Effects of Power Resources on Producer Marketing Behaviour

An Institutional Perspective on the Cocoa Market in Sierra Leone


Master's Thesis, 2012

101 Pages, Grade: 1.0


Excerpt

Table of Contents

ACKNOWLEDGEMENTS

ABSTRACT

LIST OF FIGURES

LIST OF TABLES

LIST OF GRAPHS

1 INTRODUCTION
1.1 Background on Sierra Leone economy
1.2 Cocoa marketing in brief
1.3 Problem statement
1.4 Research question and objectives
1.5 Thesis overview

2 THEORIES AND CONCEPTS
2.1 New Institutional Economics and Institutional arrangements
2.1.1 Transaction cost economics
2.1.2 Factors influencing governance forms in nature-related sectors
2.2 Marketing behaviour in practice
2.3 Power Resources
2.4 Concluding remarks

3 METHODOLOGY
3.1 Conceptual framework
3.1.1 Value chain framework
3.1.2 Power Resources framework
3.2 Selection of study area
3.3 Methods
3.3.1 Focus Group Discussions
3.3.2 Questionnaire

4 COCOA VALUE CHAIN ANALYSIS
4.1 History of the cocoa market
4.2 Importance of cocoa at household level
4.3 Key activities
4.4 KEY STAKEHOLDER

5 POWER RESOURCES ANALYSIS
5.1 Descriptive results
5.2 Transaction costs
5.3 Risks
5.4 Exit possibilities
5.5 Sanction power
5.6 Credibility
5.7 Concluding remarks and discussion

6 CONCLUSIONS
6.1 Summary
6.2 Critical reflection
6.2.1 Theories
6.2.2 Empirical methods
6.3 Outlook
6.3.1 Recommendations
6.3.2 Further research

7 BIBLIOGRAPHY

8 ANNEXE

9 Acknowledgements

Acknowledgement

I would like to express my gratitude to all those who gave me the possibility to complete this Master thesis. I would like to thank the Welthungerhilfe for giving me the opportunity for a memorable experience and to conduct the necessary research work under their guidance. Especially, I would like to give thanks to Franz Moestl, Joachim Ballweg and Emmanuel Yankson for their support without which my research activities would not have been such a great success. Many thanks also to Michael Sallu and the rest of the Welthungerhilfe staff.

I am deeply grateful to my supervisor Prof. Konrad Hagedorn who has accompanied me through the planning and writing process of the thesis. Furthermore, I express my thankfulness towards my Co-Promoter Prof. Johann Kirsten for introducing me to the New Institutional Economics school of thought and for his critical eye on agriculture development in Sub-Saharan Africa.

My special thanks go to Christian Schleyer for all his help, support, interest and valuable hints and without whom I would have got lost on the way to completing my Master thesis.

I am deeply indebted to my friends and especially my family in Germany and Sierra for inspiring and encouraging me to follow my dreams!

Furthermore, the thesis would not have been possible without the participation and openness of the farmers in Sierra Leone. Thank you.

Last, but by no means least, I thank Sebastian Deckert for his support, encouragement and for giving me the strength throughout.

Margitta Minah

Berlin, August 2012

Abstract

About two-thirds of the Sierra Leonean population depends on agricultural activities for their livelihood. Agriculture in Sierra Leone is diverse but the highest potential for increasing rural income is attached to cocoa production. Cocoa producers in the Eastern region have an option to sell their cocoa to cooperatives, companies, petty traders, resident and Lebanese buyers. Producer marketing decision is key to breaking a vicious circle of low quality, prices and incentives that hinder overall development in the sector and poverty alleviation. The purpose of this study was therefore to better understand marketing behaviour of cocoa producers in Sierra Leone with the help of New Institutional Economics. In this study, the concept of Power Resources was employed and complemented by a Value Chain Analysis to study factors which influence cocoa marketing decisions. Both qualitative and quantitative research methods were applied. First, qualitative research activities included 20 Focus Group Discussions with farmers in selected communities in the Eastern province. The research team then returned to respective communities to conduct questionnaires with 100 farmers. Considering the twelve Power Resources investigated in greater detail showed that those related to transaction costs, risks, exit possibilities, sanction power and credibility affect marketing decisions the most. The results revealed that farmers are encouraged to sell to cooperatives because of relatively lower transaction costs, risks and credible commitments. It was further found that farmers are discouraged to sell to petty traders and Lebanese buyers amongst others because of the lack of market information, the fear of being cheated and high price risks. Farmers were further found to face comparably high exit costs in transactions with cooperatives, companies and Lebanese buyers because of strong dependency and parallel business relations as well as unavailability of alternative market outlets. Furthermore, it was discovered that farmers are poorly endowed in sanction power and therefore prefer to sell to resident buyers who could be sued to the traditional chiefs in case of transaction problems. Overall, the principal conclusion was that Power Resource endowments in the Sierra Leone cocoa market encourage producers to sell to cooperatives while discouraging farmers to sell to petty traders and Lebanese buyers. Power Resource endowments have a neutral effect on marketing behaviour towards companies and resident buyers. These findings are promising for further development in the sector as particularly cooperatives promote quality production, transparent prices and ultimately higher incomes for cocoa farmers.

