enterprise uses two ports for exportCartagena (mostly for bulk shipments originating in TEAMs plant in Barranquilla, Colombia) and Buenaventura (mainly boxed product from the plant in Bogota, Colombia). Export volumes are split more or less evenly between the ports. The third-party logistics services company DHL is used to organize international transportation. Carrier space is bought on the spot market, although there are plans to negotiate longer term rates. There are three main steps relevant to understanding the logistics aspect of TEAMs exports: (i) in-country logistics, which includes plant-to-port transportation, Colombian customs, and Colombian port logistics; (ii) international logistics, which refers to ocean transport; and (iii) out-of-country logistics, which includes product nationalization, international customs, and port-to-customer logistics. Given the high-service nature of the products and the make-to-order strategy, TEAM will adjust its involvement on each of these three steps based on the client needs. For most of the United States, Argentina, and Chile exports, TEAM uses DDU or DDP incoterms (international commercial terms), which require their involvement in all three steps. For other countries within the region, including Peru, Bolivia, and Ecuador, terms may vary from EXW to CIF (see Appendix for a detailed listing). The following table shows some common terms used by TEAM in its international operations, as well as some of their internal planning lead times (in days) for each of the export steps by country.

Table 1: Transportation and shipping of TEAM Foods products

Source: TEAM Foods

Note: DDU: Delivered duty unpaid, named place of destination, not unloaded, not cleared DDP: Delivered duty paid, named place of destination, not unloaded, cleared EXW: Ex-works, named place where shipment is available to the buyers, not loaded; the seller will not contract for any transportation CIF: Cost, insurance, and freight, named ocean port of destination; this term is used for ocean shipments that are not containerized

For planning purposes, TEAM estimates seven to nine days for all the export processes to be completed at the Colombian ports. The uncertainty of the total time is a major challenge and so the planning values have been adjusted upward. This uncertainty is due to inefficiencies and lack of transparency of the Colombian port agency as well as in narcotic and customs inspections. Currently, TEAM has an international organization that manages all the export activity. All of the transportation is purchased in the spot market and partners may vary based on the customer needs. TEAM uses DHL for all the global freight forwarding activity (e.g., export, international logistics management, import) but they may still coordinate in-

country and out-of-country transportation as needed. The fragmentation of service providers as well as the associated contracting complexity and customer service implications is one of the reasons TEAM is considering a fourth party logistics provider (4PL) to manage all of their international activities. This is a project that has recently been launched within their supply chain group. The impact of levies and taxes in Colombia Until 1990 the Colombian palm oil industry was protected against foreign competition through tariffs. These trade barriers allowed the home industry to grow and mature. Starting in 1991, most of the trade barriers were dismantled, opening up the industry to competition and creating new business opportunities. But some trade protection remains, mainly to shield the industry from the volatility of world commodity markets. On April 1, 1995, Colombia implemented the common Andean Community price band (a variable import duty system). It covers 14 basic commodities, including soybeans and crude palm oil, and 153 select commodities considered substitutes. The system is meant to protect domestic producers and consumers from the volatility of world prices by raising import duties when import prices are low and lowering them when prices are high. Every year, the government issues a minimum and a maximum price for palm oil. The methodology of this calculation is openly shared among all market players. The average palm oil price is monitored every two weeks: if the average bi-weekly price is within the minimum-maximum range established for the year, the same profit tax is maintained for the following two weeks. If the price is above the maximum level, the tax is reduced to bring the effective price within the defined range; and if the price is below the minimum, the tax is increased to bring it up to the annual minimum-maximum range. Given the two-week lag for profit tax changes and the transparency and predictability of the process, TEAM can use this information to forward-buy palm oil or hold imports given its expectations of the market. In addition, there is some flexibility in Colombian customs law on the date on which products are classed as imports and can be assessed for duty payments. The date ranges from the moment the shipment is in transit to the destination country up to a few days after it has arrived in that country. This can also be used as a competitive advantage, by selecting the most beneficial time window for tax purposes. Competitiveness issues for TEAM Foods Colombia The growth potential for palm oil suppliers is substantial. Not only is the global demand for palm oil increasing, but the potential demand from the biofuels industry is an added source of growth. The efficiency measures introduced by its supplier Palmar del Oriente over recent years have made the trade more competitive both nationally and regionally. The most important factor of competitiveness has been the successful measures developed to hedge its operations from the ongoing violence and instability. However, infrastructure remains a challenging issue in Colombia, namely the poor and deteriorating state of the roads and ports, and addressing this problem has to be a high priority if the

palm oil industry is to reach its full potential. Another possible roadblock is labor and skill shortages, although the owners of the Palmar del Oriente plantation are attempting to tackle this problem through flexible work programs, a closer relationship with communities, and a substantial training program for its employees. Beyond the basics, however, the success of the oil palm business in Colombia lies in the ability to stay at the technological frontier so as to continue to engage with the largest buyers in the global market. Security concerns Security concerns in Colombia continue to stem from the countrys 40-year-old guerrilla conflict and there have been occasional cases of pilferage in customs warehouses and robberies of trucks. Recently, the governments heightened security measures have reduced terrorist attacks, kidnappings, and crime affecting business operations. The fall in levels of violence has played a key role in the growth of the palm oil industry. Palm oil plantations require substantial investments in irrigation systems and ground preparation, and investors pulled back when armed violence was at its peak. The government seems determined to maintain stability. For example, the Palmar del Oriente DA plantation in Yopal, one of TEAMs primary domestic suppliers, is protected by the army and the police. Main roads are also policed by army patrols. On the negative side there are reports of human rights violations in connection with the growth of the agricultural industry. Human rights groups claim that armed incursions, illegal expropriations of land, and the forced displacement of owners are tactics that have been used to acquire land for the planting of oil palms. Transport, logistics, and distribution Because of the time restrictions on the freshness of the product between harvest and processing, TEAM Foods ranks the relatively long distance between palm growing and extraction facilities as the second most binding constraint. Once processed, poor road and port infrastructure further restricts the flow of palm oil between processing regions and leading ports such as Barranquilla. Further down the supply chain, distribution of finished products based on oil palm is also very challenging because of the lack of adequate roads and the lack of a national rail system. Supply chain connectivity is further complicated by logistical difficulties in the sourcing of raw materials. Worse, the Colombian government imposes mandatory carrier rates for each product category, shipment size, and destination. This is a highly unpopular practice that has introduced pricing distortions and network inefficiencies. Severe bottlenecks in transport and logistics operations provide little incentive for TEAM to negotiate long-term transportation contracts. As a result, it has designated DHL as a third-party logistics (3PL) provider for its global freight forwarding where consignments are planned, negotiated, and executed separately. In the meantime, it is continuing to negotiate with the government for policy concessions that may allow an integrated fourth-party logistics (4PL) provision. Fourth-party logistics providers are organizations a level above 3PLs in the type and quality of services they offer. While 3PLs usually handle specific activities such as inbound transportation and warehousing, 4PLs are much

more holistic, thereby cutting transactions costs significantly. Some of the immediate measures TEAM is taking to cut transport costs include adherence to bulk shipping and deliveries and use of boxed cargo systems that can be exported to all destinations using standard freight containers. In general, bulk and boxed cargo are only profitable when the enterprise can arrange a round-trip. For example, sometimes TEAM exports special ingredients in bulk to Chile and brings refined product back into Colombia on the backhaul. TEAM ships about 1,200 containers of boxed export cargo per year. Another measure the company has taken is to offset the distribution problems created by Colombias poor road system by improving the efficiency of the retail outlets that sell its products. For example the company has reduced stock outs in retailers significantly from 14 percent in 2003 to 5 percent in 2008. It has especially cut down the role of regional buffers and local depots to streamline its retail transportation systems. Higher transportation costs within Colombia have eventually led to significant decentralization of TEAMs distribution system within the region. For example, TEAM Foods is now actively looking to open distribution centers in Mexico and Chile, which can lead to diversion of investments and technological expertise. Mexico and Chile are both not only important markets but can potentially offer good access to other national markets. Customs Time and cost of customs clearance is often an important barrier to competitiveness. In order to address this, TEAM has become certified under the Customs-Trade Partnership against Terrorism (C-TPAT) program, managed by the U.S. Customs and Border Protection agency (CBP). To gain C-TPAT certification, companies have to meet rigorous standards set by CBP for securing the goods they ship against terrorism; for example by making significant investments in the security of its consignment handling and tracking, training of its packaging and shipping staff, and using accredited seals on cargo containers. By becoming C-TPAT compliant, TEAM is less prone to delays caused by customs inspections in the United States, since C-TPAT members are given preferential treatment when exporting to the United States. According to CBP, importer program members are four to six times less likely to incur security or compliance examinations. TEAM has also developed extensive networks with customs brokers who stand by for assistance whenever the consignments get held in customs within various countries. For example, Mexicos regulatory system can be difficult to negotiate and Venezuela is particularly troublesome since the government there tends to unilaterally impose regulatory changes on short notice. A seasoned and well-connected pool of customs brokers are considered essential to the operations of global buyers like TEAM. Efficiency of backbone services Energy utilities in many developing countries, as in Colombia, have a history of being

unreliable and expensive, requiring companies to develop ways to mitigate these problems. Plantations cannot rely on a local utility to supply energy and a high number of outages render this arrangement untenable. The Palmar del Oriente plantation, one of the TEAM subsidiaries, overcame this problem by developing the capability to burn a byproduct of the palm oil extraction process to generate its own energy. As a further measure, the subsidiary recently signed a new agreement with the local utility it used to rely on for all its power needs to provide back-up capacity. The back-up agreement provides the plantation with another power source to cover periods when its in-house generating capacity is inadequate to meet peak demand. Similarly, the problem of communications especially in trade logistics has been overcome to a certain extent by the use of mobile phone technology. Colombia has become a leading proponent of mobile technology applications in logistics in the region. The availability of specialized business services, R&D, and technology A series of non-backbone services have also been of key importance for the TEAM business strategy in Colombia. As in other developing countries, the quality and availability of business services and support functions are relatively basic in Colombia. Although efforts are ongoing for public-private collaborations for the improvement of these services, they are only partially successful. TEAM has been somewhat successful in mobilizing other institutions for enhancing these capacities but it has been more successful in internalizing some of these functions within its own structure. TEAM uses one of its subsidiaries, Caloto (originally GRASYPLAST SA), as the preferred supplier of packaging and labeling. Having an affiliate organization as its primary packaging supplier gives TEAM close control over quality and the flexibility to alter its packaging requirements to be in line with changing customer needs. Since there is a lack of efficient services on market intelligence, TEAM is building this expertise in-house. Using consumer information such as that provided by the Nielsen and Mintel research groups, a division within TEAM analyzes consumer buying patterns in the countries in which it competes. This knowledge enhances its ability to develop solutions to customers needs, and enables the organization to be proactive by anticipating changing product specifications. The intelligence also helps TEAM to evaluate different markets and decide where to locate new manufacturing and service facilities. TEAM Foods is a strong investor in internal R&D and has recruited international experts in production engineering to help it stay ahead in its core markets. For example, it has taken steps to raise productivity by introducing hybrid palm trees to its suppliers. The hybrid tree is half the height of the traditional palm tree which makes it much easier to harvest the fruit. TEAM has also successfully accelerated the maturity cycle of trees by growing saplings in greenhouses before transplanting them to the main growing areas. The plantation claims that its productivity is now on par with palm oil suppliers in Asia. R&D is especially important in the specialty ingredients business, which requires a high level of technical sophistication. Among all of TEAMs plants, the one in Bogot has the most advanced R&D and flexible manufacturing capabilities to develop custom

