Turning Farmers into Entrepreneurs

New, vertically integrated companies are
streamlining China's agricultural sector

Tina Helsell

China's agricultural sector was among the first to be reformed in the late 1970s, when small family-owned farms reemerged from the breakup of the PRC's agricultural commune system. Commercialization of the sector, however, has lagged behind commercialization in other sectors in China such as light industry, due primarily to rigid price controls on agricultural goods and staple foodstuffs. But in the last few years, the government has relaxed such controls, and carried out economic reforms that have fostered competition among industrial and commercial entities that formerly monopolized their respective sectors. As a result, China's agricultural production sector is quickly growing more market-oriented.

Further, the PRC government has come to recognize the importance of a more streamlined, integrated approach to production and sales of agricultural products in China. The Ministry of Agriculture (MOA) is encouraging, through tax incentives and direct funding, the development of commercial agribusiness entities that integrate the production and sales activities of farmers, processors, wholesalers, and retailers (see p.26). These efforts have resulted in the transformation of provincial- and municipal-level agricultural commissions and local State farm bureaus into equity holding companies for the State farms under their jurisdiction; a growing number of township-and-village enterprises (TVEs) and collectives devoted to agricultural activities; and the establishment of economic and technological development zones intended to promote integrated agribusiness firms. Rural cooperatives also have emerged throughout the country which, like collectives, pool resources among numerous small-scale farmers and ancillary service providers such as processors, packagers, and retailers. But, unlike collectives or holding companies, which often encompass a range of different agricultural products, cooperatives tend to focus on activities surrounding one commodity, such as cotton.

Altogether, roughly 3,000 agribusiness firms of various types have been established to date, primarily in China's more developed coastal areas. These firms, which aim to link farmers to agricultural wholesale and retail outlets, developed in response to bottlenecks created by China's traditionally cumbersome and regionally focused agricultural market system. The integrated organizations supply farmers with market demand information and other important feedback; provide enterprises that process raw materials and those that market the processed goods with sufficient, consistent, and more varied supplies; and enable both farmers and sales entities to share the risks and rewards of the entire process--from production to sales.

By entering into a contract to supply raw materials to an integrated agribusiness firm, farmers benefit from the firm's purchase of a guaranteed volume of raw material, greater economies of scale, access to lucrative export markets, and access to farming technology and training. In this way, these production structures integrate rural communities with both urban and export markets--and can boost sales margins, depending on the product. Though occasionally farmers are forced to lower their sales prices to an agribusiness firm, farmers selling high-quality hybrid crops such as long-grain white rice, or raw material foodstuffs that go into premium processed foods, tend to command satisfactory prices. To foreign suppliers of raw materials and other inputs, these integrated firms represent an increasingly sophisticated customer base. Foreign companies also now have opportunities to invest in China's agricultural production sector through these agribusiness enterprises.

 

Breaking down old barriers

These new agricultural production and distribution structures stand in stark contrast both to China's traditional agricultural market system, and to the production and distribution systems characteristic of central economic planning. China's traditional market system, which preceded (and largely survived) the Communist revolution in 1949, involved an interlocking, hierarchical network of markets in which cities formed the core. Farmers typically did not sell beyond their respective localities, hindering improvements in production and sales efficiency.

Under post-1949 central economic planning, each production and supply chain component of agricultural goods and staple foodstuffs was separate, with limited or no overlap among the operations of farmers, suppliers, and sales outlets. Centrally planned allocation directives determined all output and supply and tended to result in oversupply of certain goods and inadequate supply of others. Government bodies divided up the responsibilities for agricultural production and marketing. MOA primarily oversaw production, while the Ministry of Commerce (which merged at the central level with the Ministry of Materials in 1993 to form the current Ministry of Internal Trade) controlled virtually all wholesale and retail outlets for food and food processing. Similarly, the Ministry of Chemical Industry dominated the production of raw materials such as pesticides and fertilizers, but only companies under the former Ministry of Materials were permitted to handle distribution of the materials.