List of Figures

Figure 1 : Map of Sierra Leone

Figure 2: Overview key stakeholders in cocoa market

Figure 3: Overview research process

List of Tables

Table 1: General characteristics for the Eastern Province

Table 2: Comparison international and Sierra Leonean cocoa quality

Table 3: Example of how an institutional environment affects transaction costs in Sub- Saharan Africa

Table 4: Overview cocoa value chain Sierra Leone

Table 5: Power Resources and proxies to study farmers’ marketing behaviour

Table 6: Overview case selection per chiefdom

Table 7: Focus Group Discussion activities in detail

Table 8: Marketed cocoa during 2009 season

Table 9: Effects of Power Resources on marketing behaviour

List of Graphs

Graph 1: Contribution to Agricultural GDP by activity in 2010

Graph 2: Example of asymmetries in Power Resource endowments

Graph 3: Total number of transactions by market outlet during 2011 season

Graph 4: Sources of information

Graph 5: Relative frequency of inspection by market outlet

Graph 6: Relative time to agree on price by market outlet

Graph 7: Cheating behaviour on scale by market outlet

Graph 8: Ranking of services according to their importance

Graph 9: Most important services provided by market outlet

Graph 10: Additional business relations by market outlet

Graph 11: Incidence of transaction problems by market outlet

Graph 12: Level of trust by market outlet

1 Introduction

My personal drive to engage in this research activity was cultivated by the deep interest to learn more about rural development in Sierra Leone. Being raised in Germany and having gathered experiences across the African continent, the thesis under the MSc Program in Rural Development (IMRD) provided the ideal starting point to learn more about my father’s home country. The wish to collaborate with a development partner led to the engagement in the first EU- then GIZ- funded project “Support to Cash Crop Production in Sierra Leone - Cocoa and Coffee” which is being implemented by Welthungerhilfe, formally known as German Agro Action. Working with such a renowned organization allowed me to learn from a great pool of experience in value chain and rural development on the one hand and facilitated research activities on the other.

After having learned that in the past, farmers were at the mercy of traders with the common practice to exchange one bag of cocoa against one bag of rice with the price for cocoa far above the one for rice, I was determined to delve deeper into this topic. The Welthungerhilfe project objective is ‘to improve income and wellbeing of farm families through improved production and marketing of cocoa and coffee in Kenema, Kailahun and Kono districts’. With the personal motivation to contribute to this objective, I was able to integrate my interest in the study of New Institutional Economics while focusing on the most important actors in the cocoa value chain: the farmers.

1.1 Background on Sierra Leone economy

The Republic of Sierra Leone is ranked amongst the poorest in the world. Years of armed civil war and mismanagement of natural resources have translated into a weak economy that today classifies Sierra Leone as a Least Developed Country (UN DESA 2011). The country’s economic pitfall is said to have started during the 1970s and worsened during the civil war in the 1990s. The main reasons that contributed to a declining economy can be found in poor governance, substantial state interventions, favouring of the non-poor, contradicting policies and high agricultural taxing (NEPAD & FAO 2005).

Today, Sierra Leone’s fragile economic status is also explained by one of the weakest Human Development Indices (HDI) in the world (0.336) which is only about half of the world’s average HDI (0.682) and far below the average in Sub Saharan Africa (0.463). As a result, Sierra Leone is currently ranked on the HDI-Index list 180th out of the 187 United Nations member countries (UNDP 2011). With such a low HDI it is also not surprising that the status of health and education as well as the living standards are rather poor. The latest Integrated Household Survey in 2004 has found more than 70% of the population living below the poverty line and 26% living in extreme poverty. Above that, the poverty assessment showed that nationwide most households considered themselves as poor with an exception of only 1.2% who considered themselves as non­poor (Statistics Sierra Leone 2007).

Looking more closely, one can however notice differences in poverty levels across the country. Generally speaking, poverty is more severe in rural households with 79% of the rural population living below the poverty line compared to 47% in urban areas. Although a more recent poverty assessment under the second Poverty Reduction Strategy Paper in 2007 has recorded a substantial fall of people living below the poverty line to 60%, Sierra Leone is still far from achieving its first UN Millennium Development Goal which sets out to reduce the population living on 1 US$ a day to 40% until the year 2015 (Government of Sierra Leone 2012).

Against that background, the responsibility of the agricultural sector moves into the centre of attention. Engaging about two-thirds of the population, farming activities are still the main income source for the population and main contributor to GDP and state revenue. According to the Ministry of Agriculture, Forestry and Food Security the agricultural sector accounted for about 61% of the provisional GDP in 2010 and was followed by the service sector’s contribution of about 34% while the industrial sector took the balance (MAFFS 2011).

Contribution to Agricultural GDP

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Graph 1: Contribution to Agricultural GDP by activity in 2010

Source: MAFFS 2011

A close-up on the agricultural sector itself shows that although agricultural activities are diverse in Sierra Leone, crop production is the strongest contributor to the agricultural GDP with 77% which is then followed by the fisheries, forestry and livestock sectors (MAFFS 2011).