ingredients with higher margins for a wider range of customers. It often directly collaborates with its large customers such as Kraft and Unilever to tailor ingredients to their manufacturing processes. These ingredients are revenue-generating and they add significant value to the customers end products. This strategy not only moves TEAM up the value chain but also makes it more difficult for TEAMs major customers to go elsewhere for these highly engineered ingredients. Recently, the R&D unit in TEAM Bogota has developed satellite R&D offices in Chile and Mexico. Other necessary public goods Although firm sophistication lies at the heart of competitiveness, it is inextricably interknit with a series of public goods that create the environment in which the firm operates. TEAM acknowledges this and is keen to engage with public organizations working to support or regulate private sector operations. TEAM is actively involved in most trade associations and participates in the Council of Competitiveness of Colombia. It is working especially to influence and expedite the reform of the countrys transportation regulations. TEAM also uses the export promotion agency PROEXPORT and the Chamber of Commerce to help promote its export business. It receives minimal government support on training although it develops its own training program and administers it through private service providers on a regional basis. It does engage with an educational institute, LOGyCA, to undertake supply chain research. However, in most of these areas, TEAM acknowledges it is not dependent on public institutions for any of the public goods because of the large scale and high degree of sophistication it commands. Summary and lessons learned Earlier theories on global commodity chains argued that commercial plantations in developing countries were controlled by the decisions made by firms in advanced countriesand as a consequence, those plantations were frequently trapped in lower tiers of the global value chain from which they could not extricate themselves. TEAM Foods sustained success in the national, regional, and international markets shows the competitive potential of developing country firms in the global market. Firms are free to make strategic choices but their choices are made within an institutional setting. TEAM Foods was able to overcome some of the Colombian governmental and market failures through selective efforts to influence. For example, it has developed meaningful collaborations with the government to heighten the security measures against terrorist attacks, kidnappings, and crimes affecting its business operations. It has also made considerable progress in overcoming trade logistics bottlenecks by gaining preferred status on customs by developing a network of customs mediators in its destination countries and by reforming its retail distribution model for the use of road networks. Despite these successes there is still a need to mobilize public and private institutions to deliver specialized business services, labor skills transfer, and R&D. TEAM chose to develop capabilities in-house or to collaborate with external parties. This option is available to a large conglomerate like TEAM Foods but it may not be possible for other smaller firms. Nonetheless, TEAM Foods was able to internalize most of its

specialized services and R&D through close-knit deals with large buyers such as Kraft and Unilever. This model of firm consolidation and sophistication is of interest to other primary commodity producers from other developing countries who are also working to be more competitive in the processing, branding, and marketing of primary commodities. The insights offered through TEAM Foods mixed experience of collaborations with the public sector are useful in better articulating the needs of a wide range of public goods for firms to be competitive.

Chapter 4: CPGco Inputs to Personal Care Products

A consumer packaged goods companys (CPGco) Andean and Central American success is due in large measure to the cutting-edge technologies it employs to gain competitiveness in its supply chain management, and to the collaborative arrangements the organization has forged with local and global institutions to further its innovation goals. 13 The Company CPGcos supply chains deliver personal care products to its retailer customers in Bolivia, Colombia, and Peru. The enterprise is a multinational companys regional counterpart for the Andes and the Central American region. Additional examination of CPGcos Ecuadorean and Venezuelan markets helps to provide a broader perspective on the companys activities in the Andean region. It has three primary plants in Latin America that serve the regions secondary national markets. Both production and the international movement of products are centrally planned. CPGcos supply chain configuration enables it to manage the movement of products to national markets while using local expertise for keeping track of the regions economic, political, and operational inconsistencies. The different supply chain challenges in each of the national Andean markets highlight the business impact of the regions shifting economic and political winds as well as its uncertain regulatory regime. CPGco has to devote significant resources to keeping abreast of these changes in order to remain profitable in the Andean region. Although the Americas region is the smallest operation within the parent group, its growth has been significant. In 2008, it had US$18.4 billion in revenues and an annual growth rate of 6.5 percent. Figure 7: Regional turnover and underlying sales growth, 2008

Source: Case study interviews The hundreds of fast moving consumer goods (FMCG) that the multinational company

To keep the company studied for this report anonymous as requested, the companys name has been replaced with CPGco, which stands for a consumer packaged goods company.

13

sells in the region fall into four broad categories: home care; savory, dressings, and spreads; ice creams and beverages; and personal care. Of these, personal care goods rank second in its overall sales profile, and this category comprises a wide range of products associated with skin care and cleansing, deodorants, oral care, and hair care products. This is the category that has developed the most dynamic supply chain system in Latin America and hence has been chosen as a case study in this report. Other product categories also have regional movements, but a bigger share of products in those categories are manufactured and consumed locally. Some of the categories are present only in selected countries and not others. Such product categories have been omitted in this discussion because nation-specific supply chains or selective country operations are less relevant for analyzing the region-wide supply chain. Figure 8: The Groups portfolio of categories

Source: Case study interviews Note: This case study focuses on the personal care category CPGco sells about 50,000 tons of personal care products per annum in Latin America. This represents about 20 percent of the organizations total product volume in the region and about 40 percent of its total sales. Within the region, 66 percent of its volume share lies in the Andes region with a much higher concentration in Colombia, Ecuador, and Venezuela than in Peru and Bolivia. Most of the personal care products bound for the Andean customers are manufactured in three main plants in Argentina, Brazil, and Mexico. These primary facilities supply markets in Bolivia, Colombia, Costa Rica, Ecuador, Guatemala, Honduras, Nicaragua, Panama, Peru, El Salvador, and Venezuela. A relatively small volume of about 7 percent

of the personal care products are manufactured locally in Peru and Colombia, and are especially targeted toward poorer customers. Summary of operations The 1990s saw growing interest within the multinational company to design products and packaging that especially adapt to the special needs of developing and emerging markets. CPGco inherited this priority from its parent company. Such a strategic shift came in response to the growing realization that developing countries could be the next frontier for retail distribution of fast moving consumer goods (FMCGs). In 2008, 47 percent of the multinationals sales were in developing and emerging markets, and the company anticipates further growth in this market as population and purchasing power grow in these countries. In 2008, the companys highest sales growth of 14 percent was in its Asian, African, and Eastern European markets. The parent company estimates that these markets will add one billion new consumers in the next decade and it is moving aggressively to capture a share of this growth. The group aims to be a multi-local multinational company, catering to its diverse customers from both developed and developing countries around the world. The multinationals strategy developed for adapting to this new emerging market is twofold: it is developing low-cost technologies as well as micro-marketing techniques to meet the needs of its poorer customers, and it is reforming its distribution systems in such a way to make them especially resilient to the market and institutional failures in developing countries. Two examples of the groups low-cost technology can be seen in its new personal care products. Its new liquid skin cleaning line is 30 percent cheaper than its previous lines. Its new foam product requires a single rinse rather than three as was the case in prior products. Two examples of the companys micro-marketing technique can be seen in its new packaging of hair care products. For the Colombian and Peruvian markets, CPGco has developed micro sachets of shampoo, which are not only more affordable to poorer customers but also they can be transported more efficiently to retail shops that do not want to keep large stocks. For the Bolivian market, CPGco has developed package-less soaps, which keep costs down for consumers who prefer to buy soap without individual wrapping. Further, these new packaging and distribution systems are more localized, thus reducing the costs of imported inputs. At times, CPGco has used these product lines to fill in any gap that may arise in their plants and inventories while following a centralized operations system (see following section on sales & operations planning). An important business strategy for the group in becoming a truly multi-local multinational is to harmonize its product formulations globally so that they are less subject to scrutiny by national standards regimes in individual countries. The parent company has 17 brand centers and 15 design centers across the globe. In South America it has centers in Buenos Aires and Sao Paulo. Product harmonization begins in these centers. In the past five years, it has reduced the number of base formulae in its skin cleansing products from 56 to 4 globally, a change that has yielded cost savings and faster product rollouts. It also rolled out a common formula for all its concentrated laundry detergent across North and Latin America as well as Europe.

Just as the adaptation of products and packaging allows deeper penetration into emerging markets, country-level competitiveness is extremely sensitive to the quality of the logistics system through which it manages its supply chain. Distribution costs can be up to a fifth of total costs and CPGco sees a large scope for cost-saving through enhancement of its distribution system. S&OP-driven Supply Chains CPGcos supply chains in the Andean region are driven by a central sales & operations planning (S&OP) process. S&OP is not a new concept; it has been widely used in the United States for over a decade. It has shown to be especially efficient in aligning production resources with market demand within a company by systematically integrating key disciplines, i.e., manufacturing, sales and marketing, supply chain, and procurement. Figure 9: S&OP Concept Within a company, these disciplines often have different planning horizons and demand forecasts that are tied to their particular departmental goals. These goals can be in conflict, causing planning dysfunctions that can be extremely inefficient both tactically and strategically. An example that is most often cited is the conflict about stock definition: while the manufacturing team Source: The Conference Board and The typically wants to maximize plant World Bank utilization, the sales department may see some justification in compromising this to some extent to meet the demand from customers. A conflict can also occur when sales decides to accommodate an important customer that wants to change a large order, even though the change creates excess production capacity. Another example is that marketing generally prefers to have many product variants to meet the needs of niche markets; but one of supply chain managements goals is to minimize the number of product variants in order to simplify the supply chain. The purpose of S&OP is to build consensus between these disciplines and to generate a unified production plan based on commonly agreed upon demand forecasts. The plan is used to allocate resources on a day-to-day basis and is also used by senior management to adjust the companys strategic goals. This is important for any business, but particularly for enterprises such as CPGco that manufacture multiple products for different tiers of regional and national markets, each with their own management structures. S&OP groups meet regularly, as often as weekly in some cases, to adjust production plans in response to changing market conditions and shifts in the companys strategic objectives. In the case of CPGco, S&OP operations are carried out on a monthly basis in four distinct steps (Figure 10). In the first week of every month, each local demand planner analyzes the statistical demand forecasts for each country in the region. These are adjusted to reflect projected impacts from any local events such as special sales promotions or introductions of new products. Each planner is responsible for his or her

assigned country but also reports to a central supply chain organization located in Colombia. Figure 10: In-country operations using S&OP

Source: Case study interviews In the second week of each month, all the data are loaded into a central software component supplied by Manugistics, a well-known S&OP solutions vendor. The software analyzes the demand data and evaluates current inventory available in each of the countries covered. It then decides the quantity of each product to be shipped to every country while matching sources with multiple plants as per the companys inventory status and projected shipping time and costs. Once this process is completed, notifications are sent to each plant and each country sales team about the amount of product that is scheduled to be sent next month. Once verified by the country managers, these delivery plans become a primary basis for planning manufacturing schedules for the following month. In the third week, the manufacturing plan is converted into a financial plan through the use of an S&OP software component attributed to Cognos. Each country manager independently reviews the business goals for that month. If necessary, adjustments might be made to the manufacturing and distribution plans to bring them in line with the companys profitability goals. The complete plan is finalized in the fourth week of every month and it represents the income statement for CPGco. This then becomes the basis on which the general management monitors company performance in the short, medium, and long terms. In-country retail distribution Based on the S&OP-based manufacturing and distribution plans, there is a schedule for all orders to be shipped from each manufacturing plant in Argentina, Brazil, and Mexico

to each of the regions distribution countries. These planning orders are moved from the Manugistics system to an SAP information management system that develops manufacturing plans and matches them with purchase orders. Each country has a unique distribution center (DC) for the companys personal care products that are shipped from its manufacturing plants. While the international movement of products is managed by a special internal division, DCs own these products once they are deposited there, and are financially and materially responsible for the final delivery of goods to retailers. The condition of DCs in a country is an indicator of that countrys competitiveness for the groups operations. The investment decision for these DCs depends on the overall incentive regime, business enabling environment, availability of localized services, and size of the market in a country. Of these, the first three points generally weigh much more heavily than the last point. For example, Colombia is a much bigger market than Peru for the group, yet the multinationals investment in the Peru DC has had a superior return even though the company classifies 80 percent of the market in Peru as traditional trade, or small retail mom-and-pop shops, compared to 55 percent for that category in Colombia. Rather than market size, investment decisions are usually based on a local economys stability and deregulation. For example, after 10 years the group recently authorized an investment for construction of a new DC in Cali, Colombia that will replace the current smaller and more rudimentary facility. The groups decision to invest reflects the more stable business environment that Colombia has cultivated in recent years. In contrast, Peru has long offered a relatively stable environment for businesses, which enabled CPGco to construct a modern DC there. CPGcos least sophisticated DC is in Bolivia, where business environments are relatively volatile. The Bolivian facility is equipped with a non-standard product storage system that CPGco acknowledges is inefficient and primitive compared to the systems used in its more modern facilities. Key competitiveness issues Effective FMCG market performance requires a well-established distribution network, low operational costs, and intense competition for the most efficient coordination among the diverse components within the company supply chain. In addition, continuously changing market composition and consumer tastes require that the system must be ahead of its rivals in terms of innovation. In many developing countries, companies face the added challenges of having to deal with unpredictable policy measures and inefficient regulatory systems imposed by public bureaucracy. Logistics and the business enabling environment Adapting to the local policy environment is a key competitiveness challenge for CPGco operations. For example, the organizations distribution systems in Colombia and Peru differ markedly on one important dimension: relationships with truck carriers. In Colombia, CPGco has a third-party-logistics agreement (3PL) with DHL, whereas the Peruvian logistics provider, CLI, operates under a fourth-party-logistics agreement (4PL).