This system changed in the late 1970s and early 1980s with the partial relaxation of central planning. In the mid- to late-1980s, MOA began allowing State farms to purchase fertilizers and pesticides directly from factories or independent distribution companies, eroding the monopoly formerly held by local bureaus of materials. State farms also started to source raw materials directly from factories and sell goods directly to retail markets and, in some cases, export markets. Other government-controlled monopolies dissolved during this period, enabling competition in food retailing to arise. For example, local bureaus of commerce and local agricultural commissions were able to establish competing food retail operations.

Despite such recent progress, barriers to open competition in China's agricultural sector persist. Vestiges of the traditional market hub system remain intact in many regions of the country, with farmers in the interior provinces still serving local markets almost exclusively. In general, there are few large-scale, vertically integrated production and sales structures in these regions. Moreover, price controls on certain staple grains and cereals, including wheat and rice, remain in place. As a result, many of the new vertically integrated companies in urban centers focus on high value-added, specialty crops, including certain types of grains and cereals that are used in packaged breakfast cereals, breads, and other processed foods sold in high-end supermarkets. Such crops command relatively higher market prices.

 

Shaping up the State farms

The development of vertically integrated agribusiness operations nonetheless attests to the gradual commercialization of the agricultural sector. Shanghai's transformation of its State farm sector reflects Beijing's commitment to improving efficiency and attracting foreign investment and Western technologies to the sector.

The Shanghai Agriculture, Industry & Commerce General Group Corp. (SAICGC) was spun off from the Shanghai Agricultural Commission in 1995 to oversee economic growth of the municipality's agricultural production sector. Local State farm bureaus (formerly subordinate to the Shanghai Agricultural Commission) at the county, district, and village levels were transformed in 1993 into "agriculture, industry, and commerce corporations" (AICCs) (see The CBR, November-December 1994, p.28). These AICCs are now equity holding companies for State farm operations, with SAICGC at the top of the hierarchy as an asset management and business development company. Management of commercial operations thus has been hived off from the Shanghai Agricultural Commission, which has retained responsibility only for administrative matters and for developing and implementing government policies.

With over 40 subsidiary AICCs, 460 factories, 230 joint ventures, and 52,000 hectares (ha) of land, SAICGC integrates production, processing, and marketing of agricultural commodities. Its products include beef, pork, aquatic products, milk and dairy goods, fruit and vegetables, high quality grain, flowers, and turf. SAICGC also operates food processing and transportation services, and runs wholesale companies and supermarkets. It supervises and assists the AICCs, which also are vertically integrated entities. The AICCs sell the agricultural goods that they produce, process, and package to wet markets or retail outlets that they or SAICGC own.

The Shanghai Dairy Group Co. (SDG), for example, subordinate to SAICGC, is among the largest vertically integrated dairy products companies in China. SDG has annual sales of roughly RMB14 billion ($1.7 billion) and employs 5,600 people. The company, which supplies 95 percent of Shanghai's dairy needs (local small-scale dairy companies satisfy the remaining 5 percent), has a virtual monopoly over the sales and marketing of dairy products in Shanghai. SDG also has a nationwide sales network, and has milk and milk powder production bases and dairy processing facilities in North China. The firm operates cow breeding farms, dairy farms, dairy processing facilities, dairy machinery factories, storage companies, wholesale sales and distribution companies, retail chain stores, and joint ventures such as the Shanghai France Dannon Dairy Co. SDG also subcontracts with farms, feed factories, and local dairy companies. The company sources 60-70 percent of its raw materials from its wholly owned farms and subcontracts with suburban Shanghai dairy farms for the remaining 30-40 percent. For the local farmers with whom it contracts, SDG provides technology and equipment, and offers training and profit-sharing programs.