To sum up, agricultural development in Sierra Leone is of great importance and was made top priority under the country’s Poverty Reduction Strategy Paper. Moreover, through participation and implementation of the Comprehensive African Agriculture Development Programme, the government of Sierra Leone has made strong commitments “to make agriculture the engine for socio-economic growth and development through commercialization and the promotion of the private sector, including farmers and farmer-based organizations” (GOVERNMENT OF SIERRA LEONE 2009b).

1.2 Cocoa marketing in brief

The Comprehensive African Agriculture Development Programme assessment has found Sierra Leone to feature several comparative advantages within the agricultural sector amongst which cocoa production was particularly mentioned (GOVERNMENT OF Sierra Leone 2009b). In addition, a World Bank Study of the Sierra Leonean economy concluded that agricultural exports offer the highest potential for increasing rural incomes. More explicitly, the study highlights the promising role of cocoa production in kick-starting broad economic growth (WORLD BANK 2006).

Although output rates in agriculture have risen substantially since the end of war in 2002, production levels and export earnings from cocoa are still considerably low. Cocoa is nevertheless a very important cash crop for Sierra Leone contributing to about
50% of cash incomes for many farm households as other income sources are absent (Welthungerhilfe 2008b).

With a total population of roughly 5.5 Mio, Sierra Leone is considered a low populated country. Roughly one-fourth of the population lives in the Eastern Region which is considered the main cocoa producing area and constitutes the study area for the research at hand.

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Figure 1: Map of Sierra Leone

Source: Ezilon Maps

As depicted in Figure 1, the Eastern Region is one of Sierra Leone’s four provinces and made up of three districts, namely Kono, Kenema and Kailahun. In total, these three districts account for about 80% of the total cocoa production in Sierra Leone (Lahai et al. 2006), but show differences in regard to importance and quantities produced. Kenema is considered the cocoa trading and administrative centre for the Eastern region, while Kailahun is regarded as the main cocoa producing area. In Kono district,
cocoa production is highly competitive with mining activities in regard to labour, natural resources and capital.

Table 1: General characteristics for the Eastern Province

illustration not visible in this excerpt

Source: Thomas et al. 2006; Dupigny et al. 2006; World Bank 201; UN Statistics division 2011;*Males per 100 females

The climate in the Eastern region is characterized by high levels of annual rainfall and temperature that provides favourable conditions for coffee, cocoa and oil palm production while large inland swamps allow for rice cultivation. Amongst cassava and vegetables, rice is considered the main staple crop. Due to its climatic situation, agro forest systems can been found in the Eastern region to promote biodiversity where cocoa and coffee grows amongst other food crops like oil palms, avocados, bananas and other fruits, guaranteeing both food supplies and cash income (Balmed GmbH).

The Government of Sierra Leone (2009a) describes the cocoa sector as a viscous circle of low quality, low prices, little incentives to improve and adherence to quality standards. According to the World Bank (2007), the reasons for that can be found in a disruption of market signals and weak enforcement of quality standards right with the producer (See Table 2). Furthermore, the study highlights that little effort has been done to create strong relationships between farmers and buyers that would reduce transaction costs and rent-seeking behaviour respectively.

Table 2: Comparison international and Sierra Leonean cocoa quality

illustration not visible in this excerpt

Source: Government of Sierra Leone 2009a

Developing the cocoa sector therefore does not only depend on production levels but also on prices being paid. Low cocoa prices for producers are standard in Sierra Leone and result in low motivation to invest in quality. This can be traced back to various reasons but are mainly due to the lack of price differentiation by quality which is constantly mixed by farmers and traders. Due to that, Sierra Leonean cocoa receives a discount of about 200 US$/ton on the world market price which moves between 2200 and 3500 US$/ton, depending on the time of the year. Heavy discounts are automatically applied and prices may drop even further due to bad quality and high risk perception (Welthungerhilfe 2008b). Especially the practice of some exporters to sell in large volumes and quantities at low prices with disregard to the produce quality translates into discouraging incentives to farmers to improve cocoa bean quality and ultimately fails to increase farm incomes.

International organizations as well as private and public actors have realized the potential of cocoa and have made strong commitments to develop the sector. The emergence of new market actors like cooperatives and alternative companies in the form of marketing associations have contributed to a heterogeneous set of cocoa buyers that either promote or challenge overall development in the sector (World Bank 2007). Although the number and role of players in the value chain changed systematically in the past years, the chiefdom and village actors remain the same. For the purpose of the study, five possible market outlets for farmers were identified: cooperatives, companies, petty traders, resident and Lebanese buyers.

illustration not visible in this excerpt

Figure 2: Overview key stakeholders in cocoa market

Source: Own illustration

Looking closely, buyers differ in their function, characteristic, prices and services provided to farmers and thus affect the incentive system and marketing decisions considerably. For example, a major constraint for public and private organizations is access to capital to pre-finance their purchase, like for farmer cooperatives that compete with powerful private Lebanese traders. 'Food for loan' or microcredit schemes are approaches practiced by traders though very limited by most producer organizations (Welthungerhilfe 2008b).

