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BMcase001

Financing the BioRe® organic cotton chain in Tanzania By Niranjan Pattni, Managing Director, BioRe Tanzania Ltd., niranjan.pattni@biore-tanzania.com Abstract: This case describes the links in the cotton chain from Meatu district in northern Tanzania, where over 2000 smallholder farmers grow organic seed cotton for Remei AG, the trading company in Switzerland that manufactures sustainable cotton fashion for the European market. The focus is on the financial arrangements necessary for the proper functioning of BioRe, the local buying agent of Remei AG. BioRe has a longstanding relationship with the farmers, while BioRe and Remei AG have enjoyed a close partnership from the beginning. Remei is a committed buyer that actually co-ordinates the entire chain. BioRe and Remei AG jointly determine the export price of BioRe’s lint. The aim is to establish BioRe as a fully independent Africa-based company with, ultimately, the farmers as shareholders. The case demonstrates that organic farming and integrated chain partnership provides a viable model for securing smallholder livelihoods in developing countries. Keywords: procurement– cotton – organic farming - smallholders – export – certification Tanzania – Switzerland

Establishing a new chain BioRe Tanzania Ltd is a company that buys organic cotton from over 2000 cotton growers in Meatu district, northern Tanzania. It was founded in 1994 and currently (2008) operates under the BioRe Foundation, which was established in 1997 by Remei AG, a Swiss trading company that sells certified organic cotton yarns and threads and manufactures cotton garments for the European market. Farmers are given a premium on the conventional market price and a purchase guarantee. The cotton farmers in Meatu cultivate 11,000 ha of cotton, producing around 8,000 tons of seed cotton with a farm gate value of US$ 3.5 million, or a free-on-board export value of US$ 5 million. Remei AG is the chain co-ordinator. Its garments are sold in supermarkets and fashion outlets in Switzerland, France, Germany and other western European countries. Remei had set up BioRe to secure its supply of certified organic cotton lint. Starting as a project, BioRe is now a separate company. Remei AG buys lint from BioRe, and has a similar relationship and history with another firm in India. Conventional cotton cultivation is associated with a number of social and environmental problems: intensive use of pesticides, soil degradation, depletion of water resources, child labour and rural poverty. Remei wanted to create a viable business model based on organic farming, fair treatment of farmers and textile workers, and genuine partnering among all actors in the cotton chain. In 1994, BioRe was set up in Tanzania with just 45 farmers. It now works with over 2,000 farmers, and 1


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has a staff of 66. In each of the 15 villages, BioRe has a local office with a supervisor and several extension workers, who each serve 50 farmers. It was converted from a project into a subsidiary of Remei AG in 2002, and in 2006 into an independent firm. BioRe retains very close links with Remei: the Swiss firm buys all of its output, provides financial services, and coordinates the value chain. Remei AG and BioRe want to make BioRe fully independent, establishing a truly Africa-based company with local management and, ultimately, the farmers as shareholders.

Farming, harvesting, ginning, and spinning Meatu is an agricultural district where most households depend on rainfed farming. Each family has about 32 ha of land. On 4-5 ha they grow cotton, yielding 1250 US$/year, which is 80% of their cash income. On another 2.4-3.2 ha they grow food crops, mainly for home consumption. The farmers grow cotton under 5-year contracts that oblige them to use only organic production methods, follow the advice of BioRe's staff, and deliver the entire output to BioRe. In return, BioRe purchases the entire crop, provides seeds and bio-pesticides, and offers training and extension advice. The farmer can terminate the contract at any time, but BioRe can only do so if the farmer violates the contract, for example by spraying chemical pesticides. The cotton is sown in 2-week intervals from November to February. Relay sowing serves to spread the risk of drought. BioRe's extension officers visit the farms twice a month. The organic certification agency, too, makes random inspections. BioRe sets up farmer field schools in each location, where farmers learn about cultivation techniques, pest control, and other matters. One farmer from each group is regularly trained on BioRe's demonstration farm, and is expected to transfer this knowledge on to the other farmers in his location. The company also supplies implements such as ox-drawn weeders for the farmer groups to use collectively. The seed cotton is harvested from May to July and stored at home. When the price is right, the cotton is taken in bales of 60-100 kg to the BioRe village office, where it is sieved, inspected, weighed, and stored for transport. The farmer is then paid in cash and goes back home. A lorry takes the cotton to the nearby Bibiti Ginnery, which separates the seeds from the lint, presses the lint into bales, and transports them to the port of Dar-es-Salaam. For these services, Bibiti receives a fixed fee per ton of cotton. Part of the seed is kept for sowing, rest is sold to mills that process it into oil and cake. Bibiti works exclusively for BioRe to avoid any risk of contamination.

