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dissertation entitled

STRATEGIC RESPONSES TO STRUCTURAL CHANGE IN
AGRIFOOD MARKETS:
ESSAYS FROM THE FRESH PRODUCE MARKET OF SAO
PAULO BRAZIL

presented by

DENISE YVONNE MAINVILLE

has been accepted towards fulﬁllment
of the requirements for the

DOCTORAL degree in AGRICULTURAL
1, ECONOMICS

 

 

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STRATEGIC RESPONSES TO STRUCTURAL CHANGE TN AGRIFOOD
MARKETS:

ESSAYS ON THE FRESH PRODUCE MARKET OF SAO PAULO BRAZIL

By

Denise Yvonne Mainville

A Dissertation
Submitted to
Michigan State University
in partial fulﬁllment of the requirements
for the degree of
Doctorate in Philosophy
Department of Agricultural Economics

2004

ABSTRACT

STRATEGIC RESPONSES TO STRUCTURAL CHANGE IN AGRIFOOD
MARKETS:

ESSAYS ON THE FRESH PRODUCE MARKET OF SAO PAULO BRAZIL
By

Denise Yvonne Mainville

Agrifood markets have seen dramatic change worldwide as the result of the emergence of
large international supermarket and hypermarket chains as dominant players. Increased
retail concentration and new competition patterns have affected the participation and
welfare of actors throughout the marketing chains. Important questions concern how
different actors in agrifood chains have been affected by the rise of large retail chains,
and how they have responded strategically to the competitive challenges the large
retailers present. This dissertation attempts to contribute to knowledge in this area. It
examines the strategic responses of diverse retailers and suppliers to the rise of large

retailers as major players in the fresh produce markets of Sic Paulo Brazil.

Three broad research questions are addressed: 1) What gave rise to the emergence of
large retail chains as major actors in Brazil, and how has the market structure changed
since their emergence? 2) How have retailers responded to the competitive pressures that
they have experienced since the emergence of large chains, particularly in terms of the
organization and institutions governing fresh produce procurement? 3) How have
growers responded to the changed conditions in the market in terms of their market

channel choice and technology use?

The dissertation ﬁnds that large retail chains gained prominence in fresh produce markets
due to changes in the incentives they faced as a result of economic stabilization. The
large retailers’ fresh produce procurement and merchandising strategies permitted them
to reduce their costs and improve the quality of their merchandise. As the large retailers
increased their share of the market, smaller retailers were in a position of having to
respond if they were to remain competitive. Independent retailers were most proactive in
changing procurement strategies to meet new market conditions, changing the
organization, sources and coordination of their fresh produce procurement. Traditional
retailers were less responsive, making few changes to their procurement strategies. This
was likely a signiﬁcant factor contributing to their decline in numbers and market share
over the past decade. Shifts in retailers’ competitive strategies led to changes in the
structure of the market, particularly the emergence of a Supermarket Channel
characterized by high quality and service requirements, as well as high returns, risk and
entry requirements for suppliers. Growers participating in the supermarket channels had
higher levels of human capital and used more capital-intensive technology, except in the
case of tomatoes where market intermediaries played a major role in ensuring that
supermarket channel quality and service requirements were met, thus facilitating the

participation of growers with lesser levels of technology.

ACKNOWLEDGEMENTS

First, I would like to thank Dr. Thomas Reardon, my major advisor, for his support,

enthusiasm, mentorship and encouragement throughout my graduate studies.

I am also very grateful to my doctoral committee for their guidance of my research, and
their willingness to mentor me. I am very indebted to Dr. Christopher Peterson for his
many actions that smoothed my way through graduate school and for the mentoring
relationship that he fostered; to Dr. Elizabeth Farina for supervising the ﬁeld research in
Brazil and for her encouragement and input; to Dr. John Allen for his mentorship and
encouragement; and to Dr. Lawrence Busch and Dr. Kellie Raper who also provided

valuable input into the formation and reﬁnement of the project.

I also am grateful for the many people in the Department of Agricultural Economics who
went out of their way to assist me in various ways during my graduate program. The
Administrative Staff, Reference Room Staff, Computer Services personnel, and a number

of Faculty members were generous in their time and support.

In Brazil, I thank the people at the Agribusiness Research Program (PENSA) and the
Economics Department at the University of 850 Paulo for their camaraderie, with special
thanks to Carolina Graca Torres and Ana Elisa Bressan Smith Lourenzani for their
friendship during my stay in Brazil and since. I owe the successful completion of my

research project to many people, particularly those who participated in my surveys and

iv

interviews. I am especially appreciative of the efforts of Anita de Souza Dias Gutierrez,
Paulo Ferrari and others at the Horticultural Quality Center-CEAGESP, to Tomas
Nitzche and Renato Abdo in Moji das Cruzes, to Trond Vidar Larsen at CAISP, to
Leonardo Miyao, Helio Nishimura and others who were willing to be subjected to

numerous interviews at Companhia Brasileira de Distribuicao, and to the Sapori family.

My doctoral dissertation research was supported by a Fulbright-11E grant, and I also
received support for pre-dissertation research, post-dissertation follow-up research, and
during the completion of my dissertation from the Glenn and Sandy Johnson Fellowship
program, the Institute for Food and Agricultural Standards, the Walker-Hill Fellowship,
the Center for Latin American and Caribbean Studies, and the College of Agriculture and
Natural Resources. The ﬁnancial support was, of course, crucial to the successful

implementation of the project and I am very appreciative of it.

Finally, I thank my friends whose help, patience, support, and cheer were indispensable
at different times during my graduate program, among them Amy Damon, Brian Scott,
Epi Katijuongua, Lorie Srivastava, Lourdes Martinez, Meeta Punjabi, Mollie Woods, and

Rajesh Lal.

TABLE OF CONTENTS

 

 

LIST OF TABLES -- xi
LIST OF FIGURES xiv
CHAPTER 1 Introduction 1

 

CHAPTER 2 Strategic Responses to Structural Change: The Recent Evolution of

 

the Fresh Produce Markets of 850 Paulo Brazil 5
1 Introduction ............................................................................................................. 5
2 Conceptual Framework ........................................................................................... 7
3 Empirical Application to $50 Paulo’s fresh produce market .................................. 9

3.1 Phase 1: The pre-liberalization, pre-stabilization market environment ........ 12
3.2 Phase 2: Market liberalization and economic stabilization transition .......... 14
3.3 Phase 3: Post-stabilization ............................................................................ l8
4 Implications and policy considerations ................................................................. 39
5 Conclusion ............................................................................................................ 46
REFERENCES ............................................................................................................. 48
APPENDIX ................................................................................................................... 51

vi

CHAPTER 3 Determinants of Retailers’ Decisions to Use Public or Private Grades

 

& Standards: What Policy Makers Should Know 52
1 Introduction ........................................................................................................... 52
2 Grades and Standards in Agrifood Markets .......................................................... 54
3 Modeling the Decision to Adopt Public vs. Private G&S .................................... 56

3.1 General Conditioning Factors ....................................................................... 56
3.2 Determinants of G&S Regime Beneﬁts and Costs ....................................... 60
3.3 Hypotheses on Firm-Speciﬁc Factors Inﬂuencing the Adoption of Public and
Private G&S .............................................................................................................. 62
4 Evidence from Sac Paulo’s Fresh Produce Market .............................................. 65
4.1 Fresh Produce Retailers in 850 Paulo ........................................................... 65
4.2 G&S in Sao Paulo’s Fresh Produce Markets ................................................ 66
4.3 G&S Adoption Patterns ................................................................................ 71
5 Discussion of results ............................................................................................. 75
6 Policy Implications ............................................................................................... 79

CHAPTER 4 Coordination Strategy Decisions in 850 Paulo’s Fresh Produce

Markets: An Empirical Test of the Peterson, Wysocki & Harsh Framework .......... 85
1 Introduction ........................................................................................................... 85
2 Conceptual Framework: The PWH Framework ............... q .................................... 87
3 Background to Sic Paulo fresh produce markets ................................................. 91

vii

4 Case analyses ........................................................................................................ 94

4.1 First case: Companhia Brasileira de Distribuicao ......................................... 94
4.2 Second case: Sapori .................................................................................... 100
4.3 Third case: Sacolao FLV ............................................................................ 108
4.4 Fourth Case: Galeria dos Paes .................................................................... 112
5 Discussion and conclusions ................................................................................ 116
REFERENCES ........................................................................................................... 119

CHAPTER 5 Fresh Produce Procurement Strategies in a Constrained Supply

 

Environment: Case Study of Companhia Brasileira de Distribuicio 120
1 Background ......................................................................................................... 120

2 The Role of Fresh Produce in Retail ................................................................... 121

3 The Fresh Produce Supply Chain ....................................................................... 122

4 CBD and its Fresh Produce Activities ................................................................ 125

5 CBD’S Procurement Strategy in Transition ........................................................ 132

6 Discussion questions ........................................................................................... 134

7 Teaching Notes ................................................................................................... 135
7.1 Purpose of the teaching case ....................................................................... 135

7.2 Case summary ........................ I ..................................................................... 136

viii

7.3 Teaching objectives .................................................................................... 137

7.4 Theoretical applications .............................................................................. 137
7.5 Recommendations on teaching the case ..................................................... 140
7.6 Suggested answers for discussion questions ............................................... 142
REFERENCES AND ADDITIONAL RESOURCES ................................................ 147

CHAPTER 6 Supermarket Market-Channel Participation and Technology

 

Adoption Decisions of Horticultural Producers in Brazil 148
1 Introduction ......................................................................................................... 148
2 Conceptual Framework ....................................................................................... 150
3 Context (Market Channel Characteristics and Categories) ................................. 153

3.] Tomato market channels and marketing chain ........................................... 154
3.2 Lettuce market channels and marketing chain ............................................ 157
4 Empirical Model, Hypotheses, Methods and Data ............................................. I60
4.1 Data ............................................................................................................. 160
4.2 Market Channel Choice .............................................................................. 161
4.3 Technology Choice ..................................................................................... 164
5 Results ................................................................................................................. 165
5.1 Cluster analysis results of market channel choice ...................................... 165
5.2 Results of technology use analysis ............................................................. 172
6 Conclusions ......................................................................................................... 175

ix

REFERENCES ........................................................................................................... l 77

CHAPTER 7 Conclusion ..... - - - - 179

 

LIST OF TABLES

CHAPTER 2 Strategic Responses to Structural Change: The Recent Evolution of
the Fresh Produce Markets of $50 Paulo Brazil

Table 1 Evolution of Basic Conditions, Firm Conduct and Market Structure .................. 11
Table 2 850 Paulo’s Fresh Produce Retailers ................................................................... 20
Table 3 Role of Fresh Produce Sector by Retail Category ............................................... 21
Table 4 Trends in the Organization of Bulk, Leafy Green, and Specialty Produce
Procurement .............................................................................................................. 23
Table 5 Sources of fresh produce by retail type ............................................................... 25
Table 6 Number of Total and Regular Suppliers, Current & 5 Years Ago ..................... 26
Table 7 Traditional and Growing Region Tomato Wholesaler Market Channels ............ 28
Table 8 Deﬁnition of Small vs. Large Lettuce and Tomato Producers (hectares) ........... 29

Table 9 Small Tomato Growers’ Activities Current and 5 Years Ago: Comparison of

Mean Values ............................................................................................................. 29
Table 10 Large Tomato Growers’ Activities Current and 5 Years Ago: Comparison of
Mean Values ............................................................................................................. 30
Table 11 Small Lettuce Growers’ Activities Current and 5 Years Ago: Comparison of
Mean Values ............................................................................................................. 31
Table 12 Large Lettuce Growers’ Activities Current and 5 Years Ago: Comparison of
Mean Values ............................................................................................................. 32
Table 13 Food Market Participation in Brazil by Traditional, Chain and Independent
Retailers .................................................................................................................... 36
Table 14 Specialty produce markets in Brazil ................................................... 38

CHAPTER 3: Determinants of Retailers’ Decisions to Use Public or Private Grades
& Standards: What Policy Makers Should Know

Table 1 Factors Inﬂuencing the Decision to Adopt Public or Private G&S ..................... 57

Table 2 Characteristics of fresh produce retailers ............................................................. 67

xi

Table 3Public and private G&S regimes in Sic Paulo’s fresh produce market ............... 68
Table 4 Adoption and administration of G&S for Fresh Produce in Sao Paulo ............... 71

CHAPTER 4 Coordination Strategy Decisions in $50 Paulo’s Fresh Produce
Markets: An Empirical Test of the Peterson, Wysocki & Harsh Framework

Table 1 PWH analysis of CBD cases facts in lst stage of evolution ......................... 97
Table 2 PWH analysis of CBD cases facts in 2nd stage of evolution .............................. 99
Table 3 PWH analysis of Sapori cases facts in lst stage of evolution ........................... 102
Table 4 PWH analysis of Sapori cases facts in 2nd stage of evolution .......................... 105
Table 5 PWH analysis of Sapori cases facts in 3rd stage of evolution ........................... 107
Table 6 PWH analysis of Sacolao F LV Case Facts ........................................................ 111
Table 7 PWH analysis of Galeria dos Paes Case Facts for Pre—packaged Produce ........ 114
Table 8 PWH analysis of Galeria dos Paes Case Facts for Fresh-cut & Organic Producia15
CHAPTER 5 Fresh Produce Procurement Strategies in a Constrained Supply
Environment: Case Study of Companhia Brasileira de Distribuicio

Table 1 Holdings of the Companhia Brasileira de Distribuicao ............................. 126
Table 2 Organization of fresh produce procurement by task .......................................... 129

CHAPTER 6 Supermarket Market-Channel Participation and Technology
Adoption Decisions of Horticultural Producers in Brazil

Table l Cluster analysis results for market channel participation and composition for
tomato growers ............................................................................... 165

Table 2 Characteristics of tomato growers participating in different market channels .. 166

Table 3 Cluster analysis results for market channel participation and composition for
lettuce growers ........................................................................................................ 168

Table 4 Characteristics of lettuce growers participating in different market channels... 170

Table 5 High and low technology holdings and market channel choice among tomato
growers .................................................................................................................... 172

xii

Table 6 Speciﬁc technology holdings and market channel choice among tomato growers
................................................................................................................................. 173

Table 7 High and low technology holdings and market channel choice among lettuce
growers .................................................................................................................... 173

Table 8 Speciﬁc technology holdings and market channel choice among lettuce growers
................................................................................................................................. 174

xiii

LIST OF FIGURES

CHAPTER 2 Strategic Responses to Structural Change: The Recent Evolution of
the Fresh Produce Markets of 850 Paulo Brazil

Figure 1 $50 Paulo Fresh Produce Market Flows ............................................................. 37

CHAPTER 4 Coordination Strategy Decisions in 850 Paulo’s Fresh Produce
Markets: An Empirical Test of the Peterson, Wysocki & Harsh Framework

Figure 1 PWH Decision-making Process ......................................................................... 89
Figure 2 Coordination Strategies ...................................................................................... 92

CHAPTER 6 Supermarket Market-Channel Participation and Technology
Adoption Decisions of Horticultural Producers in Brazil

Figure 1 Tomato Marketing Chain ................................................................................. 155

Figure 2 Lettuce Marketing Chain .................................................................................. 158

xiv

CHAPTER 1

Introduction

Supermarkets are among the major movers in agrifood markets today. They have
gone from being peripheral players just a few years ago to powerful actors today, with
major shares of food retail markets in more and less-developed countries alike.