Knowing that, one can raise the question of how a better understanding of the farmer’s marketing behaviour contributes to getting the cocoa market working again. The answer to this question simply lies in the fact that stakeholders active in the cocoa market including nongovernmental organizations like the Welthungerhilfe find it difficult to anticipate farmers’ behaviour when designing strategies to support their marketing activities and suitable incentive systems to enhance development in the sector. Although all participants contribute in one or the other way towards development in the sector, farmers play the leading part as they are the ones determining the quality of produce. In the end, improved quality production which translates into increased prices for cocoa in Sierra Leone can only be achieved through better harvesting, drying and fermentation techniques at farm level (Welthungerhilfe 2008b).

1.3 Problem statement

“Get the cocoa sector working again!” was the quintessence from a Diagnostic Trade Study of the Sierra Leonean economy in 2006 (World Bank 2006) after the Comprehensive African Agriculture Development Programme assessment had highlighted the potential of cocoa production to raise rural incomes (GOVERNMENT OF Sierra Leone 2009b). Many international organizations, private and public sectors have ever since dedicated their work towards that target in order to kick-start broad economic growth.

A Value Chain Analysis under the World Bank Project in Sierra Leone has described the cocoa value chain as complex and equally dysfunctional which constitutes the starting point for the thesis at hand (World Bank 2007). Although the disrupted cocoa market structure affects all key stakeholders, it particularly translates into lower prices and incomes for cocoa growers not the least because it creates a poor reputation and prices paid on world markets. The aftermaths of the decade long civil war have heavily affected the disruption of market signals and price incentives which now result in a vicious circle of low quality, low prices and little incentives to enforce quality standards (Government of Sierra Leone 2009a).

The current cocoa market structure becomes in particular a problem when farmers are encouraged to sell poor quality cocoa. With the intention to get the sector working again as compared to pre-war levels, organizations like the Welthungerhilfe are in the place to support farmers’ marketing decision and therefore need to raise the question of how decision-making actually takes place. The answer to that question punctuates the relevance and significant contribution of the thesis at hand and to poverty reduction and sustainable economic development in Sierra Leone as a whole.

1.4 Research question and objectives

Against the problem of a dysfunctional cocoa market in Sierra Leone, this thesis sets out to answer the following question:

How do Power Resources affect marketing decisions of cocoa farmers in Sierra Leone?

The answer to the research question will shed light on the most relevant determinants of marketing behaviour within a ‘dysfunctional’ market structure and complex incentive system as it was described earlier. From that, it will be possible to identify the critical leverage points for change and where to focus in order to get the cocoa market working again.

To contribute to the research question, the following sub-questions will be addressed:

a. How can New Institutional Economics contribute to a better understanding of decision making and contracts in the cocoa market in Sierra Leone?
b. What are Power Resources and how can they affect marketing decisions?
c. What are the most relevant Power Resources in the cocoa market?
d. How do farmers perceive the effect of Power Resources on their marketing decision to choose trader A over trader B?
e. What is the individual effect of the most relevant Power Resources on the individual channel choice decision?

By answering these questions, the thesis at hand hopes to serve the following general and specific objective:

The overall objective is to better understand cocoa producer marketing behavior in Sierra Leone. In particular, the objective is to provide an overview of the effects of Power Resources on marketing decisions.

The theory of New Institutional Economics will be applied to serve these objectives. In New Institutional Economics, researchers are however confronted with the fact that theory is exceeding empirical research because the challenge lies in the complexity of economic institutions, theoretical modelling and above that empirical work appears to be more difficult than in other fields (Matthews 1986, as cited in Hubbard 1997).

According to MÉNARD (2001), analysis in New Institutional Economics is confronted with two major constraints which include the lack of refined concepts that facilitates the collection of data and the necessity to collect data on different levels. The first constraint can be tackled by employing a rather new concept of Power Resources to the analysis of producer marketing behaviour. The review of previous works on marketing behaviour will show that concepts were mainly aligned to Transaction Cost Economics which is considered too limited for the paper at hand (See Chapter 2.2). The concept of Power Resources allows for more room to study factors which go beyond the ones considered in previous works in order to better understand the relationships between farmers and their buyers, including formal and informal institutions. The second problem put forward by Ménard (2001) will be addressed by the choice of methods to collect relevant data. Focus Group Discussions have been conducted to allow for comprehensive qualitative data while a questionnaire was used for the collection of quantitative data.

Finally, it is thought that the choice over the conceptual framework and data collection instruments will serve to analyze the most relevant factors in explaining producer marketing behaviour in Sierra Leone in order to draw a clear picture of the status quo and development process in the cocoa sector. Furthermore, results are expected to contribute to overall research in the country.