This difference is directly correlated to the degree of market deregulation of backbone services: Colombian trucking prices are highly regulated whereas the Peruvian trucking market is more open and companies are able to generate competition among logistics providers for the best quality services. As a 3PL, DHL in Colombia will not be part of the parent groups engagements and negotiations with trucking companies. Aside from that, DHL will provide a wide range of services for CPGco at the new distribution center (DC) in Cali, Colombia, including: Finished goods inbound receiving Goods from adjacent plants will arrive at the loading docks at the Colombian DC. DHL will handle all receiving operations of these goods such as unloading, scanning, and shipment verification. Storage DHL will manage all the associated put-away operations for storage in the DC, including warehouse layout and pallet/case breakdown. The DC has pre-designed storage areas to comply with the groups safety requirements, which DHL will follow. Light manufacturing Light manufacturing includes added product bundling (e.g., to support promotional activity) or re-labeling (e.g., for new product regulatory registration). DHL facilitates space and time for such tasks to be handled within the DC as needs arise. Outbound shipments Based on customer orders, DHL will pick and pack the required products to be sent to CPGcos customers. This arrangement includes order picking from storage, pallet consolidation, shipment verification, and truck loading. Transportation planning and negotiation will vary and this is currently not within DHLs services. Figure 11: Logistics adapt to business enabling environments

Source: Case study interviews As part of the 3PL agreement, DHL is allowed to provide similar 3PL services to other

companies, although there are restrictions on the size of non-group jobs and selection is from a pre-agreed list of the groups competitors. CPGco also reserves the right to expand the amount of storage space allocated for its operations at the DC, should the need arise. CPGcos 3PL agreement in Colombia differs significantly from its 4PL agreement in Peru. In Peru, its local logistics services provider CLI benefits from the groups localization policy, where local firms enjoy long-term relational contracting with multinationals after having been selected on a competitive basis and demonstrating capacity to meet the groups service standards. 14 CLI offers comprehensive logistics services, which comprise import/export cargo and the added warehouse responsibilities previously described as well as services such as selection of, negotiations with, and management of trucking firms on behalf of CPGco. Such an internalization of the groups distribution systems by CLI is beneficial to the multinational because local providers like CLI are intimately familiar with local regulations and any anticipated changes. CLI manages all unloading, storage, and picking operations at the DC. Its warehouse management system (WMS) communicates directly with CPGcos SAP-based component of S&OP for allocating shipments from the main plants. CLI also assigns a local customs expert to stay on-site within the groups operation in Peru to maintain trading relationships with the government and resolve any issues that might arise in its distribution system. The trucking services CLI performs for CPGco are especially important for its operations in Peru because the Peruvian carriers are small transportation providers that typically own two to three trucks. Technologies such as truck-based GPS navigation are seldom used by the Peruvian carriers. To prevent theft, CLI ensures that transportation providers legally own the product as soon as it is handed over to them. If product is lost, the carriers are obligated to pay the retail pricenot the cost pricein order to preempt any profiteering. During high-selling seasons carriers usually employ guards especially for protection when traveling on country roads. Although Colombias overall security situation is worse than Perus, it has been more successful in developing efficient technologies for industrial transport protection because local transportation service providers in Colombia are larger and more technologically savvy than their Peruvian counterparts. For example, leading carriers in Colombia use GPS tracking technology to monitor the whereabouts of their trucks, and are electronic data interchange (EDI) capable. This capability enables companies such as CPGco to take advantage of electronic billing, which has not been possible in Peru. Dealing with policy fluctuations and unpredictability Political instability and policy uncertainties in the Andean region require constant global buyer vigilance. Trade regulations in this region are in a constant state of flux. For example, Venezuelan, Bolivian, and Ecuadorean foreign exchange regulations are
14

The localization concept is shared by other global buyers; CLI serves a major competitor of the groups parent company and other multinationals in a similar 4PL capacity.

problematic and can change quickly without warning. State-business relations can deteriorate rapidly and unexpectedly, and the political volatility found in most Andean countriesrecurrent cases of corruption and an overall lack of transparencyfurther exacerbate these problems. As other global buyers have done, the group has developed several ad hoc measures to anticipate possible changes in policies that have likely manufacturing, storage, and distribution impacts. Its informal interactions with business associations, chambers of commerce, and local experts are not sufficient for coping with this degree of uncertainty. Recently, the company has formalized a process for local assessment of anticipated changes. For example, with regard to trade policies, the company now controls the regions international shipments through a special division, that handles all cross-border movements, including the selection of ocean and truck carriers and the negotiation of freight rates. The division also monitors changes in trade policies such as new tariffs, duties, import/export quotas, customs procedures, and exchange rate regimes. The division is headquartered in Bogota but runs satellite offices in each of the countries that CPGco operates in. Each of the divisions local offices feeds intelligence to Bogota, and this information is relayed to CPGcos planners who incorporate it into their S&OP deliberations. If, for example, the Bolivian government decides to impose a new import quota on soap, that change will affect the demand forecasts within the S&OP system. The divisions organizations are staffed with local talent and they maintain a flexible structure that can respond quickly to any crisis situations. For example, staffing at the Venezuela office has lately been doubled to meet an increase in workload and the complexity of changing regulations in that country. Similar changes are ongoing in other countries in response to the continual policy flux. GS1-LOGyCA-MIT collaboration for excellence CPGco has also developed important collaborations with nonprofit organizations to develop some of the public goods necessary for its operations. Its efforts to overcome lack of transparency and policy predictability through collaborations with the chamber of commerce, business associations, and local experts have not always been adequate even in relatively modest information-seeking tasks. The inadequacies are greater when it comes to more demanding aspects of support to the private sector, such as technology and innovation, labor and specialized skill development, hard and soft infrastructure, and enabling the business environment. Therein lay the problems that have stalled local firm development of sophisticated procedures; affiliates of global buyers also face these challenges. These problems prevent competitiveness in the Andean region and illustrate the need for greater articulation of competitiveness-oriented policies and institutions beyond market deregulation. The parent groups representatives suggested that the companys pursuit of collaborative efforts with nonprofit institutions came in response to company needs for inter-firm coordination within and outside national boundaries for harmonization of technology, and quality standards for faster movement of goods. The public sectors role in coordinating technology transferfrom the group to its local counterparts like CPGco and then further to others down the supply chainhas not been taken seriously by government.

Technology transfer agreements in the Andes are ad hoc; rather than mandating and expediting such processes, government policies hinder initiatives taken by local firms. The capacity of the ministries of industries and the chambers of commerce fall short of the private sector needs in this regard. As a result, firms including CPGco have explored other alternatives to meet their needs on technology upgrade. One important development is its collaboration with GS1, a nonprofit organization dedicated to the design and implementation of global technology standards for improving the efficiency of global supply chains. The GS1 system of standards underpins the use of bar codes for identification of individual product items through its movement within and across borders. This system of standards has emerged through the 2000s as one of the most widely used supply chain standards systems in the world. GS1 has more than 100 member organizations globally and GS1 Colombia is one of its most active and productive satellites. In most parts of the world, GS1 limits its activities to issuing unique electronic product codes (EPCs) for radio frequency systems. In Colombia, GS1 has collaborated with local research and training organization LOGyCA and has taken its services a step further. Together they have played an important role in fostering inter-firm coordination in the retail market, a partnership that has benefited not only CPGco but also other multinational and local firms. The services they provide in Colombia include: Technology validation Establishment of an EPC laboratory where technology providers can test new products and obtain certification of services. This laboratory also has the capacity to validate and incorporate the proof-of-concept pilots developed by local technical staff in Colombia. Logistic process enhancements (i) Development of independent benchmarking services that monitor inventories and replenishment between CPGco and all of its major retailers in Colombia; (ii) Design of a common technological platform where data can be consolidated from multiple supply chain partners and can be shared and analyzed to enhance trade partner relationships; (iii) Analytical services and customized solutions in this area. Training and knowledge exchange Free and subsidized logistics process education programs for its members. It has a warehouse and retail spaces where trade partners can share best practices and develop trade events and workshops tailored for improvement of supply chain logistics. As has been previously discussed, LOGyCA brings educational expertise in supply chain technologies within the GS1-LOGyCA collaboration; its role is especially prominent in a country where links between universities and companies have been weak. Despite several efforts to strengthen academic-industry partnerships, which have been successful elsewhere in expediting local adaptation of global technologies, local universities participation in technologies and R&D related to supply chain logistics has been limited to peripheral activities in Colombia. This makes the role of organizations like LOGyCA

especially prominent in skill and technology development. LOGyCA has built a critical mass of human capital with an understanding of supply chain technology infrastructure through its comprehensive skill development programs. These efforts have catalyzed the adoption of important technologies such as EDI and radio frequency identification technology (RFID). In 2008, LOGyCA entered into an agreement with the Massachusetts Institute of Technology (MIT) in the United States to provide high-end education and research as part of its portfolio. Since then, it has been making steady progress in improving human capital and in building a coherent knowledge system on supply chain management with a more active role for the service to the private sector. Summary and lessons learned The 1990s were a decade of rapid growth in the parent groups Andean and Central American personal care products business. The company responded to this regional growth by designing products and packaging to adapt to the special needs of the regions emerging markets. In confronting local challenges such as policy unpredictability and transportation bottlenecks, the companys resourcefulness proved to be a significant competitive advantage in a growth market. The group drew on these assets to harness technology for its distribution and logistics supply chain management but it was the product innovation that enabled it to set new terms in its relationship to its customers. While some of its competitiveness efforts were internal and private sector specific, others involved close collaboration with a diverse range of public and private sector entities. For example, a S&OP system was internalized for distribution system efficiency. To overcome transport logistics bottlenecks, CPGco needed to be flexible in selecting and negotiating terms with its logistics service providers. Additionally, the company adapted on a case-by-case basis to local market conditions. When confronted with Colombias strictly regulated policy regime, it developed a top-down approach while spelling out its 3PL logistics system with trucking and dispatching systems. In contrast, in Peru where trucking rates are market-based, it adopted a localized approach with a 4PL contract that enabled it to obtain the full benefits of a system that allowed competitive trucking prices. The company also showed ingenuity in choosing diverse collaborative partners for innovation. It assembled a comprehensive team of global nonprofit organizations that included a world-class university that develops product and process innovation systems and assesses them for their sustainability. In contrast to the usual price, product, and transport considerations, CPGco is faced with the broader challenges of distinguishing its products and institutionalizing its processes. Going forward, there is a need for government to play a catalytic role for Andean and Central American firms to move to the next knowledge-intensive stage of development. Acquiring technologies such as S&OP is a private job but ultimately broader collaboration with the public sector is needed for future technological development and innovation. Government can best achieve this objective by coordinating collective action among smaller firms to enable growth of public-private knowledge-generation institutions.