The rise of supermarkets was enabled by a number of technological and economic
factors underlying supply and demand conditions in agrifood markets. On the demand
side, increasing urbanization, the growing participation of women in the paid labor force,
and rapid grth in real mean per capita income during the 19905 shifted consumer
purchase patterns in favor of supermarkets. On the supply side, trade liberalization and
reduced regulation of foreign direct investment facilitated the proliferation of the large
retailers in both developing and more developed economies. Meanwhile, advances in
production, communications, processing, storage and transportation technologies led to
innovations in organization and coordination that reinforced scale economies. This led to
consolidation at the retail level and favoring a shift in the balance of economic power
from the wholesale to the retail level.

The emergence of large supermarket and hyperrnarket retail chains as major
actors in agrifood markets has been accompanied by increased competition and
consolidation. Their activities and the competition they present have had both direct and
indirect impacts on structure of agrifood markets. Direct impacts include shifts in ﬂows
of agrifood products along the marketing chain from the farm to the retail outlet, Indirect

impacts stem from the changes in competitive strategies enacted by other retailers who

seek to keep pace with them, as well as the shifts in production, marketing and
technology choices of their suppliers.

In Brazil, the ten largest retail chains increased their share of the retail market
from 24% to 37% between 1994 and 2000, and supermarkets (including both chains and
independents) currently account for about 75% of food retail sales. The dissertation
investigates the effects of the rise of large supermarket chains within the context of S50
Paulo’s fresh produce markets, focusing on the strategic responses of diverse ﬁrms to the
challenges the large retailers present and their responses to the structural changes that
have occurred in the market. The dissertation addresses change on three levels: a
structural level looking at the entire fresh produce marketing chain, the retail level, and
the grower level. Three broad sets of research questions are addressed: 1) What factors
gave rise to the emergence of large retail chains as major actors in Brazil, and how has
the market structure changed since their emergence? 2) How have retailers responded to
the competitive pressures that they have experienced since the emergence of large chains,
particularly in terms of the organization and institutions governing fresh produce
procurement? 3) How have growers responded to the changed conditions in the market in
terms of their market channel and technology choices?

The dissertation employs two conceptual ﬁelds in its general theoretical
framework. Industrial Organization’s Structure Conduct & Performance (SCP)
theoretical framework studies interactions between the basic market conditions, ﬁrm
strategic conduct, and the market structure, and their implications for market
performance. Transaction Cost Economics looks at the effects of information costs,

information asymmetry and asset speciﬁcity on the governance of transactions. These are

factors underlying the basic conditions of the market that condition ﬁrms’ strategic
conduct, particularly with regard to their willingness to make investments and the
governance of relations between suppliers and buyers.

Data was collected during a year-long ﬁeld research period in 850 Paulo. The
ﬁeld research involved key informant interviews with specialists in academia,
government, and industry; case studies at both the retail and grower levels, and surveys of
retailers, wholesalers, and growers. In total surveys were conducted with 33 retail ﬁrms,
15 tomato wholesalers, 23 tomato growers and 33 lettuce growers. Though the research
focused on issues in the fresh produce markets in general, where greater speciﬁcity was
needed then focus was directed to tomato and lettuce markets. These are two of the most
important fresh produce items produced and consumed in 850 Paulo, and their marketing
chains reﬂect very different physical processes and information problems. Analytical
methods used in the essays are case study analysis, sub-sector analysis, and statistical
procedures including cluster analysis and descriptive statistics.

The dissertation is comprised of ﬁve essays. Each essay constitutes a chapter.
Chapter 2’s essay establishes the background and context for the ongoing changes in the
market. It describes the rise of large retailers and reports survey results on trends in
retailers’ merchandising and procurement strategies and supplier’s production and
marketing strategies. Chapters 3, 4 and 5 analyze retailers’ responses to the changing
competitive environment following the rise of large retail chains. They focus on the
institutional innovations that retailers utilize to ensure adequate supplies of produce that
meets their quality and quantity needs. Chapter 3 analyzes the determinants of retailers’

choices between public and private grades and standards. The chapter builds on the

existing literature on the exogenous factors affecting the emergence of public and private
grades and standards regimes by proposing ﬁrm-speciﬁc characteristics that drive ﬁrms’
adoption decisions. Hypotheses are addressed through a study of retailers’ procurement
behavior in the fresh produce market. Chapter 4 applies the Peterson, Wysocki & Harsh
(PWH) theoretical framework for ﬁrms’ coordination strategy decision-making to case
studies of four ﬁrms’ fresh produce procurement strategies. The chapter analyzes the
evolution of the ﬁrms’ coordination strategies and draws from the results to propose
further hypotheses aimed at reﬁning the framework. Chapter 5 narrows in on the case of
Brazil’s largest retailer, Companhia Brasileira de Distribuicao, and presents the strategic
challenges that they have faced' designing and implementing their own procurement
strategies. This is a teaching case where the problem decision facing CBD and relevant
information to the decision is narrated and the reader is asked to recommend a course of
action. Accompanying teaching notes provide insight into the conceptual issues that are
relevant to the case and reveal the actual decision that was made by the ﬁrm. Chapter 6
examines the ongoing changes in the fresh produce market at the grower level. The paper
uses cluster analysis and descriptive statistics to test hypotheses about the determinants of
ﬁrms’ market channel and technology use decisions. The dissertation concludes with a

synthesis of the major results.

CHAPTER 2
Strategic Responses to Structural Change:

The Recent Evolution of the Fresh Produce Markets of 850 Paulo Brazil

1 Introduction

Over the past decade, Latin America’s agrifood markets have undergone dramatic
change. Large, internationally capitalized retail chains have become major players,
capturing power from the wholesale level and a large portion of market share from other
retailers. Concern among policy makers and other agents in agrifood markets has
intensiﬁed, regarding what the concentration of market share among large retail chains
means for competition in the market and for the welfare of diverse market actors.
Evidence shows that large retail chains have signiﬁcant effects on the structure and
organization of agrifood supply chains both horizontally and vertically, consequently
affecting the participation and welfare of diverse actors. Their activities have been linked
both directly and indirectly to the marginalization and exclusion of smaller and more
resource-poor actors as well as changes in market ﬂows and price discovery (Loseby
1997; Green and Schaller 2000; Reardon, Codron et a1. 2001; Farina 2002; Ghezan,
Mateos et al. 2002; Rodrigues, et a1. 2002; Reardon and Berdegué 2002; Dolan,
Humphrey et al. nd).

These trends are manifest in Brazil, where large retailers have taken a major role in

the post-Real Planl economy, as evidenced by an increase in retail concentration from

 

1 The Real Plan was the ﬁnal of a series of ﬁnancial plans instituted by the Government of Brazil that were
aimed at stabilizing the economy, in particular putting an end to the hyper-inﬂation that had dominated the

Brazilian economy for more than a decade. The Real Plan’s basic approach included 1) the de-indexation of

24% to 47% between 1994 and 2000 (Farina 1999). Some optimism exists, however, over
the prospects of smaller players in food retail markets, as they have made a slight
resurgence in terms of both numbers and market share relative to large chains over the
same period (A.C. Nielsen 2001).

This paper outlines the processes of strategic and structural change in $50 Paulo’s
fresh produce markets, in order to provide insight into questions that are relevant not only
in Brazil, but throughout Latin America and the rest of the developing world. First, how
have changing economic conditions shaped the evolution of the fresh produce market
over the past decade? Second, how have retailers, wholesalers and growers responded to
the changing economic conditions in their strategic behavior and how have these
responses shaped the current market structure? Finally, what hypotheses can be drawn
regarding the continued participation and roles of diverse actors in the fresh produce
market in the near future?

Fresh produce provides an important and interesting case for analysis. It is a sector in
which large retailers tend to lag in capturing market share—their participation is
generally about two-thirds their overall participation in agrifood markets at the country
level (Reardon and Berdegué 2002). Furthermore, fresh produce is considered a small
farmer-friendly sector due to both its high-value for volume produced and high labor and
management-intensity of production. Sﬁo Paulo provides an appropriate site for research

since it produces more than 25% of Brazil’s fresh produce. The state is also responsible

 

prices and salaries, 2) the establishment of a new currency, the real, and 3) liberalization and privatization

of numerous government regulated or owned industries.

for more than 20% of its consumption, which is concentrated in metropolitan Sic Paulo,
a city of more than 18 million.

The remainder of the paper is organized in three sections. In Section 2, a framework
for understanding the interlinked processes of structural and strategic change in agrifood
markets is presented, then applied to the evolution of Sio Paulo’s fresh produce market
from the late 19808 to the late 19905. In Section 3, retailers’ merchandising and
procurement strategies, wholesaler activities, and growers’ production and marketing
strategies are depicted, and the current structure of the fresh produce market is described.
In Section 4, hypotheses are made about the implications of these changes for diverse
actors in the market and policy implications are drawn.

The paper draws heavily on existing literature on the subject (particularly work by
Farina and Machado, Belik, and Chaim). Information on trends in retailers’, wholesalers’
and growers’ strategies are drawn from a survey of 35 in metropolitan Sic Paulo, 15
wholesalers operating in and around Sio Paulo, and 55 lettuce and tomato growers in

peri-urban Sio Paulo.

2 Conceptual Framework

The interlinked processes of strategic and structural change in markets can be
conceptualized with reference to Industrial Organization’s Structure-Conduct-
Perforrnance analytical framework, which examines the interaction of basic market
conditions, ﬁrm conduct and market structure, and their implications for performance in
the market (Caves 1987; Scherer and Ross 1990). Working in the SCP paradigm, Sutton

(1992) analyzes how the endogenous and exogenous elements of sunk cost investments

interact to inﬂuence patterns of industry evolution. Following Sutton, the focus in this
chapter is on how “ﬁrst-moving” retailers’ investment decisions and other strategic
responses to changes in the basic conditions in the market affected the market structure,
and the second-round investment decisions that “follower” ﬁrms made in response to
these changes.

The basic conditions of the market are ﬁxed in the short to medium term and include
the institutional environment and basic conditions of supply and demand. The
institutional environment includes both formal (legislative) and informal (cultural)
controls in the market place that establish norms of behavior and seek to curtail
opportunistic behavior. Supply and demand conditions include costs structures in
production, seasonality of supply and/or demand, the distribution of income, and demand
and supply elasticities. Strategic behavior reﬂects ﬁrms’ attempts to pursue proﬁt and
utility objectives given the constraints imposed by the institutional environment and the
interdependence that exists among market actors (North 1990). Strategic behavior
includes investment in production facilities, research and innovation, pricing practices,
non-price competition, and the organization and governance of relations with suppliers
and clients. At an aggregate level, the conduct of many individual ﬁrms conditions the
market structure——that is, the number of buyers and sellers in the market, the
participation of different types of actors, the degree of product differentiation, cost
structures, and baniers to entry. This process of basic conditions affecting ﬁrm strategies
and market structure is iterative, with feedback loops catalyzing continual change in
many markets. Finally, an aspect of the market of prime interest is that of market

performance. Performance is a multi-faceted concept that refers to the extent to which the

market contributes to diverse valued objectives (Sosnick 1964]. Here two dimensions of
performance will be addressed—price and quality. Speciﬁcally, a market performs well
with respect to quality if the quality of produce that consumers seek and are willing to
pay for is available to them to purchase. A market performs well with respect to prices if
the prices at which produce is bought and sold approximate the marginal costs of
production and the marginal beneﬁts of their consumption (which are equal to one
another in a competitive equilibrium).