1.5 Thesis overview

The thesis is organized into six main chapters. The first chapter provides a brief introduction to Sierra Leone and the cocoa sector in particular. Furthermore, it gives an outline of the problem, corresponding research questions and objectives to guide analysis. The second chapter is dedicated to theories and concepts to provide a common understanding of underlying issues in New Institutional Economics, previous approaches in studying marketing behaviour in African agricultural markets and finally introduce the reader to the theory of Power Resources. Following that, chapter three explains the fundamental methodology for this thesis, including the conceptual frameworks of value chain analysis and Power Resources. Furthermore, the chapter describes research activities more in detail, its instruments and methods. Results of the value chain analysis and Power Resources will be explained in chapter four and five respectively. A brief discussion of what the analysis revealed in regard to Power Resources is attached to chapter five. Chapter six gives a summary of the results and answers to the research question that was put forward in the introduction. Doing so, a set of 11 theses are formulated and unpacked into a format that allows the capture of individual effects of Power Resources on respective market outlets. The thesis ends with a critical reflection of the theories and methodology chosen for which is then complemented by a brief outlook, that formulates recommendations and starting points for future research.

2 Theories and concepts

The current study sets out to draw a holistic picture of the cocoa market and how Power Resources affect producer marketing decisions. The following will therefore outline the framework on which analysis is based. Firstly, a brief explanation of the theory of New Institutional Economics provides a common understanding of underlying issues. Following that, the chapter will focus on how institutional arrangements emerge to explore theoretical understanding of how contracts and thus marketing decisions are made. Further, previous studies concerned with marketing behaviour from an institutional point of view are presented. Finally, Power Resources are explained, what they are and how they can influence contractual arrangements before explaining the five most relevant Power Resources in detail.

2.1 New Institutional Economics and Institutional arrangements

Literature around New Institutional Economics is vast and has even found its way into international nonfiction bestseller lists explaining reasons behind state and market failure as well as economic development to a broad audience (Acemoglu & Robinson 2012).

The academic literature of New Institutional Economics, however found its momentum in the mid 20th century and put the making, monitoring and enforcing of contracts at the heart of analysis. Transaction costs with underlying information asymmetries are thought to determine the complexity of contracting and thus the type of contracts made (Williamson 1996). From a broader view, formal and informal institutions such as legal environments and the conventions of a society are put in place to reduce transactions costs or fail to do so (HUBBARD 1997). With this understanding and anticipation of the real world complexity, the following definition of institutions will be adopted:

“Institutions were defined as formal or informal rules that govern people’s behaviour by providing a framework of incentives that shape economic, political, and social organization. ” (Dorward & Omamo 2009)

Attached to this definition, the purpose of institutions is to reduce uncertainty in human exchange while improving individuals’ welfare (NORTH 1992). Comparing developing to developed societies, it is impossible to neglect the impact of different types of institutions and more specifically, dysfunctional institutions which often persist over time and benefit some individuals more than others (NORTH 1992).

This thought might explain how the lack of pro-poor policies can result in excluding weak market actors like small scale farmers from existing markets, thus locking a society into a ‘low level equilibrium trap’. From this point of view, economic development is tightly linked to the question of whether a country’s institutions support broad-based economic growth (Dorward et al. 2005). Looking at poverty rates, one could assume that institutions in Sierra Leone have not been pro-poor and today result in poor governance and capacity, poor delivery of public services as well as poor provision of infrastructure (Government of Sierra Leone 2012).

Institutions and their impacts receive little or no attention in neoclassical theory where models are applied under a limited set of assumptions, assuming frictionless exchange, perfect and costless property rights and information (Wouter Ebben & Albert de Vaal 2009). But markets are not perfect! Human social and economic interaction is strongly limited by incomplete information and a limited capacity to process available information. This leads to the need for human beings to structure interactions through conventions, ideologies and contracts. Starting from the Coase Theorem (1960) which postulates that in a world without transaction costs institutions will be unimportant, it is clear that in a world with transaction costs, formal and informal institutions and thus bargaining power will become key to reach economic advancements (NORTH 1992). When transaction costs are absent property rights do not matter in terms of efficiency as right can be voluntarily adjusted and exchanged. However, if transaction costs are quite substantial as they usually are, then the allocation of property rights becomes of utmost importance.

Furubotn (1994) highlights the fact that other than neoclassical economics, New Institutional Economics puts the individual decision maker at the centre of analysis, given the fact that individuals follow diverse objectives and behave in opportunistic ways to reach those objectives. Therefore, New Institutional Economics can be applied to study social and economic human behaviour.

Institutions are made up of institutional environments and institutional arrangements (Davis & NORTH 1971). More explicitly, institutional arrangements are embedded within the institutional environment that entails “general property rights, enforcement mechanisms and costs, expected human behaviours, power relations, communications infrastructure and information flows” (Dorward et al. 2005). The institutional environment thus includes all formal and informal institutions and can be assigned to the following three levels (Dorward & Omamo 2009):

1. Formal economic institutions and rules
2. Culture, values and conventions
3. Social networks

Institutional arrangements are concerned with actors structuring contracts to reduce transaction risks and costs (Dorward 2001). Through institutional arrangements, actors agree to a set of rules which govern their activities and which optimally lead to coordinated transactions. It is said that coming to such arrangements includes the spending of resources, which are referred to as transaction costs (Eaton et al. 2008).

2.1.1 Transaction cost economics

The transaction cost school is based on the theory of imperfect information which implies that within most transactions, one party usually has information that the second party does not have and which is crucial in determining the value of transacted goods or services (Bardhan 1989). This obviously undesirable situation, in which a party can take advantage of the other party’s lack of information, has been associated with works by Akerlof, Stiglitz and others. The main assumption is, however, that imperfect information leads to risk and uncertainty in transactions which in turn increase respective transaction costs (Dorward & Omamo 2009).