In addition to AICCs such as SDG, SAICGC operates wholesale commodity distribution centers throughout Shanghai, to which SAICGC's subsidiaries can deliver products for sale to domestic or overseas customers. SAICGC has foreign trading rights through its import/export corporation, the Shanghai AIC Foreign Trade Co.

SAICGC's mandate is to produce high-quality, value-added food for an increasingly sophisticated consumer base. Indeed, SAICGC is known for high-quality, well-packaged food, which it sells at premium prices (as much as 40 percent higher than competing products) through its subsidiary markets. Stores owned by SAICGC or subordinate AICCs range from small wet markets to large supermarkets and compete with those run by local bureaus of commerce or private entrepreneurs.

SAICGC's joint ventures, meanwhile, report healthy sales margins and profits. These joint ventures serve specialized markets such as foreign hotels, restaurants, and premium sales outlets catering to China's growing middle class. The Vegetable Division of the Shanghai Agricultural Commission has been particularly successful in promoting foreign investment in greenhouse projects. To date, five such joint ventures have been established in Shanghai between SAICGC or its AICCs and several foreign partners to produce high-quality, organically grown vegetables. The Shanghai Dong Hai Vegetable Demonstration Base and the Shanghai Pudong New Development Zone Sun Qiao Modern Agricultural Development Area are Sino-Dutch joint ventures established in 1996; each covers 3 ha and employs 40-50 people. The Shanghai Minhang District Ma Qiao Vegetable Garden, Shanghai Nan Hui County Vegetable Garden Ltd. Co., and Bao Shan Luo Dian Vegetable Garden are all joint-venture greenhouses between the local district governments and three Israeli firms. Each of the temperature-controlled greenhouses covers 3 ha and employs 30 people, and produces primarily beans, cucumbers, herbs, lettuce, sweet peppers, and tomatoes.

The Shanghai region, though the leader in implementing new forms of agricultural business, is not the only area to have established integrated agricultural enterprises. Beijing Agricultural Industry and Commerce Group Co. (BAIC) is a large-scale, vertically integrated conglomerate with a structure similar to SAICGC's. BAIC supervises 16 AICCs, over 2,000 subsidiary companies, a veterinary medicine factory, more than 245 joint ventures (including a cattle breeding farm), and numerous restaurants and retail food outlets. Another operation, the Beijing Huadu Group Co. (Beijing Huadu)--formerly the Beijing Animal Husbandry Bureau--is a vertically integrated animal husbandry conglomerate, with 28 subsidiaries including processing, sales and marketing, and wholesale and retail distribution companies. Beijing Huadu also has six commercial egg-laying farms, seven feed mills, vaccine production plants, and pig processing facilities.

The Beijing Agricultural Commission formed BAIC and Beijing Huadu as separate legal entities with sole responsibility for profits and losses. Like SAICGC, they are asset management companies. Although both report to the local agricultural commission, BAIC and Beijing Huadu manage their day-to-day operations independently and compete directly with each other in the animal husbandry market.

 

Pooling production

Agricultural collectives, formed by merging local farming operations, are also enabling a growing number of farmers to benefit from greater economies of scale and expansion of their customer bases to include more distant urban consumer markets. As the collectives have developed, many have become conduits for the introduction of technology, management systems, and high value-added raw materials and other inputs into local farming communities.

In Shanghai's Fengxian County, for instance, economic reforms, coupled with local government incentives to encourage small-scale farming units to form collectives, have met notable success. The Shanghai Fengxian Food Group Corp. was created by the merger of Fengxian Food Company and several hundred of the county's small-scale pig farmers, after the Fengxian County government encouraged local pig farmers to pool their land and resources to form a large-scale, vertically integrated company. The county government contributed funds to reconfigure land and resources, purchase equipment, buy additional real estate, and set up retail stores and other basic facilities. The farmers now own and manage Shanghai Fengxian Food Group Corp., which integrates pig breeding and raising, feed and meat processing, and meat packing and sales through its large-scale processing, and meat packing plants, 14 large-scale pig farms, and 15 sales outlets.