Of key importance to the evolution of the fresh produce market in particular is how
the characteristics of fresh produce lead to high information costs and asymmetry,
increasing transaction costs and risks for market actors who have limited access to
information and limited information-processing capacities. This increases
interdependence between market actors, affects their strategic behaviors and
consequently the organization and structure of the market. Speciﬁcally, fresh produce is a
very perishable product whose quality is sensitive to handling and post-harvest treatment.
Damage to fresh produce does not necessarily Show up when it is inﬂicted, increasing the
risk of a buyer unknowingly purchasing damaged produce, and making it difﬁcult to
allocate responsibility once damage is evident. Furthermore, if produce has value-added
attributes that are difﬁcult and costly to identify and preserve, then specialized marketing

needs increase the cost and risk of opportunistic hold-up and coordination failures.

3 Empirical Application to Sio Paulo’s fresh produce market
The rise of large retail chains in Sic Paulo follows patterns identiﬁed in other

countries, both more and less developed (Loseby 1997; Green 2000; Farina 2002;

Reardon and Berdegué 2002; Dolan, Humphrey et a1. nd). Brieﬂy put, shifts in
underlying supply and demand conditions affected strategic incentives in the fresh
produce markets, altering retailer behavior with consequent effects for market structure.
On the demand side, increasing urbanization, the growing participation of women in the
paid labor force, and rapid growth in real mean per capita income during the 19905
shifted consumer purchase patterns in favor of supermarkets, especially large retail
chains, over traditional retail formats. On the supply side, the proliferation of the large
chains was facilitated by trade liberalization and reduced regulation of foreign direct
investment, as well as advances in production, communications, processing, storage and
transportation technologies, leading to innovations in organization and coordination and
resulting in consolidation at the retail level. Together these factors are associated with
multinational supermarket and hypermarket chains’ quick rise to dominance in agrifood
markets worldwide.

Three recent phases of evolution are discernable in Sio Paulo’s fresh produce
markets. Phase 1 takes place prior to economic liberalization and stabilization in the late
19805 and to the mid-19905. This stage is associated with a weak institutional
environment and a general lack of economic incentives to invest, and consequently a lack
of dynamism among ﬁrms in the fresh produce market. Phase 2 is a transitional stage,
begun with market liberalization and economic stabilization, which catalyzed new
investments and competitive strategies on the part of some “ﬁrst-moving” ﬁrms. Phase 3
is the post-stabilization phase during which the rest of the retailers make their own

strategic responses to the new patterns of competition and market structure that have been

10

forged during Phase 2. The evolutionary phases that are described below are summarized

in Table 1.

Table 1 Evolution of Basic Conditions, Firm Conduct and Market Structure

 

Basic Conditions

F inn Strategic Conduct

Market Structure

 

 

 

 

Phase Weak institutional No productive investment Many small growers
1 environment Retailers proﬁt through Few, concentrated
Poor incentives to invest playing inﬂation-induced wholesalers
“ﬂoat” Many small retailers
Phase Economic stabilization &- “First mover” retailers Increasing retail
2 liberalization of controls Increase market share concentration
on foreign investment through mergers & Bifurcation of
acquisitions marketing chain
Seek to reduce costs and
improve quality through
procurement centralization
and direct purchases
Phase Changed structural “Follower” retailers invest Diversity of retailers et
3 conditions including to reduce costs and Marketing chain

 

Different product ﬂows
Different demand
characteristics

Changed cost structures

 

improve quality
“First-movers” seek new

market niches

 

bifurcation reinforced
Horizontal and vertical

market segmentation

 

11

 

3.1 Phase 1: The pre-liberalization, pre-stabilization market environment

Basic conditions: In the late 19805, prior to market liberalization and economic
stabilization, the functioning of the fresh produce market was heavily inﬂuenced by the
general economic crisis afflicting Brazil and a weak institutional environment. Brazil’s
economic crisis was reﬂected in elevated inﬂation (up to 80% a month and averaging
105% per year in the late 19805), reduced real incomes and high price sensitivity among
consumers, and legislated price freezes that depressed demand and restricted
opportunities for proﬁtable investment (Chaim 1999; Helfand and de Rezende 2001;
Retail Forward 2001). The institutional environment in which fresh produce trade took
place was also very weak. Poor contract enforcement and low transparency due to the
inadequacy of the public system of grades and standards and the lack of a market
information system raised the transaction costs and risk involved in trade in fresh produce
(Farina and Machado 1999).

Strategic conduct: Together, these factors contributed to a general dearth of
incentives to undertake productive investment to increase efﬁciency, improve
coordination, or reduce waste. Retailers’, wholesalers’ and growers’ behaviors reﬂected
this skewed incentive environment. Retailers sought to proﬁt through ﬁnancial
management techniques that took advantage of the inﬂation-enhanced ﬂoat on receipts
and expenditures rather than productive investments to expand markets or reduce
marketing costs (Chaim 1999; Retail Forward 2001). Fresh produce wholesalers were
well entrenched in the public markets, and beneﬁted from the information asymmetries
caused by the lack of transparency (for example no clearly speciﬁed or enforced grades

and standards), which left them with privileged information about supply and demand

12

conditions, giving them advantages in their negotiations with suppliers and buyers. This
facilitated tacit collusion and oligopsonistic trade practices (Farina and Machado 1999;
Zylbersztajn, Farina et al. nd). Meanwhile, growers’ small scales and geographic
dispersion left them dependent on wholesalers for the performance of marketing
functions and with little access to information on current market conditions. The non-
existence of consistently employed grades and standards meant that there was no reward
for producing high quality produce, encouraging instead a focus on increasing the
quantity of production regardless of quality.

Market structure: During this phase, the fresh produce market was comprised of a
primary physical market channel served by a large number of geographically-dispersed
small farmers; a large number of wholesalers who were based in the public2 wholesale
markets and who worked in close proximity to one another and tended to specialize in the
items they traded; and many small traditional retailers including open-air market vendors,
comer markets, small and medium-sized supermarkets and food service ﬁrms.

Given the general lack of a quality-orientation in the market, the lack of
transparency, and the concentration of power at the wholesale level, informal relations of
mutual trust and obligation were key institutions facilitating fresh produce transactions.
These informal relations were often based on social, ethnic, and community ties, and
served as the basis of “preferred” buyer and supplier relationships which mitigated
incentives to undertake opportunistic behavior (Makabe 1999; Zylbersztajn et al. nd). In
the absence of such relationships, or in combination with them, ﬁrms also relied on labor-
intensive procurement practices involving the inspection of individual lots of fresh

produce prior to their purchase and sorting for quality afterwards.

 

2 The term “public” is used here to refer to access, rather than ownership.

13

Market performance: At ﬁrst blush, one might surmise that the fresh produce was
performing very poorly during this period. This was true in some respects, but not all.
Considering the performance dimensions of the quality and price of produce available to
consumers, and the price at which they could purchase it, it is apparent that organoleptic
quality tended to be quite low. This does not in itself indicate poor performance,
however, in fact given the lack of demand for high quality produce due to the economic
conditions in the country, the quality can be said to have been roughly reﬂective of
demand in the market, which would be a positive indicator of performance. In terms of
price, however, the concentration of market power at the wholesale level and the
information asymmetries that they beneﬁted resulted in both lower prices to growers than
would likely have been seen in a market environment that more closely resembled
“perfect competition.” Likewise, it is likely that retailers and consumers also paid more

than they otherwise would have.

3.2 Phase 2: Market liberalization and economic stabilization transition

Basic conditions: In the late 19805 and early 19905, the Brazilian economy was the
subject of programs of market liberalization and economic stabilization that signiﬁcantly
altered a number of the basic conditions underlying market structure and ﬁrm conduct
(Farina 1999; Belik and dos Santos ). The most fundamental change was economic
stabilization that resulted from implementation of the 1994 Real Plan. Economic
stabilization ended hyperinﬂation and opportunities for ﬁrms to proﬁt through ﬁnancial
management strategies. It also increased consumers’ incomes, boosting demand for fresh

produce among other products. As the attractiveness of Sic Paulo’s fresh produce market

14

grew for investors, trade liberalization reduced constraints to international retail
participation, facilitating the entry of international investment capital and new
competition.

Strategic conduct: The changes in these basic conditional variables led to rapid
responses in some retailers’ competitive strategies. “First-moving” retailers’ adopted a
mix of strategies oriented to market expansion and cost reduction. Market expansion was
generally pursued through mergers and acquisitions (de Oliveira e Silva 1999) and entry
into emerging markets for high-value products. Between 1997 and 1999, the ﬁve largest
supermarket chains in Brazil absorbed 17 other supermarket chains (Chaim 1999 p34).
Meanwhile, economic stabilization led to growth in consumer purchasing power across
all income strata, and increased demand for produce with a wide range of attributes, such
as convenience, perceived healthfulness, and better organoleptic quality. Markets for
“Specialty” product lines like organic, fresh-processed, hydroponic, and pre-packaged
produce emerged.

As mergers and acquisitions led to increases in the volume of fresh produce traded
by individual ﬁrms, “ﬁrst movers” capitalized on their large scale and scopes (volume-
wise, product-wise, and geographic) to implement innovative procurement systems that
enabled them to reduce costs and improve the variety, quality, and consistency of the
products and services offered. They constructed centralized facilities for fresh produce
procurement, shifted procurement away from the public wholesale markets towards direct
purchases from production regions and instituted more formal governance of

relationships with suppliers (Farina and Machado 1999). These investments, though

15

involving high startup costs, allowed ﬁrms to reduce the marginal search costs of produce
acquisition as volumes of throughput grew.

Market structure: Following the strategic moves of the dominant retailers, the fresh
produce market structure shifted to reﬂect 1) increased concentration at the retail level, 2)
changed cost structures, and 3) a bifurcation of the marketing chain. Each of these shifts

in discussed below.

1) Increased retail concentration: While yearly data on concentration in fresh produce
markets is not available, ﬁgures on concentration in retail food markets provide a good
indication for fresh produce markets. Between 1995 and 1998, the share of supermarket
and hypermarket chains in retail markets (food and non-food) increased from 44.4% to
46.6% (A.C. Nielsen 2001), and supermarkets currently account for 75% of retail food
sales in Brazil (Farina 2002 p3). These ﬁgures are expected to be lower in markets for
perishable foods like fresh produce due to the tendency for smaller stores to specialize in
their provision and the persistence of consumers’ traditional purchase patterns for such

products.

2) Changed cost structures: Among the largest chains, the investment in centralized
purchase and distribution facilities has four major implications for cost structures of fresh
produce procurement. First, they permit the retailer to integrate the wholesale function,
allowing direct purchases from growing areas, cutting out the wholesale stage of the
marketing chain. Second, the integration of the wholesale ﬁrnction enables cost savings

through economies of scale and scope, facilitating chains’ purchase of large lots of

16

produce for redistribution to individual stores and providing cost savings of up to 30%
(Belik 2000 p152). Third, they are crucial to the establishment of more advanced
logistical systems such as mechanization of loading and unloading, palletization of
shipments and information-intensive logistical procedures such as Electronic Data
Interchange and continual replenishment. Fourth, their establishment presents a barrier to
entry in the market, both because of the large ﬁxed costs of establishing the physical
infrastructure, and because they have a minimum efﬁcient scale of operation (estimated

at 2000 tons per month (de Souza et al. nd)).

3) Bifurcation of the marketing chain: The concentration of buying power among large
retailers and their tendency to buy direct from the growing areas led to shifts in the
structure of the marketing chain that supplies these retailers. Initially, the marketing chain
consisted of a single predominant channel (referred to here as the “traditional marketing
chain”) along which produce moved from growing regions through the public wholesale
markets to retailers. With shifts in large retailers’ procurement practices, there was a
bifurcation of the marketing chain to also include a series of private supply channels that
moved produce from the growing area to private distribution centers and then to

individual retail outlets.

Market performance: In the move from the ﬁrst to the second phase, the shifts in
the basic conditions, consequent strategic responses and resulting structural changes in
the market led to improvements in market performance. Speciﬁcally, increases in demand

for quality produce were matched by efforts to provide the quality and varieties of

17

produce sought due to higher levels of competition in the market. This was accompanied
by price reductions for consumers due to increases in the efﬁciency along the marketing
chain. Furthermore, growers not only saw new opportunities for production (to respond to
demand for new products), but the shift away from reliance on the traditional wholesale
market also provided them with alternative avenues to market their produce that

circumvented the traditional wholesale market.

3.3 Phase 3: Post-stabilization

Basic conditions: Changes to the basic conditions in the market in the third phase
were a direct result of the market restructuring that resulted from the “ﬁrst movers’”
strategic actions in the prior stage. This market restructuring presented new challenges to
the “follower” or “non-dominant” retailers in the market, inducing shifts in their own
strategic behavior in the third phase.

Strategic conduct: Four types of retailers currently operate in the market
(deﬁnitions of these are also given for reference in a Glossary in Appendix A)3. The
“ﬁrst-moving” retailers of the second phase of evolution became the “dominant” retailers
of today. These are the large super and hypermarket chains. Three other groups,
categorized here as “non-dominant” retailers include small and mediums grocery and
supermarkets, discount green grocers, and open-air fairs.

The market share held, competitive points and sizes and scales of each of these

retail formats are summarized in Table 2. The size and scope of the fresh produce sectors

 

3 A ﬁfth group, depicted in the ﬁgure, are food service providers. These are not discussed here due to

scarcity of data.