Transaction costs can be divided into (1) Information costs which refer to activities such as screening attributes in goods and services, looking for a lower price or for potential trading partners; (2) Bargaining and negotiation costs include those cost that arise from reaching an agreement; (3) Monitoring costs appear when conditions that have been agreed upon are not met and consequences need to be enforced (VAKIS et al. 2003).

The transaction costs school gained popularity through COASE’s (1937) analysis on the nature of the firm in which he explains the effect of transaction costs on the size and becoming of firms. He also draws a line between different modes of coordination which Williamson (1994) later on describes as market, hierarchy and hybrid forms of governance that have neo-classical spot markets, vertical integration within a firm and bilateral contracts as respective modes of coordination. Those forms of governance structures evolve to minimize the risk of opportunistic behaviour which is caused by incomplete contracts and the cognitive capacity to process all information available. As a result, complex institutions emerge as complementary safeguards either formally or informally. Formal safeguards are specified in contracts and lay out guarantees for mutual investments amongst others. Informal safeguards are based on relation, social capital and reputation thus linking to the matter of trust to secure incomplete contracts (MÉNARD 2004).

According to Williamson (1991), the choice over the most suitable mode of governance is highly influenced by three factors, namely asset specificity, frequency of exchange and uncertainty that directly affect transaction costs and information asymmetries as decision-making factors. In other words, highly specific assets, frequent relationships, and uncertainty push firms to internalise some stages of the production process to decrease transaction costs.

It is a fact that contractual arrangements are costly and costs have to be borne if negotiating and writing the terms of the arrangements, monitoring performance of contracting parties and enforcing contracts is to be successful. Therefore, transaction costs impede economic and human exchange and hinder markets to agree on efficient equilibriums which New Institutional Economics considers the underlying reason for market failure (KIRSTEN et al. 2009). Rural areas in developing countries especially face exacerbated transaction costs and risks to access input, output and financial markets which results in thin markets, unprofitable opportunities for exchange or even market failures in the extreme form (Dorward et al. 2004a).

The root causes for exacerbated transaction costs and information asymmetries in developing countries are related to a set of generic problems (Dorward et al. 2009b):

- poor roads and telecommunications
- poor human health
- an underdeveloped monetary economy with narrow base
- thin markets resulting in poor access to agricultural inputs, outputs and finance
- poor information

Farmers in poor rural areas further face exacerbated transaction costs because of the nature of their agricultural product. Not only cocoa production but any other agricultural produce is strongly exposed to seasonality, production and price risks. Furthermore, small scale farming and subsistence productions are characterized by small transactions and small quantities of trade and thus are characterized by a relatively high number of transactions, subject to additional efforts to acquire information, conduct negotiations and to monitor and enforce property rights (Dorward et al. 2009b).

The work of Bijman et al. (2009) gives an overview of possible transaction costs in agricultural markets in Mozambique. The analysis further postulates that sectors can only be developed once institutional arrangements are aligned with their environment (See Table 3).

Table 3: Example of how an institutional environment affects transaction costs in Sub-Saharan Africa

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Source: Adopted from Bijman et al. (2009)

2.1.2 Factors influencing governance forms in nature-related sectors

To recall, Williamson (1991) lists asset specificity, frequency and uncertainty as main determinants for choosing the most efficient governance form. Although the importance of those factors shall not be disregarded, they are however limited by the characteristics of the good traded and cannot be applied to the agricultural sector without further reflection.

According to Ruth S. Meinzen-Dick (2009), factors affecting coordination institutions of natural resources and thus agriculture, can be roughly rationed into three categories related to (1) techno-physical characteristics of the resource; (2) socio-economic characteristics of resources users; (3) policy and governance factors[1].

Also, in his work on institutional analysis in nature-related sectors, HAGEDORN (2008) highlights the interdependence between the ‘biophysical’ and ‘social’ world that both affect institutions and choice over governance structures. Thus, to study transaction costs in agriculture, HAGEDORN (2008) argues that transactions need to consider additional elements that are unique to nature-related systems. Doing so, HAGEDORN et al. (2002) extend Williamson’s thoughts and identify nine features of transaction which might influence the adequate coordination mechanism for agricultural activities that might cause environmental problems. They additionally point out that problems often occur because of the character of property rights and the legal situation that occurs when property rights are transferred between actors.

Firstly, Hagedorn et al. (2002) name excludability as a factor for coordination in agriculture. Excludability from access to natural resources and environmental goods might result in free-riding if coordinated poorly and due to weak entitlements to make use of goods and resources. This is tightly linked to rivalry that refers to competition amongst actors and how benefits of a good are reduced when the number of users increases. The authors explain asset specificity as durable investments that are unique to a transaction and might result in problems like lock-in and hold-up situations if not properly managed. HAGEDORN et al. (2002) draw on S langen and Polman (2000) to further differentiate three cases of asset specificity in agriculture: (a) site specificity where a certain area is dedicated to a specific crop or species (b) capital specificity where sunk-cost investments were made into for example planting hedges (c) specific knowledge, collected by land users and inhabitants about their habitat and environment.