Chapter 5: Hindustan Unilever Mobilizing Unlikely Partners for Supply Chain Development
Hindustan Unilevers manufacturing, distribution, marketing, and selling of its personal care product, Wheel, shows that supply chain effectiveness depends on a myriad of local collaborations. As such, HULs experience is consistent with the evolution of supply chain literature from a focus on efficiency to a concentration on effectiveness: early supply chain literature concentrates on efficiency improvements and devotes less attention to ways of enhancing the effectiveness of the supply chain. More recently, there has been a developing view that supply chain management models need to evolve to address relevant methods for achieving consumer focus in the context of the supply chain, i.e., supply chain effectiveness. 15 With regard to Wheela mass market consumer product such as laundry detergent that has overall consumption figures between 85-90 percent, supply chain effectiveness has its own particular set of challenges because more than two-thirds of the Indian population lives in villages. 16 Only 41 percent of poor rural households in India have access to television, and most of them rely on regional television. 17 The managers describe this market, with its limited access to information, as first, very difficult to reach; for that reason, it is one where local experience and tangible value are key drivers. For those reasons, HUL considers its two innovative market penetration and distribution strategiesWheel SMART SHRIMATI (WSS) and the Shakti networkkey factors in communicating value and getting consumer feedback. In such a market, supply chain effectiveness in marketing the product depends on four factors: affordability, acceptability, availability, and awareness. Hindustan Unilever (HUL) The Anglo-Dutch company Unilever entered the Indian market in 1888 with the importation of Sunlight soap through the port of Calcutta. In 1918, Dutch margarine companies that would later merge into Margarine Unie began selling Vanaspati Ghee (hydrogenated vegetable fat) in India. The Hindustan Vanaspati Manufacturing Company was registered in 1931, and manufacturing operations began at a factory in Sewri, near Mumbai, a year later. Lever Brothers India Limited was incorporated in 1933 to

For a review of existing literature regarding the efficiency vs. effectiveness approaches and an argument for the importance of effectiveness as a necessary element in the supply chain model, see Keivan Zokaei and Peter Hines, Achieving Consumer Focus in Supply Chains, International Journal of Physical Distribution & Logistical Management 37, No. 3 (2007) pp. 223-247.
16

15

This is a 2003-2004 figure. Villages are defined as units with a population of less than 1000.

17

Jamie Anderson and Costas Markides, Strategic Innovation at the Base of the Pyramid, Sloan Management Review 49, No. 1 (2007) pp. 83-88.

manufacture and market soap. In 1935, United Traders was incorporated to market personal products. In the early 1940s, Lever Brothers India acquired its own sales force, and HUL began to train Indians for managerial positions. By 1955, about two-thirds of the managers in the three companies were Indian. In 1956, the three companies merged to form Hindustan Lever Limited, with 10 percent Indian equity participation. Unilever held 51.5 percent of the Indian companys stock; domestic and foreign institutional investors held 14.3 percent each; and the Indian public held the remainder. A number of Unilever brands were launched successfully in India: Sunlight, Pears, Vim, Lifebuoy, Lux, Surf, and others helped consolidate HLLs position in the market. Industry organization: Market size and consumer habits The Indian Household Detergent Market Figure 12 A changing composition of the market

The pyramidal living standard module (LSM) is divided into three segments: (base) 1-4 (lowest); (middle 5-7) (middle); and (top) 8+ (highest). Ninety percent of the Indian population is in the lowest level. For comparison, 98 percent of the UK population is in the top (8+) section. At the base of this pyramid, India has 171 million poor households that have spending power of about $378 Source: HUL billiona market that is vital to Hindustan Unilevers continuing growth and sustainability prospects.a Further, with an 8+ annual growth rate projected from 2003 to 2013, HUL planners expect that Indias pyramidal wealth structure will evolve into a diamond with 86 million new households added to the middle (78) and top (8) of the consumer economy. Next to soap, detergent bars and laundry detergent have proven to be the easiest points of entry for the bottom of the pyramid (BOP) market. In fact, detergents have very nearly the same penetration level as soap and along with soap are the only personal care products where there is a near equal penetration of rural and urban markets. With respect to the other products (e.g., toothpaste), there is Figure 13

significantly greater usage by urban consumers (Figure 13). In achieving over 84 percent rural market penetration for its detergent products, Hindustan Unilever (HUL) has overcome formidable logistical, marketing, and competitive challenges. Laundry detergents are divided into three categories: (1) mass market; (2) popular; and (3) premium. The mass market is a key focus of HULs effort because of the potential for gaining the brand loyalty of first-time poor consumers and retaining and ultimately moving at least some of them into the popular and premium consumer categories. As might be expected, the Indian consumer mass market laundry detergent category is intensely competitive. Local brands, such as Nirma and Ghari, held well-established positions and were the key competitors. At the outset, Nirma was the market leader. Nirmas founder had developed a process that enabled the company to synthesize washing powder using soda and ash, minimizing the need for electricity. Packaging, advertising, and sales costs were minimal. Rather than a sales force, the company relied on a cluster of wholesale distributors to sell its products. Initially, it was able to market its brand at roughly one-quarter of the cost of Surf, HULs leading detergent. Consumer Habits Only one percent of the Indian population does its laundry in machinesa figure that has changed little since 1980. What has changed is the greater expenditure of effort to get clothes cleaneran activity that consumer education has linked to improving health. More people are doing their laundry now, even if it is still by hand. The process involves the use of powders or soaps to loosen dirt, which 70 percent of households undertook in 2008 compared to 0 in 1980; and for cleaning such as removing spots, which an additional 21 percent (a 13 percent increase since 1980) did in 2008. It is in these two markets, particularly the households that use soaps and powders to loosen dirt, that Wheel is focused. Collectively, 3 million tons of powders (1.6 million) and soaps (1.4 million) were sold in 2008 (compared to .825 in 1980). The market penetration throughout India for laundry detergents and detergent bars is in the mid-80 percent figure, with rural India lagging only slightly behind urban areas. With strong brand identification, there is significant growth potential in other personal care product areas (e.g., toothpaste, shampoo).
a

C. K. Prahalad and A Hammond, Selling to the Poor, Foreign Policy (May-June 2004): 30-37. See also Jamie Anderson and Costas Markides, Strategic Innovation at the Base of the Pyramid, Sloan Management Review 49, No. 1 (2007) pp. 83-88.

Summary of operations: HUL/Wheel This case study will discuss HULs operations for one of its personal care products, Wheel, a detergent powder for household use. HUL emphasizes overall profit rather than gross margins. Cost control is the key to achieving this goal but in a highly competitive arena to gain market share the company is willing to absorb short-term cost pressures. However, this strategy leaves very little money for effectiveness measures such as advertising and promotional support (2 percent compared to 8-10 percent for higher end products). Instead, the company relies on other innovative approaches to achieve supply chain effectiveness. Hindustan Unilever has managed to boost its market penetration of consumer goods categories such as laundry detergent, detergent bars, and soap in rural areas, but there is still growth potential in other product categories. Wheel SMART SHRIMATI (WSS) The key to finding a way to reach the fragmented and hard-to-reach market for personal care products in India is the use of a simple message and effective delivery of an accurately priced product. Hindustan Unilever has relied on innovative methods to build brand awareness for its personal care products: it uses a program called Wheel SMART SHRIMATI (WSS) in its campaign, Bringing the smart homemaker to squeeze Nirma and Ghari. WSS hits the acceptability component especially hard by seeking consumer peer endorsements. In this campaign, WSS uses a street-play narration that integrates product demonstrations to [make] the brand experience visible and alive to villagers. It also serves as an extensive recruitment campaign to select a smart homemaker in every village. These pageants use street performersmagicians, singers, dancers, and actors adjusting their scripts and acts based on the clientele the company wants to reach. 18 The local spectacles work. The company says that over one million housewives have contacted WSS to participate. Thirty thousand people have gone to audition centers at their own expense and there is a very high unaided recall of brand imagery (70-80 percent). The message focuses primarily on a single, simple point: cleanliness is critical for health and hygiene.

Unilevers use of street performances is also discussed in R. Balu, Strategic Innovation: Hindustan Lever Ltd., Fast Company Online 47 (May 2001): 120. For more detailed information on the companys strategy in the detergent market, see P.H. Werhane, M.E. Gorman, and J. Mead, Hindustan Lever Limited (HLL) and Project STING (B), Darden Business Publishing, Case no. UVA-E-0267 (Charlottesville, Virginia: University of Virginia Darden Business Publishing, 2004). For a wider discussion of the fast-moving consumer goods industry in India, see A.N. Radhika, Changing Trends in Retailing and FMCG Industry in India, ICFAI Center for Management Research Minicase no. CLBS019 (Hyderabad, India: ICFAI Center for Management Research, 2004).

18

The Shakti Network Shakti means strength in Hindi. Project Shakti began in December 2000 in the Nalgonda district in the Southern state of Andar Pradesh. It had both a business and social objective: the business goal was to reach remote markets through the endorsement of local influencers. As a mass market household detergent (which is the product group with the largest rural penetration), Wheel had the potential to be the most successful Shakti product. This expectation for Wheel was justified: HUL estimates for 2003 and 2004 were that Wheel accounted for roughly one-fifth of Shakti sales (18 and 19 percent respectively). Of the remaining HUL products, only Lifebuoy came close to Wheels sales figures (16 and 15 percent respectively). All of the other products had single digit contributions. Shakti had a second and possibly more important long-term objective: to provide sustainable income for poor rural women. 19 Initially, the company sold products to three federations of self-help groups (SHGs) that in turn sold them to constituent organizations, which in turn marketed them to village outlets. The model (MACTS) achieved success in getting HUL products into untapped markets, but the incomes generated were very small. An additional problem was that the SHG federations were a poor entrepreneurial model because no one person owned the enterprise. A new approach was needed, so it became that an SHG member in each of fifty villages would be a Shakti entrepreneur in those fifty villages. These Shakti women entrepreneurs borrowed money from their respective SHGs to purchase and sell HUL products to local outlets. Eventually, the Shakti entrepreneurs were allowed to sell directly to villagers. The new model afforded a sufficient incentive for the entrepreneur to work hard. What was a relatively small amount of incomeparticularly if it had to be shared with other SHG memberswas significant if it could be earned by one person. The choice of entrepreneur was left to the group to ensure group unity and support. Still, there were limits on what the entrepreneur could make because local outlet sales needed to be at a price that enabled the outlet to earn a viable retail margin when it sold the product to its consumers.

19

This story is told in V. Kasturi Rangan and Rohithari Rajan, Unilever in India: Hindustan Levers Project Shakti Marketing FMGC to the Rural Consumer, Harvard Business School, 9505-056, REV. June 27, 2007. It is the source for much of the material that follows.