18

of different formats are summarized in Table 3. Super and hyper-market chains, and
small and medium-sized supermarkets are both full-line retailers selling general
merchandise, dry foods, and perishables (including meats, dairy, and fresh fruits and
vegetables). The large chains tend to focus on carrying bulk produce, while specialized
products such as organics, pre-packaged, pre-processed, and hydroponic produce often
have an important place in stores that attend a wealthier clientele. Small and medium-
supermarkets ﬁrms generally carry relatively small volumes of a variety of fresh produce
items, and seek to respond to consumers’ willingness to pay for convenience, quality and
variety. Discount green grocers and open-air fairs, on the other hand, are specialized
vendors of fresh produce, though they sometimes carry a limited range of other
perishable foods as well. Discount green grocers offer low prices, variety, freshness, and
the convenience of extended hours. Open-air fairs attract clients who value the product
variety, quality, customized service, and tradition that they offer. The Household Budget
Survey of 1996 (the most recent available) attributes 23% of retail sales of fresh produce
in Sic Paulo to supermarkets and hypermarkets (of all sizes), 24% to discount green
grocers, and 43% to open-air fairs, and just under 8% to grocery shops who are treated
here under the category of small and medium-sized grocery and supermarkets (IBGE
1996). This reﬂects a 22% decline in purchases from open-air fairs for fresh produce
since 1986, in favor of increased purchases from supermarkets and discount green

grocers (which are a relatively new format).

19

Table 2 Sio Paulo’s Fresh Produce Retailers

 

 

 

 

 

 

 

 

 

 

 

Large super
Small and
and Discount green Open-air
medium
hypermarket grocers fairs
supermarkets
chains
Share of produce
31% 24% 43%
sales
Variety,
Price, Price, service,
Price, service,
Competitive convenience convenience
convenience freshness,
strengths (one-stop (hours,
(hours, location) tradition,
shopping) location)
quality
Number of outlets 105 2 7 1
Store sales area (m2) 5760 837 730 23
Revenue (R$,000/yr) 2,561,985 4,084 1,468 102

 

 

*Source: IBGE Houshold Budget Survey 1996

 

“Follower” retailers have responded strategically to the changing market

conditions in two areas: 1) merchandising and 2) procurement. Their efforts in

merchandising have been directed to increasing their participation in emerging niches for

specialty products such as pre-packaged, fresh-cut, organic, and hydroponic produce.

Specialty produce markets represent a small share of fresh produce sales, but are among

the most dynamic markets, showing high growth rates particularly among wealthier

clientele who are willing to pay for the extra convenience, healthfulness, and quality that

20

 

specialty produce is perceived to offer relative to conventionally-produced produce.
These high-value segments are served primarily by large retail chains and small and
medium-sized supermarkets oriented to high-income clientele where they constitute on
average 32% and 41% of retailers’ fresh produce sector revenues, respectively, as seen in

Table 3.

Table 3 Role of Fresh Produce Sector by Retail Category

 

 

 

 

 

 

 

Small and Discount
Large super and Open-air
medium green
hypermarket chains fairs
supermarkets grocers

Number of fresh

359 232 111 42
produce items sold
Fresh produce sales

473 202 636 23
area (m2)
Number of FLV

8 8 14 5

employees per store
Fresh produce share of

13% 14% 88% 100%
total sales area
Fresh produce share of

8% 15% 89% 94%
ﬁrm revenue
Specialty produce share
of fresh produce 32% 41% 12% 15%
revenue

 

 

 

 

 

 

 

21

Trends in retailers’ procurement activities: Some retailers, but not all, have also
changed their procurement strategies with the aim of improving product quality and
reducing costs. Changes to procurement strategies have most commonly involved shifts
in the organization of procurement and sources of produce. Produce procurement can be
centralized, decentralized or contracted out. Centralized procurement means that the
headquarters of the ﬁrm or some other central authority is responsible for tasks such as
deciding what to buy, choosing suppliers and making product orders and delivering
produce to individual outlets. Decentralized procurement means that each of these tasks
is the responsibility of individual outlets. Contracted out procurement means that the
tasks have been contracted out to a third party, often a supplier or distributor who
conducts them on the retailers’ behalf. Table 4 summarizes trends in procurement
strategies for each major retail format for tomato and lettuce. The table shows the
consolidation of shifts in procurement on the part of large chains—ﬁve years ago 2/3 of
the respondent ﬁrms had centralized procurement for tomatoes compared to 100% in the
current period. For leafy greens, on the other hand, there was a process of
decentralization—ﬁve years ago 100% of procurement was centralized, however in the
current period 2/3 of the ﬁrms decentralized their procurement. This is due to the high
perishability of lettuce and the lack of a cold chain in the area which make decentralized
procurement better for product quality. It is important to note, though, that while the
individual retail outlets are responsible for procurement in a decentralized system, among
the large chains the outlets must still choose from a list of approved suppliers and follow
negotiation guidelines provided by the headquarters. In contrast to the large chains,

smaller retail formats have been less prone to alter the organization of their procurement

22

activities, with the most signiﬁcant exception being shifts among some discount green
grocers to decentralized procurement strategies in place of contracting out for lettuce

procurement.

Table 4 Trends in the Organization of Bulk, Leafy Green, and Specialty Produce
Procurement

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Large Small &
Discount Green Open-air F air
Supermarkets & Medium
Grocer Vendors
Hypermarkets Supermarkets
5 years 5 years 5 years 5 years
Current Current Current Current
ago ago ago ago
Tomato (Bulk)
Centralized 100% 67% 42% 40%
Decentralized 33% 86% 83% 50% 50% 100% 100%
Contracted out 14% 17% 8% 10%
Leafy Greens
Centralized 33% l 00% 9% 9%
Decentralized 67% 86% 83% 73% 64% 100% 100%
Contracted out 14% 17% 18% 27%

 

 

 

 

 

 

 

 

 

 

 

Though the organization of procurement has changed little among smaller
retailers, there have been signiﬁcant shifts in the sources of procurement among them.
Table 5 shows sources of produce categorized among growers, distributors, wholesalers,

and a mix of wholesalers and growers. The Growers category includes individual

23

producers, associations and intermediaries who are based in the growing regions.
Distributors are small ﬁrms who purchase produce, typically from the wholesale market,
and re-distribute it among retailers who contract their services. Wholesalers are those
actors based at the traditional wholesale market. The table shows that over the past 5
years, 2/3 of the large chains shifted from tomato purchases in the wholesale market to
purchases from the growing regions. They have also increased the proportion of
purchases of lettuce from the growing region to 100%. Small and medium-supermarkets
have likewise reduced their reliance on the wholesale market for tomato, shifting instead
purchases from the growing region and distributors. For lettuce, the move away from the
wholesale market has been even more pronounced—none of the small and medium-
supennarkets interviewed relied wholly on the wholesale market for lettuce anymore,
whereas 60% of the respondents had ﬁve years ago. Among discount green grocers, there
has been an interesting shift—over the past ﬁve years, some of these ﬁrms actually
increased their reliance on wholesale markets for tomatoes. This could be due to the fact
that they try to make their product available year-round which is easier to do buying from
the wholesale market. In lettuce, however, they have followed the overall trend of
shifting purchases from the wholesale market toward growers. Finally, the open-air
vendors have shown the least tendency towards changing their sources of fresh produce.
Among these actors, there has been only a marginal increase in the purchase of lettuce
from growers at the expense of the wholesale market.

Table 6 complements the information on trends in retailers’ organization and
sources with information on trends in the numbers of suppliers of tomato and lettuce over

the past ﬁve years. The results here are mixed. Large supermarket and hypermarket

24

chains have only slightly increased the numbers of tomato suppliers, but have greatly
increased the number of lettuce suppliers they buy from—from three ﬁrms on average to
20. This makes sense given the shift toward decentralization of lettuce purchases among

these ﬁrms and increased purchases from the growing areas—it takes more ﬁrms to

Table 5 Sources of fresh produce by retail type

 

Large Small & Medium Discount Green Open-air F air
Supermarkets & Supermarkets Grocer Vendors
Hypermarkets

 

Current 5 years Current 5 years Current 5 years Current 5 years

ago ago ago ago

 

 

 

 

 

 

 

 

 

Tomato

 

Growers 67% 0% 14% 0% 17% 30% 13% 13%

 

Distributors 33% 33% 29% 17% 0% 0% 0% 0%

 

Wholesalers 0% 67% 57% 83% 50% 50% 63% 63%

 

Wholesalers 0% 0% 0% 0% 33% 20% 25% 25%

/ Growers

 

 

 

 

 

 

 

 

 

Leafy Greens

 

Growers 100% 67% 60% 40% 46% 44% 44% 38%

 

Distributors 0% 33% 20% 0% 0% 0% 0% 0%

 

Wholesalers 0% 0% 0% 60% 27% 44% 44% 50%

 

Wholesalers/ 0% 0% 20% 0% 27% l 1% l 1% 13%

Growers

 

 

 

 

 

 

 

 

 

 

25

 

distribute lettuce among the many stores interspersed throughout metropolitan Sic Paulo,
and there is a greater emphasis on buying from growers rather than wholesalers. While
large chains and small and medium supermarkets have both tended to increase the
numbers of total and regular suppliers or lettuce and tomato, discount green grocers and
open-air fair vendors have both shown decreases in the number of suppliers serving them.
Discount green grocers have half the number of regular tomato suppliers now compared
to ﬁve years ago, while fair vendors have shown slight decreases in the number of regular
tomato vendors and reductions of approximately 20% in the number of regular lettuce

suppliers. It is unclear why these shifts would have taken place.

Table 6 Number of Total and Regular Suppliers, Current & 5 Years Ago

 

Large Small & Medium Discount Green Open-air Fair
Supermarkets & Supermarkets Grocer Vendors
Hypermarkets

 

Current 5 years Current 5 years Current 5 years Current 5 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ago ago ago ago
Tomato Suppliers
Total 4 2 4 3 7 ll 14 14
Regular 3 2 4 3 3 6 9 1 1
Lettuce Suppliers
Total 20 l 1 3 2 3 3 1 3 17
Regular 20 3 3 2 3 2 1 2 l 5

 

 

 

 

 

 

 

 

 

 

 

26

Wholesaler responses to the changed market environment: As both the large
chains and some smaller retailers have shifted their purchases to the growing areas, there
has been a proliferation in the number of specialized wholesalers based in these areas and
working independent of the traditional wholesale markets. These wholesalers have sought
to serve retailers’ demand for differentiated products and services at competitive prices.
In tomato markets, for example, approximately ten new classifying plants have been built
in the growing regions around Sic Paulo since the mid—19905 and several more are being
completed (in comparison, there are about 30 tomato wholesalers in the major traditional
wholesale market, with approximately 80% of the trade there conducted by the ten
largest). These classiﬁers differ from the wholesalers in the traditional wholesale market
(some of whom also have their own classifying plants) in that they offer a quality-
differentiated product that moves directly from the growing areas to the retailers. For
example, nearly all the tomato moving from the wholesale market is packed in wooden
crates that are known to be unsanitary and to damage the product. The newer classiﬁers,
in contrast, pack their tomatoes in sanitized plastic crates and single-use cardboard boxes.
They also label them more comprehensively with information on the absolute size (in
millimeters) color and % defects, compared to the wholesale market where size is labeled
on a relative basis (e.g. large) and other precise quality parameters are absent. Not
surprisingly, the large supermarket and hypermarket chains and small and medium-sized
supermarkets account for a large portion of their sales while the traditional market

wholesalers are more oriented to smaller retailers, as seen in Table 7.

27

Table 7 Traditional and Growing Region Tomato Wholesaler Market Channels

 

 

 

 

Traditional Growing
Market Region
Supermarket Channel Buyers 46% 68%
Intermediary & Wholesale Market Buyers 6% 28%
Small Retailers and Fresh Processors 48% 5%

 

 

 

 

 

Trends in growers production and marketing activities: As retailers and
wholesalers have accommodated themselves to the new market environment, it is
probable that growers have also altered their production and marketing strategies to
account for changing economic conditions. Tables 9-12 reports the results of comparison
of means tests on trends over the past ﬁve years over the role of agriculture and
horticulture in family incomes, growers’ production activities and their market choices
for small and large tomato and lettuce growers. As deﬁned in Table 8, small lettuce
growers are those producing on between 1 and 5 hectares, and large produce than 6
hectares. Small tomato producers are those producing on up to 16 hectares, while large
tomato growers are producing on 17 hectares or above.

Table 9 reports results for small tomato farmers. It shows an increase in the share
of vegetable income in growers’ agricultural revenue in general, while the role of
agriculture in family incomes did not change appreciably. They also showed an increase
of about three hectares in the area of land they dedicated to tomatoes. A larger increase of
nearly 15 hectares in the increase in total land cultivated was not statistically signiﬁcant
at a 10% level. Finally, there were no statistically signiﬁcant changes in the shares of

sales going to different types of buyer.

28

Table 8 Definition of Small vs. Large Lettuce and Tomato Producers (hectares)

 

 

 

 

 

 

 

 

 

 

 

Small Large
Min. Max Mean Min. Max. Mean
Lettuce l 5 3 .8 6 120 24.95
Tomato 3 16 8.7 17 125 37.33

 

Table 9 Small Tomato Growers’ Activities Current and 5 Years Ago: Comparison

of Mean Values

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Variable Current 5 Years Ago t-stat Signif.
Role of Agriculture and Horticulture in Income
Agriculture share of family budget 78% 79% -.430 .676
Vegetable production as share of 62%* 46% 2.136 .058
agriculture income
Production Activities
Total area cultivated (ha.) 87 72 1.406 .190
Vegetable area cultivated (ha.) 9* 6 2.090 .063
Marketing Activities
Share of sales to Intermediary (%) 71% 78% -.769 .464
Share of sales to Wholesale market 18% 6% 1.369 .208
Share of sales to Classiﬁer 10% 0% 1.146 .285
Share of sales to Other buyers 1% 6% -.906 .391

 

*Signiﬁcant at a 10% conﬁdence level

29

 

 

Table 10 reports results for large tomato farmers. Large tomato farmers showed an
increase in the contribution of their vegetable production to their agricultural revenue of
22 hectares over ﬁve years. There were no signiﬁcant shifts in the role of agriculture in

the household budget, in their total areas cultivated or in their marketing channels.

