In peri-urban areas of the world where cattle are present, dairy farming has typically been part of the adjustment in production patterns of smallholders faced with shrinking arable land, higher population density and rising wage rates. In sub-Saharan Africa, where the economic viability of smallholder agriculture has come under increasing pressure, smallholder peri-urban dairy development has not been widespread outside of the East African highlands. Understanding the nature of constraints limiting smallholder peri-urban dairying so as to promote this activity and improve the livelihoods of smallholders is, therefore, a key public policy issue for African countries. It is argued that dairying is vital to future viability of many small farms in East Africa and that high transactions costs for dairy production and marketing limit participation by asset- and information-poor smallholders. Case studies from Kenya and Ethiopia illustrate the role of dairy cooperatives in reducing transactions costs. Analysis of the determinants of producer prices received by a sample of dairy producers near Addis Ababa suggests that different levels of access to infrastructure, assets, and information explain why they contemporaneously accept widely different producer prices for fluid milk

Delgado, Christopher L.

Nicholson, C.

Staal, Steven J.

World Development

It is argued that dairying is vital to future viability of many small farms in East Africa and that high transactions costs for dairy production and marketing limit participation by asset- and information-poor smalholders. Case studies from Kenya and Ethiopia illustrate the role of dairy cooperatives in reducing transactions costs. Analysis of the determinants of producer prices received by a sample of dairy producers near Addis Ababa suggests that different levels of access to infrastructure, assets, and information explain why they contemporaneously accept widely different producer prices for fluid milk

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Smallholder dairying under transactions costs in East Africa