Chain finance BioRe pre-finances the crop by paying an input subsidy into a special bank account. The farmer receives a bankbook to be able to make a withdrawal in order to buy seeds and bio-pesticides from the company. For first-time farmers BioRe pre-finances the crop through a loan at zero interest rate. But this is risky: in 2007, 23% of new farmers did not deliver their cotton to the company. This resulted in a US$ 7000 loss , but BioRe continues to pre-finance new farmers in order to attract new farmers. Farmers are paid cash on delivery. During the buying season, BioRe withdraws the equivalent of US$ 50,000 in cash from the National Microfinance Bank every day. If BioRe did not pay in cash, the farmers might sell their crop to other buyers - even at a lower price. In 2008, BioRe needed US$ 3.5 million in cash to pay its contract farmers. The money is brought under police escort to BioRe's office, where it is divided among the 15 village supervisors, who take it on their motorbikes to their villages. At night they come back to the office to hand in the purchase slips. The handling costs are high, and the risks of robbery are significant. Occasionally, payment slips are not backed by an actual delivery of seed cotton. BioRe has no alternative ways to pay the farmers. Some years ago, the ginnery was given an investment loan of US$ 400,000 for new equipment, to be paid back over 4 years. In return, Bibiti would would give BioRe preferential treatment. However, the ginnery stopped serving other clients, so now 2


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processes only BioRe's cotton. Every year BioRe lends it a maximum of US$ 60,000 for spare parts and maintenance. During the ginning season BioRe continues to make fortnightly down-payments, using ginnery reports to avoid overpaying for the services rendered. During the buying season, Remei transfers a significant amount of money to BioRe's bank account every week, so that BioRe can pay its staff and bills, and pre-finance the farmers and the ginnery. Remei AG buys the cotton free-on-board at Dar-es-Salaam, paying BioRe by bank transfer. The cotton is shipped to spinning mills in Europe, Asia and Africa, where Remei AG contracts with specialist firms to spin it into yarn, weave it into cloth, and produce garments that Remei AG co-designs with large retailers and fashion brands in Europe.

Fig. 1: The current BioRe/Remei cotton value chain

A new source of finance In 2004, Remei AG asked the Triodos Sustainable Trade Fund, part of Triodos Bank in the Netherlands, to pre-finance the cotton operations in Tanzania. The Triodos fund assists certified organic and fair trade producers in pre-financing their export contracts with buyers in Europe and the United States. Triodos shared Remei AG's vision that BioRe should have the opportunity to become independent. Furthermore, the above arrangement is a heavy financial burden for Remei AG. In 2005 and 2007, Triodos provided BioRe through Remei AG with seasonal loans of â‚Ź 800,000 and â‚Ź 900,000, respectively. In 2008, Triodos disbursed a loan US$ 2,325,000 directly to BioRe. Both BioRe and Remei AG are jointly liable for the loan, and Remei AG will repay it. The loan period has been extended from 7 to 10 months, and the dates of disbursement and repayment have been adapted to better accommodate the trading season. Meanwhile, Remei AG continued to finance BioRe. With the additional finance from 3


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Triodos, BioRe was able to increase its farmer clientele. Overall loans rose from US$ 2 million in 2005 to US$ 4.5 million in 2008, with half coming from Triodos in both years. The partnership with Triodos has transformed the financial flows in the cotton chain from chain liquidity to a value chain finance triangle (fig. 1). Triodos's willingness to finance is based on strong market demand for organic cotton and the strong relationships of BioRe with Remei AG, Bibiti, and the farmers of Meatu district.