Table 10 Large Tomato Growers’ Activities Current and 5 Years Ago: Comparison
of Mean Values

 

Variable Current 5 Years Ago t-stat P>|t|

 

 

 

 

 

Role of Agriculture and Horticulture in Income

 

Agriculture share of family budget 79% 80% -.142 .889

 

Vegetable production as share of 84%* 62% 2.102 .059

agriculture income

 

 

 

 

 

Production Activities

 

 

 

 

 

 

 

 

 

 

 

 

Total area cultivated (ha.) 108 108 -.010 .992
Vegetable area cultivated (ha) 39 34 .482 .640
Marketing Activities

Share of sales to Intermediary (%) 45% 44% 1.000 .347
Share of sales to Wholesale 23% 22% .028 .978
market

Share of sales to Dealer 11% 11% -- --
Share of sales to Classiﬁer 0% 0% -- --
Share of sales to Other buyers 21% 11% .942 .374

 

 

 

 

 

 

 

*Signiﬁcant at a 10% conﬁdence level

30

Table 11 Small Lettuce Growers’ Activities Current and 5 Years Ago: Comparison
of Mean Values

Variable Current 5 Years Ago t-stat P>|t|

 

 

 

 

 

 

Role of Agriculture and Horticulture in Income

 

 

Agriculture share of family 96% 98% -1.232 .237
budget

Vegetable production as share of 98% 93% .610 .551
agriculture income

 

 

 

 

 

Production Activities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total area cultivated (ha.) 3.8 5.5 -1 .464 .165

Vegetable area cultivated (ha.) 3.8 5.5 -1.433 .174
Marketing Activities

Share of sales to Large Chain 0% 1% -1.000 .333

Share of sales to Small and 3% 2% 1.000 .333

Medium Supermarket

Share of sales to Intermediary 48%* 41% 2.021 .062

Share of sales to Other Retailer 36%* 46% -2.242 .041

Share of sales to Wholesale 1% 5% -1.035 .317

Market

Share of sales to Processor or 6% 6% 1.000 .333

Consumer

Share of sales to Coop 6% 0% 1.253 .229

 

 

 

 

 

 

 

*Signiﬁcant at a 10% conﬁdence level

31

Table 11 shows that there were no signiﬁcant changes in the role of agriculture or
vegetable production in small lettuce growers’ incomes, however their market channels
did change over the past ﬁve years. Speciﬁcally, the share of their sales going to traveling
intermediaries increased from 41% to 48%, while the share of sales going to small
retailers (such as open-air fair vendors who were shown in the section on retail trends to
have made little change in the sources of their fresh produce) decreased by 10%--from
46% to 36%.

Finally, Table 12 shows that large lettuce growers made no statistically signiﬁcant
changes to their production or marketing activities over the past ﬁve years, nor did the
role of agriculture and vegetable production in their incomes change.

Shifts in public sector activities: There have also been responses in the public
sector that have been intended to help strengthen the performance of the traditional
market channels in order to slow the erosion of the product ﬂows through it. These
responses include investments into strengthening the physical, communications and
institutional infrastructure at the public wholesale markets. Such efforts include
upgrading the physical facilities, the initiation of a database providing information on the
payment histories of wholesalers and retailers in the market (to combat the prevalent
problem of non-payment by buyers), efforts to establish a stronger system of grades and
standards, and experiments with electronic auctions (Anonymous 1999; Lima 1999;

Lourenzani, Filho et a1. 2001; Gutierrez 2001).

32

Table 12 Large Lettuce Growers’ Activities Current and 5 Years Ago: Comparison
of Mean Values

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Variable Current 5 Years Ago t-stat P>|t|
Role of Agriculture and Horticulture in Income
Agriculture share of family 95% 97% -.620 .544
budget
Vegetable production as share of 98% 99% -.620 .544
agriculture income
Production Activities
Total area cultivated (ha.) 25 226 1.187 .254
Vegetable area cultivated (ha.) 25 22 1.075 .300
Marketing Activities
Share of sales to Large Chain 9% 5% 1.333 .204
Share of sales to Small and 9% 10% -.344 .736
Medium Supermarket
Share of sales to Intermediary 31% 25% 1.042 .315
Share of sales to Other Retailer 33% 39% -1.586 .135
Share of sales to Wholesale 2% 16% -1.622 .127
Market
Share of sales to Processor or 5% 6% -l .108 .287
Consumer
Share of sales to Cooperative 11% 0% 1.753 .101

 

 

 

 

 

 

 

33

Current market structure: The current market structure has several outstanding
features that have emerged as a result of the interaction of the ﬁrst-moving and follower
retailers’ strategic responses to the changing competitive environment. First, though there
are high levels of retail concentration, these are juxtaposed with a diversity of retail types
with different output and procurement strategies. Second, the bifurcation of the marketing
chain has been reinforced by the responses of non-dominant retailers as they seek to cut
costs and improve quality. Third, the market is highly segmented, both horizontally and
vertically, with different coordination requirements for each segment’s supply. Each of
these features is discussed below. A diagram of the fresh produce marketing chain is
shown in Figure 1.

High levels of retail concentration while diversity is maintained: Combining the
information on trends in retailers’ practices with aggregate information available about
market structure and performance, a picture emerges in which the competitive pressures
of the late 19905 forced a “consolidation” in fresh produce markets that led to the
weakest ﬁrms exiting the markets while others found their niches. Contrary to the
expectations of many experts, this didn’t lead to the emergence of a single retail format—
the large supermarket/hypermarket chain—as predominant in fresh produce markets. The
retailers who were subject to this process of consolidation can be divided in three groups
with reference to the action they took and the results of these actions. First, there are
those who either undertook no signiﬁcant response to the changed competitive
environment or for whom the response taken was insufficient. Little is known about the
ﬁrms that exited the market, but it is evident that small and medium-sized supermarkets

saw very variable performance in the second and third phases. According to de Angelo

34

and da Silveira (2000), small and medium-sized supermarkets saw a 60% drop in real
revenue between 1994 and 1998. More recently, however, both the numbers and market
share of small and medium-sized independent retailers have increased (at the expense of
both traditionals and chains)——from 13.3% of food retail ﬁrms and 44% of sales in 1994,
to 16.6% of ﬁrms and 44% of sales in 2000, as shown in the Table 13. These ﬁgures are
likely even greater for fresh produce given that smaller ﬁrms tend to specialize in the sale
of perishable foods including fresh produce (Farina 2002).

Little is known about the ﬁrms that exited the market, but it is evident that small
and medium-sized supermarkets saw very variable performance in the second and third
phases. According to de Angelo and da Silveira (2000), small and medium-sized
supermarkets saw a 60% drop in real revenue between 1994 and 1998. More recently,
however, both the numbers and market share of small and medium-sized independent
retailers have increased (at the expense of both traditionals and chains)—from 14% of
food retail ﬁrms and 40% of sales in 1994, to 17% of ﬁrms and 44% of sales in 2000, as
shown in the Table 13. These ﬁgures are likely even greater for fresh produce given that
smaller ﬁrms tend to specialize in the sale of perishable foods including fresh produce
(Farina 2002).

Reinforcement of the bifurcation of the marketing chain: Finally, efforts on the part of
some of the smaller retailers to cut costs and improve product quality have reinforced the
erosion of the public supply chain, begun by the ﬁrst-moving retailers in the second
phase. These efforts have been facilitated by the producer-wholesaler intermediaries in
the growing areas, many of whom were established with the express purpose of supplying

the largest retail chains, but have since sought to diversify away from them in order to

35

 

diversify their buyer portfolios, and particularly to cultivate relations with smaller

retailers whose business and negotiating practices they prefer.

Table 13 Food Market Participation in Brazil by Traditional, Chain and
Independent Retailers

 

Concentration Index by Number of Stores

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1994 1995 1996 1997 1998 1999 2000
Traditionals 85.0% 84.5% 84.5% 84.8% 84.4% 82.1% 82.3%
Chains 1.5% 1.5% 1.4% 1.3% 1.3% 1.2% 1.1%
Independents 13.5% 14.4% 14.1% 13.9% 14.3% 16.7% 16.6%
Concentration Index by Sales Volume

1994 1995 1996 1997 1998 1999 2000
Traditionals 1.49% 15.3% 15.6% 15.4% 15.6% 13.7% 13.2%
Chains 45.1% 44.4% 44.6% 44.9% 46.6% 44.7% 42.8%
Independents 40.0% 40.3% 39.8% 39.7% 37.8% 41.6% 44.0%

 

 

 

 

 

 

 

 

Source: A.C. Nielsen.

The public wholesale market remains an important source of fresh produce for smaller

buyers (small and medium-sized supermarkets, open-air fair vendors, and restaurants in

particular), discount green grocers to some extent, and also serves to complement large

retail chains’ purchases of produce from the growing areas. It plays an increasingly

marginal role in the provision of highly perishable items, as exempliﬁed by lettuce—in

1990, 55% of the Sic Paulo’s lettuce production passed through the main public

36

 

wholesale market, but this ﬁgure had declined to only 8% by 1999. In contrast, though

the proportion of state production of fresh tomatoes, which are less perishable, marketed

Figure 1 Sio Paulo Fresh Produce Market Flows

Wholesalers and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Producers ——+ . , —~ Retailers—> Consumers
servrce provzders
l —* Open-air
l Fairs Bulk
. Individual Traditional _. Market
. Producers “Public” T'—- Discount Green
I Mar k“ —. Distributors a” Grocers
l Wholesalers
: _- Food Service SPOOF
! Providers ervrcc
I Producers in I d d t
Partnerships, ’31:? en in _. Fresh
Associations rvate ”0668075 ”Small & Mediu H
.j and Wholesalers Supermarkets _
3 Cooperatives 81:33:23
‘ Large Chains .
Niches

 

 

 

 

 

 

 

 

*Note: Box sizes do not indicate relative importance of different market sectors

though the public wholesale market fell from 62% in 1991 to approximately 45% in
1996, it has held steady at this level since. Meanwhile, the public market plays virtually
no role in trade in the very dynamic and quickly expanding markets for specialized
produce items that have thinner markets and require tight coordination between buyers
and sellers. For these products, private supply channels predominate, for example, an
umbrella organization of organic brands (themselves comprised of associations of

producers or producer-wholesalers), the Group of Organic Marketers, accounts for

37

approximately 90% of the organic produce sold in the country, all of which is marketed
through private supply channels (PENSA/FIPE 2002 p45).

Market segmentation: The segmentation of the market, particularly the emergence
of niches for “specialty” produce is also a major feature of the current market
environment. Though each niche is relatively small, as shown in Table 14, they are

growing very quickly and generating much interest among growers and consumers alike.

Table 14 Specialty produce markets in Brazil

 

 

 

 

Value per year Growth rates Principal retailers
Bulk 85% sales 2% per year All
2% value of Supermarket, farmer
Organic 30-50% per year
horticulture sales, markets
Supermarkets,
Hydroponic N/A N/A
restaurants

 

R$450 million in 1998, 200% in dynamic
F resh- Supermarkets, food
(1 .3% of fruit & buying areas over 3
processed service
vegetable volume) years

 

 

 

 

 

Sources: AgriAnual 1999; Costa and Ortiz 2001; Fares and Nantes 2001; PENSA/FIPE

2002 N/A=Data not available

 

 

Market performance: In most respects the performance trends identiﬁed in the
previous phase have continued in the current phase. Consumers demand for new and

novel produce items and their concerns for issues such as food safety is continually met

38

it remit:
mitt-pat
prices ill
Impaktlu
those \I
requxre.
eroded.
that ar

illCOLll’

with 3

4Ir

outllr
discu
finer;
cham

Consi

of di
dll'er
Cmciz

Imita‘

by retailers who are eager to gain market share. Likewise, a diversity of retailers
participate in the market and prices are competitive. Shifts are seen, however, in terms of
prices in relation to suppliers, as the ongoing shifts in market share are seen to be
impacting suppliers who both serve the increasingly-powerful large retail chains and
those who do not. Many growers are not in a good position to respond to the
requirements of the large chains, meanwhile their current market channels are being
eroded. Furthermore, some of the practices of the large chains, such as promotional prices
that are below production costs, are negatively affecting their suppliers (who are
encouraged to participate in these promotions) and suppliers and retailers who compete

with them.

4 Implications and policy considerations

This section considers the implications of these developments that have been
outlined for suppliers, particularly small farmers, in Sio Paulo’s fresh produce markets. It
discusses what the diversity of retail types combined with retail concentration, the
emergence of specialty markets, and the shift in market ﬂows from public to private
channels imply for the participation of suppliers in the market, and addresses policy
considerations that result.