Furthermore, seperability affects the choice of arrangement and relates to the jointness of production of an environmental good or common good that requires coordination mechanisms to organize and regulate activities of a number of users. Frequency of transactions affects the frequency and complexity of decision making. High frequent transactions facilitate investment in specialized structures, the utilization of economies of scale and more efficient solutions through learning by doing.

Like Williamson (1998), Hagedorn et al. (2002) also include uncertainty into their list of factors. Uncertainty results in transaction costs as information has to be collected and transactions monitored. In agriculture, this effect is leveraged due to insecurities in supply and demand of goods and services and anticipation of problems as to when and where they will occur or who will be affected. Complexity of ecological systems and their products are another factor influencing the choice of adequate arrangements as insufficient knowledge about such systems leads to heavy simplifications. Heterogeneity and variability refers to the effect of weather or differences in other aspects such as vegetation periods or soil quality. Ultimately, the measure of legitimacy raises the question if transactions are in line with normative views of those affected by the activity.

2.2 Marketing behaviour in practice

Previous works have tried to explain the effect of and strategies used to reduce transaction costs and information asymmetries on producer marketing in sub-saharan Africa. Therefore, the following will briefly outline how far previous works have come in explaining producer marketing behaviour in developing countries. Doing so, it will not only focus on transaction risks and costs of producers but also on how different market outlets help to overcome such challenges.

Shiimi et al. (2012) have tested empirically which factors influence cattle farmers in their marketing decision. A two-decision-making framework was applied and results showed that transport problems, productivity, access to market information and access to information technology significantly influenced farmer decision to sell cattle through one channel option and not the other.

Vakis et al. (2003) modelled market choices of Peruvian potato farmers. Assuming the opportunity for farmers to sell their produce on alternative markets, empiric results reveal that distance to markets, good roads, market information, social relation with potential buyers and bargaining abilities are important factors for marketing choice.

Abebe Woldie (2010) used transaction costs economics to understand marketing decision of banana farmers in Ethiopia. He came to the conclusion that transaction costs determine marketing decision to the result that 80% of farmers channelled their produce at farm gate level through private traders against 20% of farmers selling to cooperatives. Abebe Woldie (2010) further uses a two-limit Tobit model to come to the conclusion

that when selling to private traders, relational contracts and trust become key factors. He also applies a sequential bilateral bargaining model to analyze the bargaining power of farmers from which he finds that farmers are characterized by a lower bargaining power than their traders. From that, he concludes that information, horizontal coordination of farmers and trust affect bargaining power. He puts forward that it is crucial for governments to strengthen the risk reducing role of cooperatives.

Also, Oladejo et al. (2011) in their study on marketing decision of maize producers in Nigeria conclude that transaction costs determine the maize supply in the area. The authors identify transport costs and information costs as main determinants and recommends farmers to participate in cooperatives.

By analyzing the impact of transaction costs on participation of smallholder farmers and intermediaries in the banana market in Central Africa, JAGWE (2011) recommends on base of his results that farmer groups need to be used as platforms to exchange market information especially in areas that are characterized by poor infrastructure and access to information. Also, he concludes that middlemen can reduce transaction and information problems as his results show that middlemen are strongly involved in marketing activities in rural areas. He attributes middle men the role of being a cost economizer.

Comparing different institutional arrangements, Patrick & Simmons (2004) have shown in their study on contract farming in Indonesia that the majority of farmers opt for a hybrid arrangement implying advanced payments and credits. By ‘tying’ their farmers to such agreements, buyers hope to increase commitments especially in markets with high demand and limited supply. The researcher put forward the importance of frequency in transactions to create trust and credibility for such commitments.

In their study on smallholder dairy in Eastern Africa, STAAL et al. (1996) support the assumption that the frequency affects producer marketing behaviour. They show how transaction costs increase with distance to markets because of transport costs but not least because of increased information costs, the difficulty in finding buyers over distance or the risk of produce spoilage. As a result, all farmers have said they would prefer to sell their produce to a lower price in exchange for a reliable outlet.

However, contracts are conducive to their environments like Eaton et al. (2008) show. In their study they found Tanzanian market participants to explicitly note that they did not rely on ‘personal and exclusive relationships’. Eaton et al. (2008) were puzzled by this result and related it to the fact that collectors avoid relationships to maintain information asymmetries. This however only works through a strong cooperation and coordination between traders on price agreements and information sharing as from whom to source their supply thus diminishing competition.

To sum up, the majority of research has explained producer marketing through the eyes of transaction costs. Although the strong effect of transaction costs should not be neglected, the necessity of revealing other determining factors is crucial to make marketing decisions explicable. The studies presented affirm that there is no blueprint to contract choice in developing countries and farmers are subject to factors that go beyond transaction costs, risk and institutional environments. These factors are related to incentives, market power and efficiency gains which in turn depend on underlying characteristics in the market like risk attitude, information asymmetry, moral hazard or adverse selection (Hobbs and Young 2001, as cited in Vavra 2009).