August 1998Livestock Policy Analysis Brief  No. 6Smallholder dairying under transactions costs in East AfricaS. Staal,1 C. Delgado2 and C. Nicholson3*1. International Livestock Research Institute (ILRI), P.O. Box 30709, Nairobi, Kenya2. International Food Policy Research Institute (IFPRI), 2033 K Street, Washington, DC ­­ 20006, USA3. ILRI, P.O. Box 5689, Addis Ababa, Ethiopia, and IFPRI, Washington, DC, USAIn peri­urban areas of the world where cattle are present, dairy farming has typically been part of theadjustment in production patterns of smallholders faced with shrinking arable land, higher populationdensity and rising wage rates. In sub­Saharan Africa, where the economic viability of smallholderagriculture has come under increasing pressure, smallholder peri­urban dairy development has not beenwidespread outside of the East African highlands. Understanding the nature of constraints limitingsmallholder peri­urban dairying so as to promote this activity and improve the  livelihoods  of smalholdersis, therefore, a key public policy issue for African countries.The relevance of transaction costsIt is now widely accepted that the costs of arranging exchange may reduce or even prevent exchanges fromoccurring, and give rise to institutions and organisations to offset their negative impacts. Transactions costsinclude the costs of searching for and screening trading partners, bargaining with potential trading partnersto reach an agreement, transferring (transporting, processing, packaging and securing title) the exchangedproduct, monitoring the agreement to see that its conditions are fulfilled, and enforcing the exchangeagreement.The nature of milk and its derivatives partly explains the high transactions costs associated with dairying.As a highly perishable and bulky product, milk requires rapid transportation to consumption centres andprocessing at relatively high cost. This may involve  substantial losses due to spoilage and  result in smallquantities marketed, thereby limiting marketing outlets for small dairy producers.In eastern Africa, empirical evidence on the nature and importance of transactions costs in dairying isscarce. As a result, the few studies that have addressed the issue have tended to infer the magnitude oftransactions costs incurred from indirect evidence of lack of commercialisation. Indirect as such evidencemay be, it suggests that both small­ and large­scale dairy producers face high transactions costs, though atdifferent levels, and that these influence production and marketing behaviour in a manner detrimental toefficiency and equity.Case studies: Kenya and EthiopiaThe role and potential effects of transactions costs on the structure of dairy production and marketing ineastern Africa can be illustrated using data from recent surveys of dairy co­operatives in Central Province,Kenya, and of dairy producers in the Addis Ababa peri­urban area, Ethiopia.  Data for the two countries show that only a small portion of domestic dairy production is marketed. InEthiopia, which has significant per capita milk production, only 5% of estimated national production wascommercialised in the early 1990s. In Kenya, the African country with the largest number of smallholderdairy producers selling milk off­farm, estimates of commercialisation in 1990 range from 43 to 48%.In Ethiopia, most milk and dairy marketing occurs through the informal sector. Almost 88% of all urbanmilk is supplied as raw milk through the informal market, largely by small producers. Few large farms orcollective marketing organisations exist, so that production and marketing costs reflect the dispersed andsmall­scale nature of the dairy sector.  The parastatal collection system, the Dairy Development Enterprise(DDE) which acts as a buyer of last resort, handles only 12% of urban milk supply and pays the lowestaverage prices.Thus, direct sales by producers to individual and institutional consumers, by­passing the dairy parastatal and private middlemen, constitute the bulk of milk sales in the Addis Ababa milkshed. In thisenvironment, both producers and consumers of dairy products appear to put a premium on contractingwith only a small number of clients/suppliers, suggesting that transactions costs are especially high in openmilk markets.There is, however, considerable variation in the importance of marketing outlets depending on the scale ofproduction and on the location (proximity to urban markets). Consistent with this, sources of average dairyand dairy­related revenues and costs differ between small and large producers, and between urban and peri­urban producers of the same size. Since different producers face different levels of transactions costs,depending on asset (capital intensity) and information levels, season and location, they respond to thesedifferential costs with differential sales strategies.As a general rule, transactions costs increase with distance due to the increased costs of information andrisk of dairy product spoilage before a buyer is found. Thus, farmers located further away from AddisAbaba have significantly less attractive options for disposing of their milk. Average revenue per tonne ofmilk in the survey was remarkably similar across producer types. But the unit cost for large urban producerswas much lower than for other types of producers, especially with respect to feed costs. Low creditavailability, combined with the capital intensive nature of large­scale dairying, could partially explain thepredominance of small­scale production.Overall, smallholder dairy producers in the Addis Ababa milkshed appear to generally face highertransaction costs than larger producers. The prices received by producers decrease with distance and appearto vary considerably depending on the size of sales and the flexibility of contractual relationships betweenproducer and consumer, smaller producers receiving lower prices than larger producers in some marketingchannels (e.g. dairy parastatal).In terms of organisations of collective action, Kenya’s experience with the Kenya Co­operative Creameries(KCC) as a buyer of last resort seems to indicate that a full­fledged parastatal processing company like theKCC can  lower  transactions costs during the initial phase of smallholder dairy development. Indeed,KCC initially served to reduce transactions costs faced by individual producers through pooling risk,lowering collection and search costs, making inputs available to them and rendering milk supplies morereliable.In recent years, however, KCC’s financial performance has been severely compromised by pan­seasonal andpan­territorial pricing policies adopted for political reasons. Milk prices paid by KCC to co­operatives andproducers have failed to keep pace with increases in input prices, and payments for milk supplied havebeen delayed, exposing producers to higher risks and irregular cash flow.In 1992, the Kenyan Government liberalised the dairy industry, revoking the KCC’s monopoly on urbanmilk sales. This resulted in the rapid development of a variety of ‘self­help groups’ and dairy co­operativesmainly marketing raw milk. These co­operatives had largely emerged in response to the continued delays inmilk payments by the KCC and began to explore alternative market outlets, but only in regions wheretransportation and other transactions costs permitted. In avoiding KCC payment delays, however, these co­operatives had to contend with the considerable uncertainty and high transactions costs of searching formarket outlets, screening, bargaining, monitoring contractual agreements with customers etc.Some policy implicationsComprehensive policy recommendations require a more detailed study of the structure and determinantsof transactions costs and their impacts on the behaviour of economic agents. However, some tentativepolicy implications can be drawn from the evidence already available for Ethiopia and Kenya.First, because of the potentially important role of collective organisations in lowering transactions costs indairy marketing, government actions are required to provide an enabling and supportive environment forcollective action in the dairy sector. Such actions should include reducing the bureaucratic obstacles toeffective formation and management of co­operatives and self­help groups, support of market informationflows (e.g. market opportunities and prices), resources for training in management and planning and,where appropriate, greater access to credit.Another action to support smallholder dairy development would be greater transparency of dairymarketing policies, and greater consistency in their implementation. In Kenya, greater transparency is likelyto be required with regard to liquid milk marketing by private processors in urban areas. The 1992liberalisation has yet to be finalised, perhaps discouraging investment and marketing activities by privatedairy companies, including producer­based co­operatives. Ethiopia’s policy concerning privatisation of statedairy farms and the DDE has yet to be made definitive, and government support for the formation ofgenuine co­operatives is uncertain.  It is important that caution should be taken before policies are adoptedwhich impede the indigenous and sometimes informal market mechanisms which currently servesmallholder producers.Opportunities also exist for research to better document transactions costs that are observable. Perhapswhat is most needed is methodological development with regard to conceptualisation of transactions costsand how to measure them. Research on household and subsector models that better integrate both existingtransactions costs and institutions and contracts that govern individual transactions, would be beneficial ina broader sense to improve policies and promote the well­being of rural smallholders.* Current address: Department of Community Development and Applied Economics, 205 Morril Hall, The­­ ­ University of Vermont, Burlington, VT 05401, USA.For more information on this issue see: Staal S.J., Delgado C. and Nicholson C. 1997. Smallholder dairying under transactions costs in East Africa. WorldDevelopment 25(5):779–794.

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Smallholder dairying under transactions costs in East Africa

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