Diversity of retail buyers: How does the diversity of retail buyers affect participation
of different types of suppliers? Two points are in order here. First, while there is a
diversity of retail buyers, the vitality of these non-dominant buyers is not assured. Of
crucial importance is the large chains’ efforts to enter niche markets by providing (or

imitating) the products and services that consumers seek from those niches, as well as

39

their aggressive push to guarantee the safety of their fresh produce merchandise. To the
extent that the large chains are successful in these efforts, and given that they generally
have cost-superior procurement capacities, the hold of these non-dominant retailers might
be eroded considerably in the near future. Second, in order to compete in the new market
environment, the non-dominant retailers must make their own investments to improve the
quality of the products they offer and lower costs, if they are to maintain competitive
positions in the market, regardless of whom they sell to.

It is hypothesized that well-capitalized suppliers are in a good position to meet the
challenges of the changing market environment since they can diversify their buyer
portfolio to reduce their dependence on the relatively few large retailers from whom they
tend to receive low margins. Of concern to policy makers are the suppliers who are in a
relatively weaker position to make new investments. These may fall into two groups.
First, there will be those who are able to make the investments necessary to produce for
the large retail chains, but who will then be highly dependent on them for their market
and thus vulnerable and generally in a weak bargaining position. It is likely that lower
management capabilities and weaker business acumen will likely differentiate these
suppliers from those who are more successful in maintaining more diversiﬁed portfolios.
Finally there will be suppliers who may not make any changes to their product or buyer
portfolios, and as a result may be progressively disqualiﬁed from the market as their
buyers’ needs change or if their buyers go out of business. Research is needed to
determine what speciﬁc characteristics differentiate these three types of suppliers.

Emergence of specialty markets: Specialty produce markets are often promoted for

small-scale producers as a potentially proﬁtable alternative to mainstream “commodity”

40

produce markets. Markets for specialty products tend to be small and production often
requires high labor and management inputs, arguably offering a comparative advantage in
production given their access to family labor and other characteristics that favor the
production of labor and management-intensive crops. Caution is warranted, however, in
promoting these markets as a panacea for the challenges that small farmers face in the
current market environment, as these markets often have quality requirements that small
growers ﬁnd difﬁcult to meet and that raise their costs to uncompetitive levels.
Speciﬁcally, though on the surface the high labor and land-intensity of production seems
to favor small producers, other aspects of the production economies of specialty products
can negate this apparent advantage. Looking at markets for nontraditional exports (which
are analogous to the case of specialty markets), Carter et al (1996) point out that the
presence of high-value attributes (such as the production processes that lend value to
organic products and food safety attributes for fresh-cut produce) means that farmers
must adopt certiﬁcation procedures to identify and preserve these characteristics, which
are often large ﬁxed-cost investments which can shift the comparative advantage towards
larger-scale producers. Likewise, meeting the stringent quality requirements of these
specialty markets can require investments that the poorest strata of small farmers do not
have the capital to make.

Also, while specialty produce markets are growing quickly, they represent a very
small proportion of the fresh produce marketed. Again, looking at nontraditional export
markets, Barham et a1 (1992) point out that proponents of these markets tend to overlook
the effects that widespread adoption and associated production increases can have on

market prices. As supply increases and prices fall, then the current price premiums in the

41

market that result from unsatisﬁed demand may be eroded (depending on the demand
response to lower prices), so that, while specialty produce may continue to be “high-
value” relative to bulk produce, there may still be very stiff competition and lower
margins all around. Finally, specialty produce markets can offer more price and
production risk, again disadvantaging smaller farmers who tend to have fewer coping
options (Barham et al. 1992).

Bifurcation of the marketing chain: What are the roles of public and private
marketing channels for both private actors and public goods? A reduction in reliance on
public wholesale markets in favor of direct purchases of fresh produce is not a recent
phenomenon, nor one unique to developing countries. In the US. for example, terminal
wholesale markets are responsible for only 25-30% of the fresh produce volume traded
today. Though their importance has declined as large chains have increasingly sourced
direct from production areas, public wholesale markets tend to retain their importance for
some buyers and sellers (usually smaller) for whom direct purchases are infeasible or
uneconomical, and for certain types of products, particularly those which are less
perishable and for which supply and demand is less predictable. Furthermore, public
wholesale markets are also argued to play a key role in the provision of certain public
goods, particularly for agriculture sectors (characteristic of developing countries) where
the farm structures are fragmented and producer organizations are weak (Seidler 2001).
Speciﬁcally, their accessibility and large numbers of buyers and sellers make them
important sources of market information (on prices and the movement of products), thus
enhancing transparency and competition. These beneﬁts are subject to network

economies——they increase as the number of users of the public markets increases, and

42

conversely are eroded as reliance on public markets wanes. Supporting institutions, such
as clear and objectively applied grades and standards, are key to the efﬁcient functioning
of wholesale markets.

In Brazil, however, the shift toward reliance on private marketing channels that is
precedented in many other countries such as in the US. and Europe has been reinforced
by the fact that the public market does a relatively poor job in performing even some of
its “public good” roles. The lack of transparency and market concentration raise the costs
of fresh produce procurement for ﬁrms using the market, and hasten the departure of
ﬁrms relying on it, for those who are able. Thus it is important to appreciate that the shift
from a public to private-dominant supply chain does not represent a departure from the
“perfectly competitive” ideal of neoclassical economics, given the historic concentration
of market power and lack of transparency at the wholesale level. Discussion of the merits
of relying on public versus private marketing channels should be explicit about whether
they are considering the historic or the potential role that the market plays, and take into
account the feasibility and cost of promoting the public market’s performance of its
potential role.

Furthermore, while the shift in market ﬂows from public to private supply channels
may have been started by the large retail chains, it has since been adopted by many non-
dominant ﬁrms as a proactive means of reducing costs and improving quality. This
improves both their competitiveness and promotes consumers’ welfare in both the short
term, through provision of a better quality and less expensive product, and in the longer
term by keeping a diversity of ﬁrms in the market as alternative source of fresh produce.

It also increases the competitiveness of these proactive retailers, despite the erosion of the

43

public market ﬂows and consequent effects for those ﬁrms that depend on it for the bulk
of their business. It is thus unconstructive to base debate on the roles of the public and
private marketing channels on a simplistic, “straw man” model which depicts the public
market as being the bastion of small actors and the private supply channels as the
stronghold of the large retail chains. Given the presence of diverse small ﬁrms in both
market channels, then it is important to weight the private and public costs and beneﬁts
and implicit tradeoffs of investing in each market channel.

Taking these points into consideration, four arguments are made here about the
appropriate roles of the public and private fresh produce marketing channels. First,
though its role in transactions of some goods (such as leafy greens) are very minimal, the
public market can be expected to continue to play an important role in transactions of
some goods, in particular those that have broader geographic markets (permitting greater
competition), in which institutions such as grades and standards are in place and well-
employed (permitting low cost transactions), and in markets for which supply and
demand is less predictable but which are relatively minor commodities making high cost
coordination efforts inefﬁcient (such as some exotic goods). It can be argued that the
government will play a more effective and appropriate role in such markets by playing a
facilitative role, such as in the provision and enforcement of grades and standards
regimes, and strengthening transparency and communications. Concurrent with this could
be an increased emphasis on the role of the public market in a “virtual” form rather than
its current physical form. That is, it may become less and less the site for simultaneous
exchange of information, money and product, and more a network of institutions

facilitating these activities, that then take place in private channels. Indications of this

44

tendency include growing reliance on pre-arranged transactions and the use of bankcards
for payment within the public market.

Second, given that the gradual erosion of the public market’s role reﬂects both
historic trends (as seen in other countries’ markets) and the public markets’ failure to
perform a number of key roles adequately, then it is hypothesized that ﬁrms which
continue to rely primarily on the public market (and which have been hypothesized to
lack the capital resources that permit them ﬂexibility to change sourcing strategies) might
become increasingly marginal in the overall scope of the market. If so, then the decision
of whether to invest in the public market with the speciﬁc intent of supporting these ﬁrms
might be judged on the basis of welfare rather than efficiency objectives. It is worth
consideration, then, that other welfare measures might also be appropriate.

Third, the potential role of private market channels in providing public goods (as
well as supporting the provision of private goods that promote social objectives such as
broad participation) has generally been under-emphasized. The role of intermediaries in
the growing regions has been under-appreciated in terms of the potential they could have
in the provision of public goods such as price information, as well as their role in
promoting inclusiveness in the market by serving as intermediaries between resource-
poor farmers and retail buyers. These ﬁrms already play a role in facilitating the access of
resource-poor suppliers to retail markets, for example through buying and re-mixing
products, and providing credit to growers. In order to explore this potential, attention
must be given to understanding the functioning of the private market channels. For
example, it is not clear how prices are currently formed in the market and to what extent

the purchases of the large retailers and other actors in private supply chains affect price

45

formation. Furthermore, the public sector should play a role in encouraging the
establishment of alternative formats of growing area intermediaries, for example farmers’
associations, with the aim of inﬂuencing the distribution of beneﬁts that are associated
with such activity.

Finally, there is a need to bring together discussions about the potential roles of
public and private marketing channels by asking where public activity in these separate
spheres might merge. That is, whereas currently the public marketing chain is associated
with public (government) activity in the provision of both institutional (e.g. grades and
standards, market information) and physical (e.g. buildings) infrastructure, an emphasis
on the public’s role in institutions that are relevant to both public and private marketing

channels might bring about a softening of this public/private distinction.

5 Conclusion

This paper addresses several important questions about the recent evolution and
current structure of Sio Paulo’s fresh produce market, and their implications for the
participation of diverse actors at both the retail level and upstream. The discussion
provides insight into issues about the implications of the emergence of specialty markets,
shifts in product ﬂows from public to private market channels, and diversity of retail
players for the participation of diverse suppliers. The discussion points to the potential for
small suppliers to beneﬁt from a number of these features and their related trends,
however it emphasizes the mixed results that may come about in actuality due to the
underlying economics of participating in these markets that may restrict small suppliers’

access, constrain their comparative advantage, or reduce the proﬁtability of participation.

46

A closer analysis of how these issues play out for suppliers with different characteristics,
in different specialty markets, and for different commodities is called for as a means to
both better understand the ongoing evolution of the market and to be able to inﬂuence

this evolution through effective public policy.

47

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50

APPENDIX

Glossary of Terms

Large Supermarket and Hypennarket Chain: General merchandise retailers with more

than ﬁve outlets. They compete on the basis of price, quality and convenience.

Small and Medium Supermarkets: Small chains (less than ﬁve outlets) and independent

general merchandise retailers competing on the basis of convenience and in some cases

quality.

Discount Green Grocer: Specialized in perishables (primarily fresh produce but also
sometimes eggs and ﬁsh), these retailers sell produce using some version of a “single-

price-per-kilogram” marketing strategy. These ﬁrms compete on the basis of price.

Open-Air Fair: Open-air fairs operate in speciﬁc locations on a weekly basis. They are
comprised of numerous vendors each specialized in different products, including
perishable goods such as leafy greens or other fresh vegetables. These retailers compete

on the basis of quality, service and tradition.

51

CHAPTER 3
Determinants of Retailers’ Decisions to Use Public or Private Grades & Standards:

What Policy Makers Should Know

1 Introduction

The role of grades and standards (G&S) in the organization and governance of
agrifood markets has come into increasing focus with reductions in trade barriers and
growing concerns over food quality issues relating to food safety and the environment,
among others. One important tendency that has been identiﬁed in the literature has been
ﬁrms’ increasing reliance on private G&S regimes over public ones, particularly in
situations where public regimes are perceived to be inadequate to the needs of individual
ﬁrms and where there are potential gains to be made from the promulgation of private
G&S (Farina and Reardon 2000; Reardon et al. 2001; Reardon and Farina 2001;
Giovannucci and Reardon nd). This is due, in part, to a worldwide shift in the balance of
power in agrifood markets to the retail level. Large modern chains have emerged as
dominant players in agrifood systems, and they have actively promulgated private G&S
in order to be more responsive to their customers’ quality preferences and to reduce costs
by improving the quality of their inputs (Reardon and Berdegué 2002). Firms’ choices
between public and private G&S are important to policy for a number of reasons. First,
private G&S generally entail new investments by suppliers and require stricter supply
chain coordination, which increase barriers to entry and mobility for suppliers, with
implications for competition and participation at the retail level and along the marketing

chain (Farina 1999; Reardon 2000; Reardon, Codron et al. 2001). Second, private G&S

52

are less accessible to public policy makers than public G&S, with implications for the
effectiveness of quality control and food safety, as well as efﬁciency implications.
Finally, private and public G&S are complementary in many consumers’ minds, so that
understanding retailers’ choices among them is key to the effective and efﬁcient design
and employment of public G&S and the regulation of private G&S. At the same time,
however, private G&S can be potentially more consumer-responsive, and understanding
ﬁrms’ decisions between them can also help policy makers understand where it is
appropriate to maintain a “hands of’ approach. Though the determinants of retailers’
decisions to use public versus private G&S constitute an important policy issue, this issue
is largely unexplored in the literature.

This paper seeks to ﬁll this gap by addressing two questions. First, what are the
environmental and ﬁrm-speciﬁc factors that condition ﬁrms’ choices between public and
private G&S? Second, how do ﬁrms implement and regulate compliance with public and
private G&S? The focus is on the decision that is faced by retail ﬁrms and on their choice
of input G&S—that is, G&S that are imposed on suppliers to the retailers. It is a
maintained assumption throughout that ﬁrms are choosing between public and private
G&S, rather than having to choose private G&S in addition to public. This assumption is
upheld by Loader and Hobbs (1999) for the European market, and is especially realistic
in the developing country context due to weak institutional capacity to enforce even
mandatory public standards in many cases.