Figure 14: HUL sales office locations

HUL sold its products to Shakti entrepreneurs at a discount relative to the general trade price but that discount had to be controlled to avoid channel conflict. So the entrepreneurial solution was clear: Shakti entrepreneurs needed to be allowed to sell directly to consumers. The arrangement significantly enhanced the entrepreneurs value to HUL. Increasing the entrepreneurs profit margin and earning potential incentivized her to work harder and in so doing brought her into direct contact with consumers. On one hand, it allowed the entrepreneur to earn more because she now retained the retail margin in addition to the discount HUL offered her. In this person-to-person relationship, the Shakti entrepreneurs became influencers who had the potential to increase category and brand awareness as well as use. Selecting women as entrepreneurs was the key to success for Project Shakti. As women were the target consumers for HULs products, women could best sell the product to their peers and in so doing enhance supply chain effectiveness. Poor rural women were also more likely to be committed to Project Shakti because of the enhanced role it gave them as heretofore ignored members of rural communities and, of course, the additional income was not only needed by the women themselves, it improved their villages prospects as sustainable economic entities. And women with daily access to the homes of potential consumers in peer-to-peer discussions could have an impact on the entire household that would lead to improvements in health and hygiene and education. Men on the other hand were already occupied with other employment and would therefore not devote as much time to the activity. HULs Shakti team knew that for the project to be a success, it had to make a significant difference in the lives of the entrepreneurs.

The cost to HUL was modest. The women who became Shakti entrepreneurs had monthly incomes of less than Rs. 1,000. Microcredit was the most common source of funds invested in Project Shakti. Repayments were in monthly installments that ranged from 0.75 percent to 2 percent of the principal. Income of Rs. 500 a month was the minimum needed for Shakti to have a beneficial effect on the entrepreneur familys living standard. In the early months of the project this standard was not met because the higher margin consumer sales were a small percentage of the transactions. As a consequence, the Shakti team decided that Rs. 10,000 had to be the minimum stake for the new entrepreneurs. With this sum, they estimated that a Shakti entrepreneur could generate Rs. 120,000 in sales per year. This performance would translate into an income of Rs. 700 income per month. With Rs. 200 per month allocated to debt repayment (at 0.75 to 2 percent interest) the loan would be paid off in 5+ years. While the model was attractive, serious challenges remained. Inventory bottlenecks were the first problem. The Shakti entrepreneurs had thousands of rupees worth of HUL products accumulating in their homesstocks that were worth more than the familys annual incomeand they were expected to repay the cost of these items. Women with little or no business experience who had rarely if ever borrowed money were anxious. In more than a few cases, they were suffering buyers remorse. HUL devised the rural sales promoter system (RSP) to deal with these concerns. Rural sales promoters (RSPs) would be coaches who would help the Shakti entrepreneurs develop their businesses. RSPs worked six days a week and visited two to five villages a day. HUL outsourced RSP administration but selected and trained individual RSPs. To motivate the Shakti entrepreneurs, the company established incentive programs with cash rewards for visiting a specified number of homes regardless of whether they made a sale. The company also offered incentives for the sale of brands that were especially popular in particular regions. Finally, HUL negotiated with banks to offer microcredit loans with a few months grace before repayment began. NGOs were potentially key allies in this initiative. At first some of them were hesitant because they saw Shakti as a multinationals potentially exploitative program. HUL salespeople had no experience in dealing with NGOs so the company retained the Marketing and Research Team (MART), a rural consulting firm that specialized in developing and implementing rural marketing initiatives for social as well as business organizations. MART introduced the project to its district and state coordinators, who in turn would assess its potential in individual districts by examining local prosperity levels, the existence of self-help groups, the presence of NGOs and micro-credit agencies, and HULs reach. Once this review was completed, MART worked to convince governmental agencies and NGOs of Project Shaktis benefits. These efforts were very successful. By the end of 2004 the coordinators had obtained the support of nearly 300 NGOs. With support systems in place, the district and state coordinators worked with the local Project Shakti team to appoint Shakti entrepreneurs. The typical coordinator would appoint 20 entrepreneurs in a district before moving on to another district. Using this system, project Shakti expanded rapidly. By December 2004 (Shaktis first break-even year) 12,151 entrepreneurs covered more than 50,405 villages across 310 districts in 12 states. By January 2009, this figure had expanded to 45,000

entrepreneurs in 135,000 villages in 15 states and the company had plans to customize the model for use in Sri Lanka, Vietnam, and Bangladesh. 20 Though impressive, this figure was somewhat behind the ambitious goals for 2010 that were discussed in the companys 2007 annual report, in which the company forecast that by 2010, it planned to expand the program to cover 500,000 villages, with 100,000 Shakti entrepreneurs reaching out to over 600 million people in rural India. 21

The Four As in the HUL Wheel Case The following text is an excerpt from an article in MIT Sloan Management Review magazine, which explains the factors that enable innovation to be achieved in emerging markets. In developing markets, innovation is based on four factors: affordability, acceptability, availability, and awareness. Affordability is the degree to which a companys goods or services are affordable to even the poorest consumers. Acceptability is the extent to which limited resources groups in the value chain are willing to consume, distribute, or sell a product or service. Availability is the extent to which customers even in the most isolated communities are able to acquire and use a product or service. Awareness refers to the ability to reach poor and remote customers through alternative communication modes and methods.
Source: Jamie Anderson and Costas Markides, Strategic Innovation at the Base of the Pyramid, MIT Sloan Management Review 49, no. 1 (Fall 2007), p. 84.

20 21

The Economic Times, January 16, 2009. Hindustan Unilever Limited (HUL) 2007 Annual Report, pp. 22-23.

Hindustan Unilevers Response to Market Challenges: Improving Supply Chain Efficiency While the supply chain effectiveness measures previously mentioned have long-term potential to benefit company performance and have already done so to some degree for HUL, the companys improvement in its competitive position in the last decade owes much to supply chain efficiencies. HUL needed to sell the product at an affordable price. It addressed this problem with packets costing Rs.10 that would be a two-week supply of laundry detergent. This small package was twice the Rs. 5 price of the HUL bar, used only for getting out tough stains. Weaning the consumer off the bar to a powder sachet that was twice the price was supported by the previously described educational campaign in remote locations. How expensive is Rs. 10 for a bottom-of-the-pyramid family? Indias poverty line is approximately Rs. 30,000 per year, which is approximately $1.60 per day. Ten rupees is approximately 20 cents. For low-income Indian consumers, 20 cents would be an allocation of 12.5 percent or more of one days income. For comparison, New York States minimum wage is $7.15 per hour. Eight hours work at that rate pays $57.20; 12.5 percent of $57.20 is $7.15a high price for a New York State purchaser to pay for a small amount of washing detergent. Given the packaging and labeling expense for these sachets, significant production efficiencies were required to achieve a small profit margin. As the pack size gets smaller, packaging material becomes an increasingly larger component of cost. HUL has programs to find laminates for the labels that have greater strength and retention and cost less. Special attention is paid to optimizing pack dimensions to avoid waste. Factory land use is another place to find savings through cost controls on steel, cement, and maximizing the use of existing machinery. Notwithstanding these challenges, during the period of 2001-2008, HUL/Wheel went from second to the lead position in the mass market detergent category and its share increased from 16.0 to 17.6 percent (Figure 15). The former leader, Nirma, ranked third and its share declined from 19.4 to 11.7 percent. The number two brand, Ghari, had the best performance during this period, increasing its share from 6.8 to 11.7 percent.

Figure 15: Market Shares Indias Laundry Mass Market

Source: HUL, 2009 Distribution is also a critical supply chain cost. HUL attributes Gharis success to lower distribution costs (50 percent of HUL), regional domination, disintermediation in distribution (i.e., no depots), and decentralized manufacturing. With 25 manufacturing centers for Wheel in Indias 27 states, all of them located within 200-500 kilometers of the sale destination, it sources close to the market. Wherever possible, HUL seeks to avoid depots by transporting directly from factory to market. Depots are used selectively for small stockists (Figure 16). Figure 16: Mass Markets Model

Source: HUL

HULs Advantages Looking forward to 2015, as is the case with Chinese FMCG, Indian manufacturing will be dominated by local players and explosive increased demand will be fueled by a growing middle class with higher levels of disposable income. In contrast to manufacturing, retailcurrently fragmented with 12 million mom and pop storeswill confront a dramatic increase in competition from organized modern retail, which currently accounts for only 10 to 12 percent of sales. For example, more than 350 malls that will add 117 million square feet of retail space are now under construction. By 2010, India will have 600 malls with 300 million square feet of space. Though local players will be Wheels dominant product competitors, this more than 30 percent anticipated increase in retail capacity will include some very big names. Reliance plans to open 4,000 stores and a Wal-Mart-Bharti joint venture will also enter the Indian market. Given this climate, HUL is using its MNC model to gain a competitive advantage against Ghari and other local competitors. Specifically, it is using R&D to get best-in-class product costs. HUL has used regional sourcing in 25 factories. The company further expects to achieve greater supply chain efficiency by optimizing inbound logistics through savings of Rs.100 per ton (6 crore per year) on inbound materials through: alternative or proximate sourcing of salt, dolomite, calcite, and chinal clay; alternative modes of transport (e.g., coastal movement, railway); and in-house or local manufacture. Figure 17: Local competition and business strategies

Source: HUL Key competitiveness issues Again looking forward to 2015, there seem to be three threats to business sustainability: (1) inadequate Indian transportation and warehousing infrastructure;

(2) a nationwide logistics skills gap; and (3) the need for greater consumer and entrepreneurial liquidity. Private-public partnerships, possibly involving industry-wide collaboration with competitors, are a potentially useful model for addressing these problems. Roads Freight costs per ton/km for Indian manufacturers are significantly higher than for similar businesses in other countries because Indias highway infrastructure has not improved at a sufficient pace to accommodate its GDP growth. For example, Indian trucks average a distance of 350 km per day compared to 800 for Brazil. In addition to road quality, the vehicles are slowed down by state border crossings. There are 27 Indian states as well as some federal districts. Every crossing from one state to another or between a state and a federal district entails a regulatory event. These episodes take up 15 percent of all transport time and add 15-20 percent to the total cost. Government plans for a value-added tax (VAT) will streamline this process somewhat, but border crossing permits are still needed. In addition, most roads do not segregate fast and slow moving traffic (the latter includes cows). As a result, the average speed in primary lanes is 30 km/hr. Vehicle utilization is 80,000 km per yearone-quarter of the annual vehicle utilization figures for the United States or Europe. These factors result in a significantly higher surface freight expense than in Canada, Japan, or Europe. Figure 18: India suffers from high costs of trade logistics

Source: G. Vaidhyanathan (JNPT), ICS World Bank, Cygnus, KPMG Analysis Congested ports India has 118 ports, but Mumbai and Mandra account for more than 50 percent of the traffic while other ports are grossly underutilized. HUL executives say that Indias ports have been unable to cope with the 15 percent container traffic increase in the last five years. As a consequence, it can take vessels up to three and a half days to debark. This figure compares unfavorably with the seven-hour turnaround times for Hong Kong and Singapore (Figure 18).