As Bachev (2010) argues, only those governing structures will proof efficient and will sustainably dominate in agriculture that are aligned with the “economic, institutional and natural environment and personal characteristics of agents”. Therefore, the fact that the theory of transaction costs is mainly limited to explaining the economic and partly personal characteristic of human beings, neglects the existence of further factors that might be equally important.

Moreover, transaction cost economics relates ex-ante costs to “costs in acquiring information and in taking protective measures against risks of loss in transactions" (Dorward 2001). However, because decision making is also affected by the process of anticipating the behaviour of the opponent, transaction cost fails to explain human behaviour in an economic transaction sufficiently. To overcome these shortcomings in transaction cost economics, the works of Schlüter (2007) and Theesfeld (2011) have studied transaction costs as only one amongst other factors that might influence human behaviour. The researchers applied the concept of Power Resources that examine in total 12 factors which affect human decision making and the outcome of a negotiation process. By understanding the outcome of a negotiation as interplay of Power Resource endowments between actors, Schlüter (2007) and Theesfeld (2011) take account of both, the determining factors and the anticipated reaction of the opponent negotiation party. As a result and to meet the expectations of this paper, the theory of Power Resources will contribute to the underlying concept of this study.

2.3 Power Resources

Having explained the difficulty of imposing previously used frameworks on the cocoa market study in Sierra Leone, the concept of Power Resource sets base for the conceptual framework of this paper.

It is said that market actors take decisions based on (1) anticipated economic consequences of contracts, (2) the ideology referring to the distribution of benefits amongst actors as well as the (3) the use of bargaining power for transacting parties (Kirsten et al. 2009). This is where the theory of Power Resources originates. One can assume that Power Resources which determine bargaining power are especially significant in markets where contracts and property rights depend on bargaining as coordination method (SCHLÜTER 2007). Assuming that actors can use their bargaining power to derive benefits from a transaction, prices paid are the result of power constellations and resources (Harriss-White 1997). For the thesis at hand, the marketing behaviour of farmers is considered as the result of Power Resource constellations between two bargaining parties. The theory of bargaining helps to understand institutional arrangements as a product of social and political bargaining over property rights that transacting parties can sue to derive benefits from resources (KORF 2003).

Many scholars have used game theories to better understand the negotiation process between actors. Keywords such as ‘prisoner dilemma’ or ‘Nash equilibrium’ are tightly related to game theory and describe situations in which players pursue negotiation strategies to cooperate or decide not to. Self-interest therefore results in opportunistic behaviour at the cost of other players. To put it blunt, game theory shows that a player can use his resource endowments to gain economic benefits. In game theory, power is understood as the capability to “affect someone’s freedom of act ion. The more powerful actors can change, distort and/or restrict the (perceived) choices available to the other actor (s)” (Di Gregorio et al. 2008). From that understanding, Di Gregorio et al. (2008) argue that Power Resources contribute to the ability to influence payoffs of other players.

The concept of Power Resources applied to game theory is explained by the outcome of the game as a function of relative distributions of Power Resources (Schlüter 2007). If individual A has a greater resource endowment and thus bargaining power than individual B, individual A will likely get a higher share of the benefits from the bargaining process (Knight 1992).

When taking marketing decisions, actors do not only need to consider their own Power Resources but also decisions of their trading partners. Knight (1992) names this ‘strategic interdependence’ and comes to the conclusion that to take rational decisions, actors do not only need to anticipate the actions of others but as well be aware about the effect their choice has on other actors’ choices. This contributes to the assumption that the weight of Power Resources is part of a process and only come into effect once actors engage into negotiation.

illustration not visible in this excerpt

Graph 2: Example of asymmetries in Power Resource endowments

Source: Own illustration

Graph 2 depicts that to gain a better understanding of contract and marketing choices, one would have to analyze resource endowments of all parties, the farmer and the trader and compare asymmetries in their endowments. For the paper at hand, Power Resources constellations and the weight of individual Power Resources are considered as a result of the negotiation process and preferences in producer marketing behaviour.

Furthermore, it is assumed that Power Resource endowments and strategic interdependence combined contribute to a farmer’s marketing decision. According to Morriss (1987, as cited in Dowding 2011), Power Resources cannot be observed and measured directly:

[...]


[1] In her argumentation on forms of coordination and governance, Ruth S. Meinzen-Dick (2009) refers to Rasmussen & Meinzen-Dick (1995) for an overview of factors that affect local organizations for natural resource management.

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Details

Title
Effects of Power Resources on Producer Marketing Behaviour
Subtitle
An Institutional Perspective on the Cocoa Market in Sierra Leone
College
Humboldt-University of Berlin  (Ressourcenökonomie)
Grade
1.0
Author
Year
2012
Pages
101
Catalog Number
V206219
ISBN (eBook)
9783656341260
ISBN (Book)
9783656341468
File size
1602 KB
Language
English
Tags
effects, power, resources, producer, marketing, behaviour, institutional, perspective, cocoa, market, sierra, leone
Quote paper
Margitta Minah (Author), 2012, Effects of Power Resources on Producer Marketing Behaviour , Munich, GRIN Verlag, https://www.grin.com/document/206219

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