The paper draws evidence from a case study of the fresh produce markets of Sic
Paulo Brazil. The paper begins by approaching the problem from a conceptual

perspective, in which the contextual determinants of the ﬁrrn’s decision between public

53

and private G&S are explored and hypotheses are offered about the ﬁrm-speciﬁc
determinants of the decision. Then, the empirical context is introduced and patterns of
adoption of public and private G&S are analyzed with respect to the hypothesized
determinants. The paper concludes by discussing the results with a focus on their policy
implications. Data for the paper was collected using key informant interviews with
industry experts as well as during the open discussion section of a retail survey, during
which respondents were asked about their views on the adequacy of the different grades
and standards regimes, their use of different regimes, and how they undertook to ensure

the different quality aspects that they sought of the fresh produce they bought.

2 Grades and Standards in Agrifood Markets

Grades and standards consist of technical speciﬁcations, terms, deﬁnitions, and
principles by which goods are categorized or included in product groupings (Jones and
Hill 1994). They are used to classify products with respect to valued attributes. Three
crucial functions that G&S serve are 1) standardization (classifying products on the basis
of explicit attributes in order to ensure their homogeneity and reduce the transaction costs
of product acquisition), 2) product differentiation (which have the objective of
communicating the uniqueness of products deﬁned by G&S to better inform consumers
of their options and decrease price elasticity of demand), and 3) risk reduction (for
example food safety standards).

G&S can be promulgated publicly or privately. In this paper, 'public' and 'private'
G&S are deﬁned relative to the availability of their speciﬁcations, means of compliance,

and accessibility to ﬁrms. Economic theory holds that G&S are likely to emerge as public

54

goods when they reﬂect the economic characteristics of non-exclusivity, non-rivalry, and
network economies, which make it difﬁcult for individual ﬁrms to reap the returns to
their promulgation (Kindleberger 1983). These economic characteristics, however, are in
many respects products of the G&S' speciﬁcations themselves, including their
promulgation in public or private spheres, rather than exogenous. For example, privately
promulgated G&S, whose speciﬁcations are inaccessible or costly to imitate, lose some
of the “public goods” properties of non-exclusiveness. Likewise, the promulgation of
multiple private G&S regimes that have similar speciﬁcations but limited adoption for
each precludes the achievement of network extemalities, in which the beneﬁts of
adopting G&S would increase with the number of adopters.

There are numerous institutional means available to regulate compliance with
G&S, including legislation and testing by public bodies, third-party certiﬁcation, second-
party certiﬁcation (for example by the buyer) and internal certiﬁcation (by the supplier).
Reliance on trust is a complementary means by which compliance is regulated. The
speciﬁcations of quality standards and means of ensuring compliance with them together
affect the means of governing the transaction (Zylbersztajn and Farina 1999). For
example publicly-legislated G&S requirements can lend themselves to spot market
transactions as can third-party certiﬁcation, whereas the governance of G&S compliance
on the basis of trust, second-party certiﬁcation, or internal certiﬁcation is typically
associated with stricter forms of coordination such as contracts or even vertical
integration. Different means of regulating G&S compliance require different sorts of
investments and involve different distributions for the costs of their compliance. This

consequently affects the internal organization of and relations between ﬁrms that impose

55

G&S and those that must comply with them. Overall, as the need to make investments to
comply with G&S and qualify for a speciﬁc transaction increases, then the
interdependence between buyer and seller increases, encouraging ﬁrms to rely on strictly
coordinated supply systems that seek to economize on (or re-distribute) the associated

costs (Zylbersztajn and Farina 1999).

3 Modeling the Decision to Adopt Public vs. Private G&S

A ﬁrm’s choice between public and private G&S regimes can be viewed from an
adoption perspective. The decision maker under consideration is the individual retail ﬁrm
that seeks to minimize the cost of obtaining fresh produce reﬂecting a speciﬁc vector of
attributes, whether these attributes be related to the size, variety and color of a product,
the processes by which it is produced, or the absence of chemical or biological
contaminants that compromise food safety. In making its decision, the ﬁrm must evaluate
publicly-available and private standards for their suitability, costs, and beneﬁts. The
adoption decision is decided on the basis of a comparison of the costs and beneﬁts of
adopting and administering a public versus a private standard. These costs and beneﬁts
are conditioned by both the ﬁrm’s characteristics as well as the characteristics of the
product and its market and the general environment in which the ﬁrm operates. These

factors are discussed below, and summarized in Table 1.

3.1 General Conditioning Factors

The literature introduces three general factors conditioning the emergence of
public and private G&S. These are the strategic objective of the standard, the institutional

context, and the product and market characteristics.

56

Table 1 Factors Influencing the Decision to Adopt Public or Private G&S

 

General Conditioning Beneﬁt/Cost Effects F inn Characteristics

Factors

 

 

Product requirements

Strategic objective of G&S Output price differentials Importance of product in

Institutional context Input price differentials sales

Product & market Transaction cost Scale of operations

characteristics differentials Market power of ﬁrm
Reputation & brand capital

 

 

 

Strategic objective. G&S can take standardizing, differentiating, and risk-reducing

 

functions. G&S with standardizing functions are generally associated with public goods
in that their beneﬁts Show increasing returns to adoption, and are non-rival and non-
exclusive (Kindleberger 1983). Differentiating standards are generally assumed to be
private goods because they are designed so that their beneﬁts can be captured by the ﬁrm
or ﬁrms that establish them, but can ﬁt into the rubric of collective goods too, as they can
be deﬁned so that their beneﬁts are accrued by a limited group rather than an individual
ﬁrm (an example is appellation-speciﬁc wines). G&S with risk-reducing objectives, for
example those related to food safety, have often fallen under a 'public goods' rubric due
to their non-exclusive nature, for example, the difﬁculty of distributing the costs and
beneﬁts of ensuring safe food (Sporleder et a1. 1983). More recently, however, they have
increasingly become an important part of private ﬁrms' G&S activity (Northern and
Henson 2001), due to changes in liability law, the development of technologies that

facilitate traceability, and the use of brand capital and private certiﬁcation of quality as

57

 

means for individual ﬁrms to generate consumer ﬁdelity and capture the beneﬁts of their
food safety investments (Spers 2000).

Institutional context. The institutional environment, deﬁned as ‘the set of
fundamental political, social and legal ground rules that establishes the basis for
production, exchange and distribution” (Williamson 1991), inﬂuences the choice between
public and private G&S for a number of reasons. First, public institutions are generally
slow in adapting to changed demand and technological conditions that might necessitate
adaptations to G&S, even if existing public G&S were initially formulated to reﬂect
valued attributes. This is particularly true given that the deﬁnition of public G&S is
subject to political maneuvering, vested interests, and tailoring to promote social
objectives (Krislov 1997; Farina 1999). Private standards, in contrast, are under the
control of individual ﬁrms, and can be adapted more easily to changing market conditions
(Jones and Hill 1994; Aust-Sterns and Reardon 1999; Reardon and Farina 2001). Second,
the capacity of the institutional apparatus to monitor and enforce compliance varies
widely (and can be especially constrained in the deve10ping country context), creating
incentives to either cheat on compliance and compromise the legitimacy of the regimes or
to create private regimes to overcome these deﬁciencies (Loader and Hobbs 1999; Farina
and Leles Rezende 2001). Third, the informal institutional environment (that is, cultural
rather than legislative controls over behavior) plays a role in determining the feasibility
of private G&S regimes, whose success is heavily dependent on relations between
transacting ﬁrms (Northern and Henson 2001). Fourth, legislation, particularly liability
law, plays a fundamental role in determining how the costs of product failures (such as

food safety failures) will be distributed, thus motivating private regimes in many cases as

58

a risk-mitigating measure (Henson and Caswell 1999). Fifth, the institutional
environment affects the legitimacy of any external (third-party) certiﬁcation that is made
available to monitor compliance with G&S. The availability of such certiﬁcation can
increase the feasibility of relying on public G&S regimes (if their speciﬁcations are
adequate but public enforcement is weak) and/or reduce the costs of administering private
G&S regimes (if the task of monitoring compliance can be contracted out).

Product and milketcﬁharacteristics. The characteristics of the product and its
market also play a major role in inﬂuencing the emergence of public and private G&S
regimes. Product standards can reﬂect search, experience, and credence attributes
(Codron, Reardon et a1 2000), which must be identiﬁed and preserved as the product
moves along the marketing chain, creating situations of asymmetric information among
market agents and consequently room for opportunistic behavior and coordination
failures. If production of the attributes deﬁned by the standard requires specialized
investments then the risk of losing the value of the specialized investment creates
interdependence between the buyer and seller, requiring the retailer to ﬁnd ways to
tighten control over supply, including through its choice of G&S. As the attributes
deﬁned by G&S move from search (e.g., produce graded on the basis of easily observed
characteristics such as size, color and presence of external defects), to experience (e.g.,
food safety) and credence attributes (e.g., production using organic processes), market
risks and transaction costs increase, calling for stricter coordination of the supply chain
and encouraging the use of private standards as part of ﬁrms’ efforts to economize on the
transaction costs of supply chain management (Farina and Reardon 2000; Reardon,

Codron et al. 2001 ).

59

3.2 Determinants of G&S Regime Beneﬁts and Costs

The choice between public and private G&S will also be driven by the relative
ﬁnancial beneﬁts and costs of each faced by the retailer. This beneﬁt-cost relation
depends on any price premium associated with adoption, the cost of adoption, and
differences in coordination costs that result from adoption. These factors will, more
speciﬁcally, be functions of 1) any output price differential made possible by compliance
with the standard, 2) any input price differential required to ensure provision of the
standard-compliant product, and 3) the differential in transaction costs incurred through
use of the standard. Each of these are subject to network extemalities, that is, they may
change over time as the numbers of adopters of a standard increase.

Differences in output price are most relevant to differentiating standards. Revenue
can be increased for differentiating standards if they effectively reduce consumers'
sensitivity to price increases. If the ﬁrm seeks to differentiate its product from similar
products of other ﬁrms, rather than from other products (Codron et al (2000) refer to
these as producer-inclusive and producer-exclusive strategies respectively), this may
catalyze the decision to promulgate a private G&S regime. The beneﬁts of adoption of
differentiating standards tend to show a U-curve as adoption increases—some minimal
number of adopters are necessary for a differentiating standard to be recognized by
consumers in the market, however as retail adoption increases beyond a certain point, its
usefulness in differentiating it from other products declines. The U-curve will likely be
absent, however, if the ﬁrm that promulgates the differentiating standard has a very

strong brand that it manages to link to the standard, hence excluding other ﬁrms from its

60

beneﬁts and limiting the number of adopters. Supply increases resulting from widespread
adoption can also push down any price premiums that would otherwise be in place.
Differences in output price will also be affected by the consumers to whom the product is
targeted—speciﬁcally, Spers et al (2003) found that wealthy consumers are more willing
to pay for private standards than poor consumers, so that private standards can also be
seen to have characteristics of a luxury good.

Changes in compliance costs include any additional production costs incurred in
producing to meet the standard. Input cost differentials tend to be higher for
differentiating standards than for standardizing ones (Reardon, Codron et al. 2001), and
are likely to be higher for a private standard than for a public one, too, as the private
standard will be diverging from the default public standard and tends to be relatively
more complex (Farina 1999). Input costs do not always increase however—they may
even decrease in situations where the standard increases efﬁciency or reduces production
costs (Caswell et al. 1998; Reardon and Farina 2001); or where the buying ﬁrm has
sufﬁcient negotiating power to push the costs of compliance onto suppliers. Again,
network extemalities also come into play—the broader the adoption of a standard, the
lower the costs of compliance are likely to become, as ﬁrms become increasingly more
specialized in responding to the standard and at the same time ﬁnd more buyers for it. As
adoption increases, scale economies to be achieved in marketing the product further
lowering costs. These factors could come into play for a private ﬁrm with a very large
scale of operations if a large number of suppliers adopt the standard, however in general,
public standards, which are more broadly adopted than private standards, are likely to

have relatively lower compliance costs.

61

G&S regimes can reduce transaction costs when they take a trade-facilitating role,
or increase them if they necessitate special coordination needs such as the formation of
contracts with suppliers, monitoring of compliance, or enforcement of contract terms.
Generally, transaction costs will be higher for a private G&S regime than a public one.
This is because of the relatively greater requirements for transaction-speciﬁc investments
that increase interdependence between buyers and sellers for private standards, increasing
monitoring costs and the potential for hold-up on transactions (Farina 1999). The
distribution of these transaction costs will depend in large part on the negotiating power
of each of the parties to the transaction. The transaction costs of private standards can be
reduced, however, when third-party certiﬁcation is possible, as shown by Northern and
Henson (2001) , because it allows external ﬁrms to specialize in certiﬁcation of
compliance, reducing the costs borne by the buyer. Again, network extemalities
associated with the promulgation of public G&S can be associated with lower transaction
costs as adoption increases. These beneﬁts are typically foregone for private standards
except, as mentioned previously, in limited cases when a ﬁrm with a very large scale has
a large number of supplies who can beneﬁt from network extemalities in adopting a

private standard.

3.3 Hypotheses on Firm-Speciﬁc Factors Inﬂuencing the Adoption of Public and

Private G&S

Given general conditioning factors and cost/beneﬁt considerations, what
determines an individual retailer’s decision to adopt public versus private G&S? Here it

is hypothesized that ﬁve variables will lead a ﬁrm to choose private G&S over public.