HUL thinks that logistical hubs are needed to address the problem of underutilized port capacity. They propose logistical parks that avoid cities, similar to those found in the UK where trucks can drop off freight and return with a load. They say that competitors acting together in public-private partnership (PPP) where the government offers incentives for participation would be an effective way to achieve this outcome. Poor warehousing Fragmented, inefficient operations lead to higher inventory. Indias FMCG manufacturers also confront the challenge of inefficient, unorganized, and scattered warehousing facilities. Problems include an inability to obtain scale efficiencies due to indirect taxation laws, a lack of professional service providers, and usually a floor stacked go-down. These factors result in a considerably higher average number of inventory days for Indian manufacturers than is typical in Brazil and China. Manpower shortages India also has a significant manpower shortage of logistically skilled employees for maintaining sustainable growth at the current rate. It is estimated that by 2015, the country will need 4.7 million trained drivers (only half of current truck drivers are fully trained), 400,000 loading supervisors, and 35,000 warehouse managers (Figure 19). Figure 19: A wide skill gap

Source: HUL There are no current governmental initiatives to address these skill gaps. HUL managers believe that the problem affords an opportunity for a public-private partnership (PPP) industry initiative involving government, competitors, and NGOs to build capacity and offer vocational training, possibly through the construction of special enterprise zones for

related products. 22 Better inventory management is also critical. Trucks need to deliver product and return with a full load. Improved information technology can also help: integrated IT platforms can aid supply planning and better forecasting for demand, addressing questions such as, How much do we expect to see, at what location, and at the least cost? Liquidity As villagers lend money to one another at prohibitive rates, microcredit is needed to help aspiring shopkeepers, truckers, and consumers achieve greater independence and better cash flow. Credit could finance store openings, new trucks, and washing machine purchasesall vital to the sustainability of a FMCG enterprise seeking to expand its reach in the bottom-of-the-pyramid market. Summary and lessons learned First, these living standard module consumers at the bottom of the pyramid are vital to the sustainability of Indian fast moving consumer goods (FMCG) companies. Indias millions of poor households have a spending power of about $378 billiona market that is a key element in the continuing growth of Hindustan Unilever and its competitors. With a more than 8 percent annual growth rate projected from 2003 to 2013, it is expected that Indias pyramidal wealth structure will evolve into a diamond with 86 million new households added to the middle and 8 million to the top of the consumer economy. Once brand loyalty is established, these wealthier consumers can be attracted to a broader range of company products. Second, this HUL/Wheel case study shows that there is no trade-off but multiple complements between the ideas of supply chain effectiveness and supply chain efficiency for competitiveness. Cost control is the key to achieving supply chain efficiency. In a highly competitive arena, to gain market share the company needs to be willing to absorb short-term cost pressures. This strategy leaves very little money for effectiveness measures such as advertising and promotional support (2 percent compared to 8-10 percent for higher end products). Instead, a company needs innovative approaches to achieve the key supply chain effectiveness objectives of: affordability, acceptability, availability, and awareness. For example, only 41 percent of rural Indian households have access to television and most of them rely on regional television. HUL reaches these rural markets with the Wheel SMART SHRIMATI street play narration that integrates product demonstrations to [make] the brand experience visible and alive to villagers and the Shakti entrepreneurial network of local housewives who sell Wheel detergent to their peers. Third, multinationals are and should be willing to forge collaboration with the unlikeliest of partners. For example, in case of HUL/Wheel, NGOs have emerged as key allies in Project Shakti-type initiatives. If the company is multinational, it will need first to
For more about MNC-NGO partnerships generally, see Paola Perez-Aleman, Marion Sandilands, Building Value at the Top and the Bottom of the Global Supply Chain: MNC-NGO Partnerships, California Management Review 51, No. 51 (Fall 2008) pps. 24-49.
22

overcome hesitance working with an NGO because of an NGOs potential to see a rural woman program as potentially exploitative. Companies need to assess the projects potential in individual districts, examine local prosperity levels, the existence of self-help groups, the NGO presence if any, and the availability of microcredit agencies. In a bottom-of-the-pyramid market, supply chain efficiency is a key element. First, the product needs to be sold at an affordable price. In the case of Wheel, a two-week laundry supply is sold in Rs.10 packets. Given the packaging and labeling expense for these sachets, it requires significant production efficiencies to achieve a small profit margin. As the pack size gets smaller, packaging material becomes an increasingly larger component of cost. HUL has programs to find laminates for the labels that have greater strength and retention and cost less. Special attention is paid to optimizing pack dimensions to avoid waste. Factory land use is another place to find savings. There is a need to squeeze more out of existing buildings through cost controls on steel, cement, and maximizing the use of existing machinery. In this context, the points below are worth reiterating: Source close to the sale destination and eliminate or minimize warehouse costs: With 25 manufacturing centers for Wheel in Indias 27 statesall of them located within 200-500 kilometers of the sale destination, HUL sources close to the market. Wherever possible, the company seeks to avoid depots by transporting directly from factory to market. Depots are used selectively for small stockists (Figure 20). Figure 20:

Source: The Conference Board and The World Bank; HUL

Key challenges in India for FMCG sales: Going forward, FMCG enterprises face five threats to business sustainability in India: (1) road quality; (2) congested ports; (3) poor warehousing; (4) manpower shortages; and (5) entrepreneur and consumer liquidity. Again, private-public partnerships, possibly involving industry-wide collaboration with competitors, offer potentially useful models for addressing these problems. Roads Freight costs per ton/km for Indian manufacturers are significantly higher than for similar businesses in other countries because Indias highway infrastructure has not kept up with its GDP growth. In addition to road quality issues, the vehicles are slowed down by state border crossings. Every crossing from one state to another or between a state and a federal district entails a regulatory event. These episodes take up 15 percent of the transport time and add 15-20 percent to the total cost. As a result, the average speed in primary lanes is 30 km/hr. Vehicle utilization is 80,000 km per yearone-quarter of the annual vehicle utilization figures for the United States or Europe. These factors result in significantly higher surface freight expense than in Canada, Japan, or Europe. Ports India has 118 ports, but Mumbai and Mandra account for more than 50 percent of the traffic while other ports are grossly underutilized. HUL executives say that Indias ports have been unable to cope with the recent 15 percent container traffic increase. As a consequence, it can take vessels up to three and a half days to debark. This figure compares unfavorably with the seven-hour turnaround times for Hong Kong and Singapore. Logistical hubs are a potential way to address the problem of underutilized port capacities. For example, logistical parks that avoid cities, similar to those found in the UK where trucks can drop off freight and return with a load, could redirect traffic to underutilized ports. Competitors acting together in public-private partnership (PPP) where the government offers incentives for participation may be an effective way to achieve this structure. Warehousing Indias FMCG manufacturers also confront the challenge of inefficient, unorganized, and scattered warehousing facilities. Problems include an inability to obtain scale efficiencies due to indirect taxation laws, a lack of professional service providers, and usually a floor stacked go-down. These factors result in a considerably higher average number of inventory days for Indian manufacturers than is typical in Brazil and China for example. Skilled manpower shortage India also has a significant manpower shortage of logistically skilled employees to maintaining sustainable growth at the current rate. It is estimated that by 2015, the country will need 4.7 million trained drivers (only half of

current truck drivers are fully trained), 400,000 loading supervisors, and 35,000 warehouse managers. As there are no current governmental initiatives to address these skill gaps, this problem affords another opportunity for a public-private partnership (PPP) industry initiative involving government, competitors, and NGOs to build capacity and offer vocational training, possibly through the construction of special enterprise zones for related products. Consumer and entrepreneur liquidity In the Indian village, borrowing money is typically only possible at prohibitive rates. Microcredit is needed to help aspiring shopkeepers, truckers, and consumers achieve greater independence and better cash flow. Credit could finance store openings, new trucks, and washing machine purchasesall vital to the sustainability of a FMCG enterprise seeking to expand its reach in the bottomof-the-pyramid market.

Chapter 6: Structural Change during a Time of Crisis The Global Recession and the Energy Price Crisis
Thus far, the discussion has focused on effective buyer and seller responses to local and regional challenges to supply chain integration of less-developed countries and regions. From 2008 to 2009, while individual case study research was being conducted for this project, the global recession and the energy supply crisis threatened supply chains everywherenot just in less-developed regions and countries. To better understand the global context for assessing the effectiveness of supply chain integration, the World Bank and The Conference Board conducted online surveys to determine company responses to these twin crises. Respondents agreed that the ongoing global financial crisis is seriously eroding developing country export competitiveness through its impacts on trade finance, capital flow and overall demand. Over 98 percent of the global buyer survey respondents said that their international operations had been affected by the global financial crisis. Figure 21: Since September 2008, how has your international business been affected by the global financial crisis?

Source: Company Strategies for Managing Rising Fuel Costs and Climate Change Concern: A Global Buyer and Producer Survey, The Conference Board, 2008. The respondents said that developing country export transactions have been affected more strongly than import purchases and sales. Only 13.1 percent of the respondents said the crisis had no effect on developing country exports, and 34.4 percent said as much about the effect on imports. Decline in purchase orders and problems associated with trade finance are two key reasons why foreign sales are being affected.
80 70 60 50 40 30 20 10 0 Figure 22: Relationship with foreign counterparts since the crisis

trade credit terms changed Supply chain producer and buyer Supply chain service provider Global buyer and producer Global logistics service provider Other

net days to payment changed

Source: The World Bank survey, 2009

Global buyers and producers of final products were three times more likely to say that they have been hit harder than intermediate products producers and sellers with respect to availability of trade finance, working capital, and purchase orders. Further, when disaggregated by industry sector and size, difficulties in trade finance and purchase orders are more pronounced for global manufacturers than for global service providers including logistics operators (Figure 23). Smaller firms also suffered more than larger ones. Respondents with more than one billion dollars in annual revenue reported fewer orders in both foreign sales and purchases. Figure 23: What are the key causes of delay or cancellation of your foreign sales?
50 40 30 20 10 0 trade fin working fin purchase no effect orders on export manufacturing services 50 40 30 20 10 0 trade fin working fin purchase no effect orders on export firms <$1 billion firms >$1 billion

Source: The World Bank survey, 2009 The survey participants reported that terms of trade for global transactions have changed since September 2008, and that their companys global supply chains have been affected. Over 90 percent of the responding companies said that they have changed their terms of trade with their production and trade counterparts abroad (Figure 24). Within this group, 100 percent of the global buyers, producers, and service providers (including logistics) changed trade terms since the crisis; while a smaller percentage of their suppliers (75 percent), reported having done Figure 24: Percent that have changed payment terms so. Roughly half of the with trade counterparts since September 2008 respondents said that they now 120 require letters of credit for their 100 foreign transactions, while 44 percent said they demand 80 advance payment on or before 60 delivery. There was little evidence to suggest that foreign payment term changes were caused by trade finance bottlenecks. For example, when asked whether or not they made use of trade credit insurance for their
40 20 0 suppliers service Global buyer logistics providers and service producer provider Other

Source: The World Bank survey, 2009

foreign buyers foreign suppliers

foreign transactions, only 20 percent said they did. And when asked whether the prices of the trade credit insurance have gone up since the crisis, 80 percent said they have not. When asked whether the credit term changes were applicable only to certain geographic locations, more than 73 percent of the respondents said the changes were not geographyspecific. However, when asked to identify specific countries where they have insisted on more stringent payment terms from their counterparts, they cited Bangladesh, India, China, Hong Kong, Korea, Sri Lanka, Ukraine, the United States, and Vietnam. Given a list of six ways in which the crisis affected the bargaining strength between buyers and sellers, survey respondents cited an increase in foreign suppliers insistence on more demanding payment terms, which was somewhat inconsistent with reports of foreign customers insistence on longer net days for payment. For example, 8 percent reported reduced sales on credit and 7 percent reported higher demand for faster payment (Figure 25). Ten percent of the respondents reported that their foreign suppliers are more likely to offer incentives for early payments. Figure 25

Source: The World Bank survey, 2009

Global Supply Chain Impact of 2008 Energy Price Increases The past four decades have seen intense volatility in inflation-adjusted oil prices (Figure 26). The Conference Board-World Bank survey of global buyer response to oil prices was conducted in July 2008 when they reached the highest level in 38 years ($138 per barrel) before falling to as low as $40. The September 22, 2011 price was $80.78, down from its 52-week high of $114.91. Figure 26

