It appears that the farm gate prices for raw sugar in Malawi are not correlated with export prices, meaning that, minus the milling fee (40 percent of divisible revenue on sugar and molasses sales) cane growers are paid 60 percent of the domestic wholesale or ex-factory price. Overall, this situation has produced price disincentives to farmers since they received 23 percent less on average than the international equivalent price. Only in 2012 the market environment worked in their favour, since the benchmark price fell sharply while producer prices remained steady.
Sugar cane farmers in Malawi lack price negotiation power as there is one sole buyer and it is also difficult for them to switch to other more profitable crops in case of unfair and non-remunerative prices. Producers have no choice but to pay the milling fee charged by Illovo, a subsidiary of the multinational Associated British Foods, at 40 percent of divisible proceeds from sugar and molasses sales (Corporate Citizenship, 2014). By charging the milling fee to the farmers, Illovo transfers part of the processing costs to them. Such a high fee indicates that the cost of production, processing, and marketing for Illovo Malawi is very high, despite their claim to be one of the top five most efficient processors in Africa. In fact, production costs are very low according to 2007 EPA negotiations (Agritrade, 2010). However, according to Illovo, the contractual arrangements that stipulate these milling fee terms was expected to change in 2014 but evidence and documentation for this change has not been found as of yet. Ensuring that the cane supply agreements between cane growers and Illovo are fair and remunerative should be a key priority, given the lack of competition and the presence of a monopsonistic market environment.
Farmers are not receiving the price they could since the farm gate price does not reflect export price dynamics. Farmers are unable to negotiate due to the monopsony of sugar cane purchase, weak land tenure rights and lack of information.
A revised farm gate price setting mechanism to consider also the export price of sugar in addition to the domestic price may increase the farm-gate price, thus incentivize production, while at the same time protecting farmers from international price shocks. Furthermore, the milling fee charged to farmers of 40 percent of gross revenues from sugar sales is high, despite Illovo Malawi being touted as one of the lowest cost sugar producers in the world. Growers in neighboring countries like Zimbabwe pay around 15 percent less.
It is fundamental to continue encouraging private investment in new sugar mills such as the one currently under construction in Salima. However, increased competition for cane purchase cannot alone address the lack of bargaining power of growers. In the case of a perennial crop like sugar cane, which has a higher degree of asset specificity than other annual crops because the land cannot easily or cheaply be diverted to other uses, contractual relationships between out-growers and processors require increased transparency and government vigilance to ensure fairness and equity.
Furthermore, getting the necessary legislation through in order to implement the Land Bill would contribute to ensuring fair distribution of land to new growers and that displaced people are adequately compensated.
Ex-factory sugar prices would enrich the analysis by enabling the measurement of indicators at the point of competition. This would allow us to understand better the price formation at farm gate.
Furthermore, having actual processing costs and more information on access costs between the factory and border, such as Illovo’s margins, would certainly contribute to our understanding of the overall incentives structure.
Further investigation and research
The update of this technical note in 2016 will include an additional indicator that measures the profitability of sugar cane cultivation by out-growers. The Effective Rate of Protection (ERP) takes into account not only the output value chain and prices but also the cost of inputs and their corresponding value chain access costs.
In addition, to address the limitations of the current analysis as described above, it would be useful to inquire whether the 40 percent milling fee has been reduced or whether new terms have been drawn up for out-grower contracts. If the terms have changed, a comparative analysis would be highly informative.
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