Fengxian County aims to attract foreign investment for a number of similar ventures, including a vegetable production and processing facility designed to provide the Shanghai market with high-quality canned corn, asparagus, and mushrooms; a pork breeding, processing, cold storage, and feed additive venture; and a fruit and vegetable enterprise incorporating both seed development and fruit, vegetable, and flower production.

The Shanghai Pudong Modern Agricultural Development Zone Company (SPMADC), an economic and technological development zone (EDTZ) established in 1994, became one of the first EDTZs to be devoted to technically advanced agricultural production and development. The zone is intended to introduce mass production systems for fruits and vegetables, flowers, and aquaculture, and link Pudong's farming community with the Shanghai market. SPMADC integrates local farmers' land and output with SPMADC-financed mass production schemes. Output is sourced from local farms for mass processing, and sold through captive wet markets and supermarkets. The schemes also include training programs to introduce farmers to the benefits of using advanced, value-added raw materials--including high-yield seeds, bio-technology seeds, and advanced fertilizers and pesticides that enrich rather than deplete the soil.

By using such imported or joint-venture-produced technologies and raw materials, the zone company has been able to produce higher quality products with better yields: SPMADC grows five vegetable crops per year in its fields while two crops a year is the norm in China. Like SAICGC, SPMADC's output commands premium prices on both domestic and export markets, which has a direct and positive financial impact on both SPMADC and local farmers.

 

Commercialization in perspective

State farms and their holding companies, and agricultural collectives and cooperatives, are now free to engage and compete directly in all stages of the value chain, from production, processing, storage, and distribution, to wholesale and retail sales, and international trade. With ambitious productivity goals, these entities represent a large and growing customer base for foreign providers of fertilizers, pesticides, and seeds, as well as agricultural vehicles, food processing and dairy equipment, plastic sheeting for greenhouses, animal feed, animal health products, and grain and feed silos.

Increasingly attractive to outside investors, agribusiness enterprises should facilitate further the overall development of China's agricultural production sector. For example, the CP Group of Thailand recently formed a joint venture with a collective farm in Songjiang County in Shanghai that includes a pig breeding farm, feed mill, slaughterhouse, and distribution hub. The Sino-Netherland Flower Co. Ltd. joint venture between SAICGC and a Dutch firm produces more than 6 million roses and other flowers per year. With imported technology from the Netherlands, the joint venture has the most advanced flower production technology now in use in China. Other recent agreements include a rice-polishing joint venture between Nichimen Corp. of Japan and MOA on a State farm in Heilongjiang Province; and a cooperative effort between Israel and the PRC to establish a commercial fruit, vegetable, and flower demonstration farm and processing facility in Shandong Province.

Large-scale, commercially focused agricultural production centers are concentrated in China's major urban centers. Though greater efficiency in agricultural production throughout the country is crucial to sustaining overall economic growth, commercialization threatens to weed out smaller-scale and less efficient farms near urban areas. Thus, agricultural policymakers and regulators, like industrial reformers in China today, must constantly weigh the risks and rewards of further commercialization of the sector. While opportunities are likely to remain concentrated in China's major urban centers and their surrounding farming communities in the near to medium term, the implementation of pilot programs in inland regions based on these new types of agricultural production centers likely will facilitate--gradually--similar investment opportunities throughout the country.

Ultimately, despite the threat of dislocation caused by the elimination of inefficient agricultural operations, the restructuring of the sector should benefit not only China's farmers, who will gain from higher profit margins, and Chinese consumers, who will face an ever-growing variety of agricultural products in their local markets, but also foreign firms looking for sales and investment opportunities in agriculture.

Tina Helsell is a director at Pacific Rim Resources, Inc., a management consulting firm specializing in market entry and business development strategies in the Greater China region.