Mitigating risks of financing cotton The following sources of risk may affect a cotton exporter's capacity to repay a bank loan: (1) climate, because rainfed cotton is susceptible to drought and crops may fail once every few seasons; (2) price fluctuations of cotton on the world market. If BioRe has a lot of unsold lint in stock when the price falls, this implies a huge loss; (3) defaults by farmers, who may sell their cotton to competing traders or may not meet organic requirements or quality standards. By way of precaution, BioRe uses an assumed default rate of 12%; and (4) currency risks, because BioRe buys seed cotton in Tanzanian shillings and sells lint in US dollars. These factors mean that Tanzanian banks are reluctant to provide loans to cotton exporters such as BioRe without safeguards in the form of firm's office and training centre, as well as personal guarantees from BioRe's and Remei AG's managers. Triodos is more lenient: the only document underpinning the loan is the sales contract between BioRe and Remei AG, specifying the amount and price of lint to be sold. Triodos' decision to extend the loan is based on the trust that the cotton lint will be produced and sold, and will generate sufficient profit to repay the loan. In financial jargon, the loan is based on cash flow projections, rather than securities from assets. The BioRe/Remei AG chain has the following strengths: (1) BioRe has shown that it can deal effectively with the challenges of cotton production and export. The company has realistic forecasts of expected individual yields and provides 5-year contracts, inputs, training, and technical assistance; (2) BioRe and Remei have a sales contract with fixed prices and volumes, so the risk of market fluctuations is eliminated for BioRe and the farmers. Furthermore, there is strong commitment and interdependence between the two companies. Remei AG is a financially solid company with a strong balance sheet; and (3) BioRe, Remei, and Bibiti have been working in the same integrated manner for many years. As chain manager, Remei AG ensures compliance with quality standards, open communication and efficient co-ordination in the chain.

Setting prices Before the harvest starts, the floor price of the season is determined by the cotton traders in a meeting of the Tanzania Cotton Board. Once the floor price is set, the free market is left to do its work. The traders compete with each other, so the prices normally go up during the season. For that reason, farmers will wait for the highest price possible before selling the bulk of their seed cotton. BioRe's purchase price is an average of the prices offered by competing traders in the villages where the company operates. BioRe gathers the announced buying prices from the billboards outside the traders’ offices, to calculate the average. On top of this, the company offers a fixed price premium of 15%. The average traders' purchase prices have risen from around TSh 160 per kilogram in 2000, to about TSh 480 in 2008, while BioRe's prices have risen from TSh 180 to about TSh 550 in the same period. The organic premium and the input subsidy for the farmers are not paid for by BioRe, but by Remei AG from its annual profits. So the extra payments to BioRe's farmers are not added to the cost price of the cotton. This is smart, because it avoids adding a percentage mark-up to the value of the product, which in turn would otherwise have led to increased taxes. By "lifting out" these costs and paying them at the end, Remei AG avoids inflating the price of the product at each stage in the chain. That keeps the price 4


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of the final product low, making consumers more willing to buy it.