Source: www.chartoftheday.com, March 4, 2011 The World Bank surveyed 29 global buyers between January and July 2008 using an online questionnaire that asked 29 detailed questions on: (i) the nature and structure of the buyers global supply chain; (ii) any changes introduced in the supply chain in response to the increase in prices of energy and primary commodities between January and June 2008; (iii) any changes introduced on suppliers factory floors; and (iv) any changes introduced in carbon labeling. Findings of the survey were discussed at a focus group discussion of global buyers; further individual discussions with selected global buyers and producers were held for validation and clarification purposes. The survey asked participants about their businesss primary transport mode: 44 percent of them relied on roads; 19 percent sea; 15 percent by air; and 8 percent depended on rail. The remaining 14 percent of goods and services businesses required multiple modes of transport. In terms of costs, packaging, transport/cargo, and third-party logistics services were the three most cost-intensive components and were where 10-15 percent of the participating companies spent more than 20 percent of their expenses. The survey also sought information from participants on the energy and primary

commodities cost implications for production. About 35 percent of the companies said they spent more than 20 percent of their total costs on primary commodities while only about 10 percent of the participating companies said they spent the same amount in energy and freight. Forty-two percent of the participating companies said they spent less than 5 percent of their total costs in freight. And about 35 percent of the participating companies said they spent less than 5 percent of their total costs on energy and primary commodities. Figure 27: Total operating costs of transport and logistics

packaging admin inventory holding warehousing Transport/cargo 3PL 0 20 40 60 80 100

20% and more

less than 5%

Figure 28: Modes of transport

air sea rail road multi-model

Figure 29: Cost breakdowns

20% + freight primary commodity energy 0% 10% 20% 30% 40% 50% < 5%

Source: The World Bank survey, 2009

Figure 30: Cost implications of the crisis on the global supply chain
70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% major moderate no change

energy prices

primary commodity prices

freight

Source: The World Bank survey, 2009 Fifty-eight percent of the participating companies said that the impact of energy prices has affected their internal global supply chain in a major way; 27 percent said it was moderate while only 16 percent said that they were unaffected. The freight price escalation has severely affected 42 percent of the responding companies while 35 percent have been affected moderately and the remaining 19 percent have not been affected. The rise in the prices of primary commodities has affected 31 percent of the participating companies in a major way, 50 percent moderately, and has left 19 percent unaffected. Figure 31a: Supply chain implications of the crisis Sales: Percent of respondents who say attractiveness of regions has not changed

CEE Europe CAsia EAsia SAsia MENA LAC USA/Canada SSA 0 20 40 60 80

Figure 31b: Sourcing: Percent of respondents who say attractiveness of regions has changed

Europe USA/Canada CAsia MENA CEE EAsia SAsia LAC SSA 0% 10% 20% 30% 40%

Figure 32a and 32b: China has become less attractive as a sourcing option (higher score = least attractive)

Mexico

India

China 0% 10% 20% 30% 40%

and Mexico more attractive (highest score = most attractive)

Mexico

India

China 0% 20% 40% 60%

Source: The World Bank survey, 2009

The survey asked participating companies about the attractiveness of certain countries and regions after the unexpected price rise in fuel and primary commodities. Thirty-five percent of the participating companies said that China has become less attractive a location for their operations as a result of the fuel and commodity price crisis, while 41 percent said that Mexico has become more attractive. At a regional level, 35 percent of the participants confirmed that the attractiveness of sourcing from sub-Saharan Africa has changed due to the rise in the fuel and primary commodity prices. Nineteen percent of the participants said that about South Asia and Latin America. After moderate price hikes during the first half of 2007, fuel and primary commodity prices took an upward turn in June 2007, and prices rose steeply. Approximately 13 months into the crisis, when the survey was undertaken (July 2008), 81 percent of participating companies had already developed business strategies in response to price hikes. An additional 8 percent said they were in the process of developing a business strategy. Only 11 percent said they did not have a strategy. The survey asked participating companies to identify strategies that they already implemented or were likely to implement in the near future. The most popular options were: re-engineering warehousing and distribution systems (38 percent); improving local collaborations in operating countries (31 percent); and simplifying supply chains by selecting fewer locations (31 percent). The survey then asked participating companies to identify the least attractive options from a given list. Sixty-one percent of the participating companies said that it is unlikely that they will be relocating their production closer to final markets. Fifty-eight percent of the companies also said it was unlikely that they will be able to improve local collaborations in a significant way. And 46 percent said it is unlikely that they will be reducing their inter-regional trade or externalize their supply chain activities in response to the fuel and primary commodity price rises. Figure 33: Strategic responses to the crisis Did your company develop formal business strategies to respond to the crisis (by July 2008)?

Yes, already No In progress

Source: The World Bank survey, 2009

Figure 34: What are the most attractive strategic options? (highest score = most attractive)
re-engineering improve local collaboration in simplify supply chains (fewer change in preferred modes of relocate production closer to final reduce inter-regional trade externalize supply chain activities trade off between labour and increase contract manufacturing
0% 10% 20% 30% 40%

Source: The World Bank survey, 2009

Figure 35: What are the least attractive strategic options? (highest score = least attractive)

relocate production closer to final improve local collaboration in reduce inter-regional trade externalize supply chain activities simplify supply chains (fewer locations) change in preferred modes of trade off between labour and increase contract manufacturing re-engineering
0% 20% 40% 60%

Source: The World Bank survey, 2009

Profile of the Survey Respondents Financial Crisis Impact on Individual Trade Transactions in Global Supply Chains: a Survey of Buyers and Sellers (n=59) Location: Asia Europe/Central Asia Western Hemisphere Other No. Companies: 18 10 26 3 Percent: 31 17 44 5

Half (30) of the respondent companies were manufacturers and the other half (29) were service providers. The sample was also evenly divided between companies with revenues above and below one billion dollars. Thirty-one companies had less than 1 billion dollars in annual revenues while 29 had a billion dollars or more.

Figure A: Supply chain locations and shares: Regions Most important countries

CAsia SSA MENA LAC SAsia CEE EAsia Europe USA/Canada China Mexico India

100

200

300

sourcing contract manufacturing

producing sales & distribution

0 100 sourcing contract manufacturing others

200 300 producing sales & distribution

Note: Multiple answers per participant possible. Percentages added may exceed 100 since a participant may select more than one answer for this question. Three countries were especially active in the global supply chain: 85 percent of the companies had sourcing operations and 58 percent of the companies had production

operations in China. India followed with 69 percent and 35 percent, respectively. Mexico was the third active country with 53 percent sourcing and 38 percent production operations from global buyers. In terms of sales, 65 percent of the companies had sales operations in China, 50 percent had operations in India, and 69 percent in Mexico. Among the survey participants, global companies were significantly more active in advanced economies of the United States, Europe, and East Asia and were less active in sub-Saharan Africa and Central Asia. For example, 73 percent of the companies indicated that they sourced inputs or finished goods from the United States and Europe. A significantly high number of companies undertook production, contract manufacturing, and sales functions in these two regions. East Asia followed the same trends, only slightly lower: 62 percent of the companies surveyed said they sourced inputs from East Asia; 35 percent said they have production functions there; and 54 percent said they sell goods and services in East Asia. Eastern Europe, South Asia, Latin America, and Central Asia were less active regions for the companies surveyed. Companies were least active, however, in sub-Saharan Africa. Less than 4 percent of the companies had sourcing and contract manufacturing operations in sub-Saharan Africa. The region was more popular for sales and distribution (42 percent), and about 58 percent of the companies said they have other operations in Africa, most likely purchase of raw materials, which did not qualify as a sourcing activity because of the lack of processing happening within the region. Figure B: Company Strategies for Managing Rising Fuel Costs and Climate Change Concern: A Global Buyer and Producer Survey (n=29)
Worldwide revenue (2008)

Number of employees (2008)

<10000

10-25k

25000+

<USD 1 bn

1-20 bn

20 bn+

More than half of the survey respondents (58 percent) were global buyers or producers with more than 25,000 employees. A vast majority (81 percent) earned over US$1 billion and 23 percent earned over US$20 billion annually. Nearly three-quarters of the respondents (73 percent) had their headquarters in the United States while the remaining 27 percent were European companies. With respect to global supply chain categories, 46 percent of the respondents were producers of agricultural or light manufacturing products; 35 percent were service providers to manufacturers; and the remaining 19 percent were distributors of finished goods and services.

Chapter 7: Conclusions and Ways Forward

In many developing countries, company integration into global supply chains has been an important avenue for growth and competitiveness. Geographical advantages cannot be understated. Discovery and competitiveness of new goods and services may be one channel through which developing countries can attract global buyers and producers, but there are several other channels that should not be ignored. The detailed examples provided reveal a variety of channels through which developing countries can be integrated into the global supply chain. This outcome may occur as a result of development of new collaborative arrangements between global buyers, producers, and local suppliers. Case study investigation shows ways in which integration may result or be made more sustainable by improving transport and retail distribution logistics. New collaborative arrangements between global and local partners Competitiveness is key to integration of local firms into the global supply chain. Competitiveness can be introduced in the global supply chain by developing closer collaboration models between global buyers and producers and their local suppliers. When local suppliers are successful in creating new products that enhance the competitiveness of the entire supply chain, there are more opportunities for them to develop longer term relational contracting with global buyers. Product-level competitiveness should be understood in a broad sense. For example, in the case of TEAM Foods Colombia, the local suppliers were able to offer not only unprocessed oil palm but special ingredients (SI) into the global supply chain, which are not only a higher value good, but also one that gave them important leverage on which they could develop more complex collaborations with the global buyers. In another case, CPGco, the local suppliers were able to develop new product ID barcodes for differentiating their semi-finished inputs, allowing them to renegotiate their integration into HULs global supply chain in more favorable terms. CPGco was also able to develop important collaborations with scientific research organizations such as GS1 and MIT through which company-specific R&D programs were developed, which protected copyrights for inputs into CPGcos global supply chain. Logistics for transport and retail distribution are breaking new frontiers As our surveys show, transport and logistics incur substantial costs to global buyersin some cases more than 20 percent. Substantial cost-saving and better coordinationleading to increased competitivenesscan be achieved by improving the logistics and transport systems within and between countries. Despite several problems that compromised internal security, Colombia emerged as a preferred location for global buyers of oil palm because of the advanced truck tracking systems developed in a collaboration between the government and the private sector in Colombia. In fact, despite a government-regulated trucking system, Colombia still functions as the key hub through which TEAM Foods manages its regional and global distributions. An S&OP-driven supply chain management system was essential for CPGco to run its

businesses in its distribution centers in Colombia and Peru. The differences arose from the pattern of liberalization in these two countries: Colombia has government-controlled trucking systems while Peru allows competition among trucking businesses. Accordingly, the companys operation in Colombia manages its own transport systems while its operations in Peru make use of S&OP technology to call for more rigorous competition among trucking companies. Technological advances were not sufficient to overcome the complexities of the Indian transport and distribution systems. In fact, HUL adopted a localized distribution method to overcome its logistical problems. First, it collaborated with a grassroots-based NGO that would groom micro-entrepreneurs from rural villages to serve as the independent entrepreneurs who would eventually make the expensive wholesale depots redundant. The inconsistencies in government policies involving local transportation were overcome to a large extent by subcontracting the tasks of local transport to local entrepreneurs, who were better conversant with local policy changes and their implications. Globalization opens up new avenues for localization and regionalization Integration into global supply chains also tends to provide new entry points through which producers can break into the local and regional markets. While such options have always been present, acquiring global quality standards as well as development of competitive transport and distribution systems seems to have deterred producers from entering some proximate markets. The examples of CPGco and TEAM Foods Colombia, where local firm success in regional market penetration has enabled companies to better integrate into the global supply chain, offer encouragement and document experience as to how these barriers can be overcome. Such integration demands important local producer changes. For example, TEAM Foods has utilized mergers of several local firms into a conglomerate that can exert control over a much larger segment of the supply chain ranging from palm growing to packaging and processing into intermediate inputs.