Benefits All chain actors benefit of the current arrangements. Farmers receive a price premium, avoid the costs of chemicals, and cultivate a larger area of cotton, while their yields are similar to those of conventional cotton farmers. That gives them an income 40% higher than conventional farmers. BioRe's farmers also report other benefits. They obtain higher yields in other crops. Their soil is in a better condition due to better crop rotation. The soil has a higher water holding capacity, which mitigates the effect of drought. Finally, oxen ploughing and weeding reduce the labour requirement. BioRe now employs 66 staff, most of them from local villages. It is the only employer in Meatu district which provides such attractive salaries and education opportunities. BioRe's training centre is developing as a regional centre of competence. In times of need the company supports the local community. During the drought of 2006 the company provided daily lunches to 7000 schoolchildren for 3 months. Annual turnover of BioRe has increased from a fraction of a million US$ in 2000 and 2001 to almost US$ 3 million in 2007 and over US$ 5 million in 2008. The chain has outperformed conventional cotton chains, and generates profits for all actors. Without its relationship with BioRe, the Bibiti ginnery would most likely stand idle. In the last decade Remei AG has switched fully to organic cotton. Its turnover has remained more or less stable at US$ 25 million, but its profitability has more than tripled. Consumers are now able to buy sustainabily produced garments of high quality at reasonable prices. Triodos, finally, enjoys a smooth working relationship with BioRe. The loan is fully aligned with the bank's mission - it is a financial product that directly benefits people and environment, in a region of great need.

The future BioRe and Remei AG jointly determine the export price of BioRe's lint by "open book" calculation: the partners look at BioRe's costs of production, then add a small profit margin. In 2008 BioRe's free-on-board export price was US$ 1.73/kg of lint. This was significantly higher than the average Tanzanian export price of US$ 1.58. In other words BioRe is not yet competitive: it would not survive if Remei AG were not willing to pay a higher price. BioRe's higher costs are linked to its investment in training and technical assistance to the farmers. To reduce its costs and produce cotton at a fully competitive price, BioRe must: 1. Involve local banks more closely to complement the attractive loan from Triodos. An overdraft account at a local bank would allow BioRe to withdraw small amounts of short-term credit, for example, when a cliĂŤnt pays late. Another issue is to find an alternative to paying the farmers in cash by transferring money to farmers' accounts. 2. Reduce its overhead for training and staff by empowering the farmers and establishing farmer associations. These can help to distribute seeds and inputs, collect and inspect the cotton, and jointiy deliver to BioRe. They can also take over training activities. In the long term, the groups can become shareholder in BioRe. In Remei AG's Indian partner, this is already happening. 3. Establish savings and credit cooperatives for farmers to provide some of their own financial services. For example, they could save a small amount each week, then loan this money to members. The farmers could invest their loans in cotton production, or use it for other purposes.

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BMcase001

Backpage: Financing the BioRe® organic cotton chain in Tanzania BMAfrica# Agribusiness type: Keywords: Country, region: Period: Image: Original title: Original author: Websites:

Abstract

BMcase001 Ethical sourcing company of certified organic cotton for export. procurement– cotton – organic farming - smallholders – export certification Tanzania – Switzerland 2004-2008 N/A “White gold” from Tanzania: BioRe organic cotton. Niranjan Pattni, Managing Director, BioRe Tanzania Ltd., niranjan.pattni@biore-tanzania.com www.remei.ch www.coop.ch/naiuraline www.triodos.com This case describes the links in the cotton chain from Meatu district in northern Tanzania, where over 2000 smallholder farmers grow organic seed cotton for Remei AG, the trading company in Switzerland that manufactures sustainable cotton fashion for the European market. The focus is on the financial arrangements necessary for the proper functioning of BioRe, the local buying agent of Remei AG. BioRe has a longstanding relationship with the farmers, while BioRe and Remei AG have enjoyed a close partnership from the beginning. Remei is a committed buyer that actually co-ordinates the entire chain. BioRe and Remei AG jointly determine the export price of BioRe’s lint. The aim is to establish BioRe as a fully independent Africa-based company with, ultimately, the farmers as shareholders. The case demonstrates that organic farming and integrated chain partnership provides a viable model for securing smallholder livelihoods in developing countries.

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Financing the organic cotton chain