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Methodology and Interview Protocol

Trade Competitiveness and Integration of Poor Countries in Global Supply Chains: A Perspective of Global Buyers and Producers Initial Broad Themes: In addition to the three industry categories identified for study: (1) agro processing; (2) apparel and related machinery manufacturers; and (3) distributors of consumer goods, our initial literature review and initial discussions with company contacts suggest that there may be three models of purchaser/seller collaboration and a fourth model in which governments or international organizations are involved in efforts to overcome the risks and costs of poor infrastructure: (1) Technology/skills transfer and local political muscle to drive down transportation to market costs (2) Sourcing close to market to limit transportation costs (3) Enhancing product/value cost through brand equity to trump costs (4) Success in developing innovative public-private-partnership to drive productivity and competitiveness Accordingly, we looked for ways to find examples of each of these approaches or combination of approaches in our case studies. Interview Protocol: In brief, the interview protocol is divided into four parts: (1) Company history (product, activities, clusters, and LDC activity) Depending on the company, the methodology may vary, but much of this information was obtained in advance from web sites and various other sources; (2) Coping with inefficiencies This section seeks strategic input does the company have a template that is generally adaptable for use in addressing inefficiency questions; (3) Operational issues in specific supply chain clusters/LDCs In this section we focus on individual cases and how the company addressed hard (e.g., construction, electricity, connectivity costs) and soft infrastructure challenges (e.g., local specialized business services, standards and certifying institutions, R&D), and factor conditions (e.g., labor, capital, and land). We also ask about the incentive and competition framework in these examples (taxes, labor market, and services) and the companys assessment of the growth potential in that particular LDC or LDC cluster; (4) Quality and availability of institutions that regulate business and deliver policy incentives This series of questions focused on the effectiveness of local institutions to foster innovation, promote exports, develop skills, the effectiveness of public private partnerships, and the contribution of public institutions to company success compared to similar efforts in other countries.

Appendix: Interview Protocol and Case Study Outline

I. Company History Product, Activities in LDCS/cluster, etc. 1. Rationale for the selection of the company as much background information as possible obtained from the internet, secondary sources, company brochures, etc. Summary of its operations, e.g., markets it serves; number of countries where the company has presence; global market share; and shares in European, American, and Asian markets. a. How long has the company operated in these LDCs? How many different suppliers does it interact with? What percentage of the companys input come from the suppliers in these LDCs? b. What is the nature of companys involvement in the LDC? What does it operate or trade? Explain the precise supply chain of its activities. Is it only a wholesaler that buys from a number of suppliers in the LDC? Or is it involved in some of the operations on the ground? How would you best describe the primary mode of integration of the LDCs in the companys global supply chain? c. Producer of goods or services? d. Provider of trade support or other specialized business services? e. Distributor of consumer or capital goods, with or without transformation? (e.g., supermarket chains, chemical pharmaceutical office products, apparel, etc.) f. Importers, distinguishing between retailers and manufacturers g. The share of imported vs. domestic sources for inputs 2. Analysis/rationale for companys selection of particular least developed countries Cluster/Country-specific issues (encourage the respondent to give plenty of examples, of picking one country over other; one product category over other, etc.): a. What role did countrys location play in the companys selection of the LDC? What kind of role did geography and proximity to major markets play in your choice of LDC, if any? b. Are there any historic ties, political or economic, that facilitated the companys choice of the LDC? c. Are there social and political negative externalities such as ethnic conflict, war, corruption, etc., in the LDCs considered for business? If yes, has this affected companys selection of the LDCs?

d. Have the natural or human resources in the LDC played a role in its partnership with the company? e. Has the economic policy environment (tariff and trade barriers, tax, exchange rate, and capital market laws) played a role? 3. Geographical Clusters a. Is the company operating within one or more of the seven small or distant market geographical clusters? b. If yes, how is the supply-chain organized in the cluster(s)? c. What is the level of reliability in the supply chain(s), and its impact on operations and product quality? d. What are the main sources of costs and supply chain risks in these clusters? e. Are there efficient economic zones and clusters that help the buyers overcome some coordination failures within these markets? II. Coping with Inefficiencies: 4. Answer in general and where they exist describe differences between clusters/LDCs): a. Does the company have a specific strategy to cope with the inefficiencies in the supply-chains in the LDCs that it operates? How does this fit into the overall global supply-chain strategy of the company? b. What are the risk-management strategies regarding the reliability of local partners? c. What is the bottom line for the selection of local partners? What are the indispensable requirements for these selections? d. How does the company view the professionalism of the local partners? e. What is the strategy in terms of mobilizing the government to help overcome bottlenecks, re: local public goods? f. What is the strategy re: alliance with other global buyers/producers to help overcome local government/market failures? III. Operational Issues in Each Case Study Cluster/LDC Affecting Factory Floor Productivity 5. Services and Costs: Business enabling environment, logistics, infrastructure and labor, with respect to particular geographical cluster(s): a. What are the attractive/unattractive aspects of the value-chain-process for particular

LDCs in question? b. How do they affect your production/buying operations in the specified LDCs? c. Have you developed any solutions to overcome the problems, if any, and how? d. How do the following affect the business environment in developing local partners capacities? i. hard infrastructure - infrastructure (costs of constructing or renting factory shells, water, sewage, etc.) - utility costs (costs of electricity, telephone, internet) - land and air connectivity (availability, costs, conditions) ii. soft infrastructure - availability of specialized business services (designing, packaging, finishing, accessories, etc.) - product standards and usefulness of local certifying institutions (labor, product, environmental standards) - production and dissemination technology - sophistication of financial instruments to facilitate trade transactions - supplier productivity - trade logistics for imports - use of production technology (describe difference of technology used in their operations in developed and developing countries) iii. factor conditions - labor (excess workers, labor trainability; describe, if any, specific training schemes/institutions developed by the company) - capital (capital repatriation laws, etc.) - land (title acquisition, conveyance costs, etc.) 6. Incentive and competition framework: a. policies/laws related to exchange rates (capital repatriation, taxes, and tariff/non-tariff barriers);

b. policies and laws related to factor markets and product markets (labor skills); c. policies/laws on related industries and the supply chain (infrastructure and backbone services) 7. Given your assessment of the factors above, what is the growth potential for the suppliers in these LDCs? (Give specific examples): IV. Quality and Availability of Institutions that Regulate Business and Deliver Policy Incentives 8. Do the institutions below exist and function effectively? Do they foster or impair innovation? Specifically: a. Institutions that deliver inter-firm coordination b. Institutions that trigger innovation and R&D c. Institutions for export/investment promotion d. Institutions for standards/certification e. Institutions for legal/administrative reform f. Public-private partnerships that facilitate competitiveness g. Institutions/networks for skills development 9. Did the company collaborate with the government to create new public-privatepartnership? If yes, describe the process, e.g., what are the mechanisms in place for funding, operational modalities, and checks and balances? Comment on the relevance of the services of such an institution for the productivity of the factory floors and supply chains. Will the institution be finally fully handed over to government or the private sector? 10. If the institution in question already existed, rate the usefulness of its service for the company. Offer suggestions of the country in question from its experience from elsewhere in the world.

About the Authors

Ronald E. Berenbeim is senior fellow at The Conference Board and director of The Conference Board-World Bank project on Trade Competitiveness and Integration of Poor Countries in Global Supply Chains: a Perspective of Global Suppliers and Producers, and authored the Hindustan Unilever case study. An authority on business ethics and corporate governance issues, Berenbeim has written 50 studies for The Conference Board. His 2000 report, Company Programs for Resisting Corrupt Practices: A Global Study, was funded in part by a research grant from the John D. and Catherine T. MacArthur Foundation. In 2001-2003 he served as project director for a World Bank study of private sector anti-corruption practices in East Asia, and co-authored, with JeanFranois Arvis, Fighting Corruption in East Asia - Solutions from the Private Sector (The World Bank, 2003) which has been translated into Mandarin (2004) and Vietnamese (2005). In 2011 he was recognized by Trust Across America as one of 100 thought leaders in responsible business practice. In 2010 he received a Fulbright grant to teach Business Ethics at the University of Cergy-Pontoise, Cergy, France. He is a graduate of Cornell University, Balliol College at Oxford (Keasbey Scholarship) and Harvard Law School. Berenbeim is currently an Adjunct Professor at the Stern School of Business, New York University, where he teaches Markets, Ethics and Law. Mallika Shakya is a postdoctoral fellow at the Department of International Development, University of Oxford. She developed and worked on the export competitiveness initiative of The World Bank from 2006-2009. Her geographic assignments have included southern and western Africa as well as southern and eastern Asia in the areas of state-business relations, international trade and competitiveness, and industrial clusters and competitiveness. Her writings have been published in various academic journals as well as practitioners platforms. Shakya has a doctorate degree from the London School of Economics (LSE). About the Case Study Authors Edgar Blanco (CPGco; TEAM) is a research director at the MIT Center for Transportation & Logistics and is the executive director of the MIT SCALE network in Latin America. His current research focus is the design of environmentally efficient supply chains. He also leads research initiatives on supply chain innovations in emerging markets, disruptive mobile technologies in value chains, and optimization of humanitarian operations. Blanco has more than thirteen years of experience in designing and improving logistics and supply chain systems, including the application of operations research techniques, statistical methods, GIS technologies, and software solutions to deliver significant savings in business operations. Prior to joining MIT, he led the inventory optimization practice at Retek (now Oracle Retail). He received his Ph.D. from the School of Industrial and Systems Engineering at the Georgia Institute of Technology. His educational background includes a B.S. and

M.S. in industrial engineering from Universidad de los Andes (Bogot, Colombia) and an M.S. in operations research from the Georgia Institute of Technology. Ken Cottrill (CPGco; TEAM) is principal of Supply Chain Briefings, an independent consulting firm that provides communications services to the supply chain industry. He also serves as global communications consultant at the MIT Center for Transportation & Logistics (MIT CTL). Prior to his current role as a communications consultant, Cottrill was director of communications at MIT CTL. From 2005-2009 he was editor of Supply Chain Strategy, a monthly publication founded jointly by Harvard Business School Publishing and MIT CTL. He served as special projects and logistics editor at Commonwealth Business Media. He has edited many publications in the supply chain field, and written for national newspapers and business magazines in the United States and Europe. Cottrill was a researcher on TV documentaries produced for the BBC and PBS. He co-founded Lateral Marketing Ltd, a marketing communications agency based in London, UK. As a supply chain practitioner, Cottrill was a container planner for Orient Overseas Container Line and a deck officer in the British Merchant Navy. He is a graduate of Plymouth University, UK. Paul Linthorst (Cocoa processing company) is an independent management consultant in operations management and logistics. For the last ten years he has worked independently in the United States, Europe, and Africa. Prior to 2002, Linthorst was a management consultant with PricewaterhouseCoopers and its predecessor, Coopers & Lybrand, for 26 years in its offices in the United States, Japan, Korea, and the Netherlands. He had management responsibility for four start-up companies, including one electronics plant (Mexico), two management consulting companies (Korea and Netherlands), and one outsourcing services company (Japan). He also managed a consulting company in Japan and several consulting practice units in the United States, including lean manufacturing and distribution in the New York region. Clients included many multinationals in energy, electronics, pharmaceuticals, and finance, and non-profit organizations including the World Bank and Columbia University. Board memberships included Samil Coopers & Lybrand Consulting in Korea, Chuo Coopers & Lybrand Consulting in Japan, Alpha Outsourcing in Japan and FATE USA in the United States. Linthorst received an MS from Delft University of Technology in applied physics and an MBA in operations management from Columbia University Business School in New York. He is a member of APICS, ASQ, and AME.

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