62

These are l) non-mainstream product requirements, 2) the importance of the product in
the ﬁrm’s activities or sales, 3) scale of operations, 4) bargaining power, and 5)

investment in brand capital and reputation.

H1: A firm with non-mainstream product requirements is more likely to adopt

private G&S.

A ﬁrm with non-mainstream product requirements is less likely to have its needs
served by public standards, and more likely to ﬁnd it economical to invest in private
standards that more closely reﬂect their needs. Non-mainstream product requirements can
exist when the ﬁrm serves a differentiated output market—for example a domestic niche
market or emerging export market. They can also emerge on the input side—for example
when cutting-edge processing or logistical methods used by a buying ﬁrm require

speciﬁc characteristics for incoming products.

H2: Firms are more likely to adopt private G&S for products that are central to

their activities and/or revenue.

The more important a product is in the activities or sales of a ﬁrm, the more
reward (via either increased sales revenue or reduced costs) the ﬁrm can reap by tailoring
product standards to its own needs rather than making do with a product meeting a public

Standard.

63

H3: A larger scale of operations will increase the likelihood of a ﬁrm adopting

private G&S.

The scale of operations of the retail ﬁrm, over which the costs of administering
the standard can be spread, will affect the beneﬁts of a private standard. The
establishment of a private standard entails signiﬁcant ﬁxed costs, for example in its
speciﬁcation and investment in facilities and training of employees to regulate
compliance with the standard. In this respect, a large scale of operations can enable
buyers to achieve economies of scale and/or scope in the promulgation and

administration of a private standard.

H4: A ﬁrm with bargaining power of its suppliers will be more likely to adopt

private G&S.

Bargaining power will facilitate a ﬁrrn’s promulgation of a private standard by
enabling it to demand compliance with the standard and even to push the costs of
compliance onto suppliers. A ﬁrm with both scale and a large presence in the market (for
example a large share of the market) that promulgates a private standard is essentially
creating a new niche market for suppliers, perhaps allowing them to achieve scale

economies if they specialize in producing for that niche.

H5: Firms with large investments in brand capital and reputation are more likely to

adopt private G&S.

64

Finally, ﬁrms that have large investments in brand capital and reputation are more
likely to invest in private standards that are more exacting than public G&S because the
costs of product failure (which is more likely under a weaker standard) will go beyond
the immediate sale to hurt the value of the brand capital and reputation of the ﬁrm, thus

reducing future sales.

4 Evidence from Sac Paulo’s Fresh Produce Market

The hypotheses proposed above are explored here, drawing on research in the
fresh produce market of Sic Paulo Brazil. Retailers’ use of G&S was considered for three
major product groups: bulk produce, organic produce, and pre-processed or “fresh cut”
produce. G&S for bulk produce relate primarily to search attributes—variables such as
size, color, type, and the presence of external blemishes, all of which are easily
observable upon inspection of the produce. Organic standards are credence attributes in
that they are speciﬁed on the basis of production processes, the use of which is difﬁcult
to detect once production is complete. The G&S most important to pre-processed produce
relate to food safety. The assurance that food will not be contaminated with either

chemical or microbiological contaminants reﬂects experience attributes.

4.1 Fresh Produce Retailers in Sic Paulo

Three categories of retailers can be discerned in metropolitan Sio Paulo's fresh
produce market with respect to the ﬁrm-speciﬁc decision variables that are hypothesized

as determinants. These are summarized in Table 2 below. Dominant in terms of market

65

share and bargaining power are the large super and hyper-market chains—for example
Companhia Brasileira de Distribuicio and Carrefour. These ﬁrms have signiﬁcant
portions of foreign ownership and control, large investments in brand capital and
reputation, and make most of their fresh produce purchases at the ﬁrm rather than store
level (using centralized purchase and distribution centers), lending them signiﬁcant
bargaining power. The second group consists of small and medium-Sized supermarkets,
discount green grocers, and open-air vendors that work either individually or in small
chains. These ﬁrms are locally owned and individually have little bargaining power.
Third are the specialized green grocers and restaurants that market to upscale
consumers—again these ﬁrms are small and do not hold bargaining power, though they

have very signiﬁcant investments in reputation, serving a select and demanding clientele.

4.2 G&S in Sao Paulo’s Fresh Produce Markets

A range of public and private G&S regimes exist among the three product groups
considered". These are summarized in Table 3. The public G&S regimes that are seen in
the market were speciﬁed as a result of either formal or informal negotiations between
buyers and suppliers. The private G&S regimes that will be discussed were established by
retailers relative to their needs, with the exception of private food safety standards, which

are established by the ﬁrms that process fresh-cut produce in most cases.

 

4 Unfortunately, empirical estimates of the value of produce sold under each of these regimes are not

available.

66

Table 2 Characteristics of fresh produce retailers

 

Small and medium

 

 

 

 

 

 

Large retailers Specialty retailers
retailers
Product requirements Non-mainstream Mainstream Non-mainstream
Importance of products
High Medium High
in sales/activities
Bargaining power High Low Low
Small Small
Scale of operations Large
to medium to medium
Brand capital/ reputation
High Low or medium High

investments

 

 

 

 

There are two public regimes in markets for bulk produce. The Brazilian Program

for Improved Standards and Packaging (BPISP) is de jure, i.e. compliance is required by

law however this is not enforced and it shows very low rates of adoption by either buyers

or suppliers of fresh produce. The other is the de facto regime, in that it has long been the

default regime and is used by a wide range of retail ﬁrms and suppliers. The de facto

regime has long been recognized to be inadequate for the provision of produce of

67

 

Table 3 Public and private G&S regimes in Sio Paulo’s fresh produce market

 

 

 

 

 

Public Private
-De jure formal standard—Brazilian -Private standards formally
Program for Improved Standards and administered via contracts
Bulk
Packaging
produce
-De facto standard informally -Private standards informally
administered via personal relations administered via personal relations
Organic -Association of Organic Agriculture -Private standards informally
produce -Bio-Dynamic Institute administered via personal relations
-Retail ﬁrms with private food safety
-ANV ISA (Government of Brazil)
standards administered through own
and SEMAB (Municipality of Sao
Fresh-cut or third-party certiﬁcation
Paulo)
standards -Supplying ﬁrms with own standards
(both lack monitoring and

 

enforcement capacity)

 

-Vertical integration in fresh-cut

(ﬁrms do own processing)

 

consistent quality because it is not formally deﬁned and the assignment of grades by

buyers and sellers is done each day relative to what is available in the market on that day.

This means produce is classiﬁed on the basis of a relative standard not an absolute one,

for example the largest and best quality tomatoes of the day are assigned a “best” label,

even if they are only half the size of the previous day’s “best” tomatoes. In contrast, an

absolute standard such as the one used by the BPISP has speciﬁc size and quality (such as

percent defects) parameters that produce must fall into to qualify for each grade.

68

 

Private G&S regimes for bulk produce are also used by retailers who administer
them either formally or informally, and by the largest retail buyers—super and hyper-
markets, who rcly heavily on private G&S that are explicitly speciﬁed and implemented
through the use of supplier registries and contracts. Even those ﬁrms relying on the de
facto regime also typically integrate an element of private G&S through their reliance on
ongoing, informal relationships with suppliers who come to know and respond to their
preferences.

For organic produce, 2001 legislation calls for the accreditation of certiﬁers of
organic producers (Farina and Leles Rezende 2001). The two major certiﬁers of organic
produce are the Association of Organic Producers and the Bio-Dynamic Institute. These
are non-proﬁt organizations that seek to promote organic agriculture through consumer
education, farmer training, and the provision of certiﬁcation services. The organic
standards promoted by these agencies, though administered privately, are public in that
any ﬁrm can access their speciﬁcations and seek certiﬁcation of compliance with them at
a low cost to the ﬁrm. Almost all retail ﬁrms (including all supermarkets) selling organic
produce seek certiﬁcation from one of these agencies. There are also a few small retailers
and specialized restaurants that informally administer private regimes. They sell direct to
a known clientele, with which trust has been established and serves as the guarantee of
integrity. These retailers are either vertically integrated in production, or they buy from
suppliers with whom they have strong, trust-based relationships and a shared
understanding of what they feel constitutes an organic product.

Public food safety standards for fresh-cut produce exist at the municipal and

national levels, however enforcement capacity is very low due to low levels of ﬁnancial

69

and human resources. SEMAB, the municipal department for food inspection had, as of
2000, not closed a single food contamination case (SEMAB 2001). Likewise, ANVISA,
which established current food safety legislation at the national level in 2001 also lacks
capacity to effectively enforce their mandate.

Given weak enforcement capacity for public food safety standards, retailers are
left with the option of either relying on suppliers’ assurances of product safety, or
creating and administering their own private standards for suppliers to follow (a very
high cost activity). In general, any fresh-cut produce that is explicitly marketed as ‘safe
for immediate consumption’ is always marketed under the brand of the supplier which
markedly reduces (though doesn’t eliminate) retailers’ exposure to liability in the case of
product failure. Under Brazil's legislative system the onus for product failure lies largely
with the supplier, unless it can be demonstrated that the product's safety was
compromised subsequent to supply—cg. due to inadequate handling or refrigeration at
the retail outlet. Beyond this generalized, liability-mitigating response among retailers,
three diverging responses are seen. First, the large supermarket chains have developed
their own food safety standards for their fresh—cut produce suppliers, which they either
monitor and enforce themselves or contract out the tasks to third-party certiﬁers. These
private standards tend to be used more to inform selection of suppliers, rather than to
communicate a guarantee of quality to consumers, with the quality assurance still
originating from the individual suppliers of fresh cut produce. Second, the smaller (non-
specialty) retailers rely on the food safety assurances of the suppliers without making
extra investments in the form of private food safety standards beyond, in some cases,

visits to the supplier to view operations. Third, some retailers verify suppliers’ assurances

70

of food safety through visits to suppliers and/or rely on trust-based relations, or they
undertake the fresh-cut processing themselves thus creating and enforcing their own
standards for processing in order to bring the risks under their own control. The vertical
integration decision (undertaking own processing) is most common among the specialty
restaurants (which are specialized in food preparation), and to a lesser extent among

specialty retail outlets for which the fresh—cut produce is but one activity among many.

4.3 G&S Adoption Patterns

Adoption patterns for G&S for the different types of ﬁrms and products are

summarized in Table 4.

Table 4 Adoption and administration of G&S for Fresh Produce in Sao Paulo

 

 

 

 

 

Bulk Organic F resh-cut
Large Supermarkets
Private Formal Public Formal Private Formal
& Hypermarkets
Small
Undifferentiated Public Informal Public Formal Public Informal
Retailers
Private Formal &
Specialty Retailers Private Formal Private Informal
Informal

 

 

 

 

71

 

The ﬁrst group of retail buyers described, large super and hyper-markets that
purchase at the ﬁrm level, showed consistent tendencies to use private standards in both
the case of bulk produce purchases and fresh-cut produce purchases, though not for
organic produce purchases. In terms of bulk produce, the factors leading to the use of
private G&S ﬁt along the lines hypothesized. 1) They have specialized (non-mainstream)
product needs because of their use of centralized purchase and distribution centers whose
efﬁcient operation relies on the use of automated loading and unloading, thus requiring
incoming produce to be standardized in terms of quality and packaging for efﬁcient
handling. 2) Because of their bargaining power, these ﬁrms can push the cost of
compliance with the standards onto their suppliers. The suppliers are willing to take on
the associated cost in order to retain these large ﬁrms as their clients. 3) Because of the
large volumes of produce purchased, any increased transaction costs involved in the
formal administration of private standards is offset by the reduced waste and economies
of scale and scope that are achieved and reduced logistical costs resulting from the
custom standardization of incoming produce.

For organic produce, the decision to adopt the public standard is greatly affected
by the availability of third-party certiﬁcation that lowers the cost of adopting a public
standard even for a differentiated product. This is reinforced by the fact that the organic
market is still nascent and consumers’ understanding of the meaning of organic is
considered to be limited, reducing incentives to create private G&S to differentiate one
ﬁrrn’s organic produce. Furthermore, sales of organic produce under a private label

Would require that the ﬁrm incur the cost of obtaining accreditation by the government.

72

For fresh-cut produce, fonnally-legislated public standards are less important to
retailers, due to the lack of enforcement capacity, than the threat of media exposure and
its effects on their reputation in the case of a food safety failures. Negative media
exposure threatens large ﬁrms and those with large investments in brand capital relatively
more than smaller and lesser-known ﬁrms. Most retailers, then, rely on the quality and
safety assurances of their suppliers (a form of external certiﬁcation) that minimizes their
legal liability. In addition, large retailers’ typically take the additional measure of
employing private standards to inform their selection of suppliers. They do not, however,
attempt to communicate compliance with these standards to consumers so that liability
remains with the private label suppliers in the case of a product failure.

Small and medium-sized retailers serving undifferentiated markets rely on public
standards for bulk, organic and fresh-cut sales. This result is as hypothesized given the
relatively small size and mainstream product requirements of these ﬁrms, which reduce
incentives to promulgate private standards for bulk produce purchases. These ﬁrms do
not have bargaining power to push the costs of compliance onto their suppliers, nor do
they process the volumes that would allow them to achieve economies of scale or scope
in the promulgation of private regimes. Likewise in terms of organic and fresh-cut food
safety standards, there is little impetus to adopt private standards given poor appreciation
of privately differentiated products among consumers and limited costs of food safety
failures due to the ineffective public capacity to enforce, the default assignment of
responsibility to the supplier of privately labeled products, and the relatively low

investment in brand capital by these ﬁrms.

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An interesting result among these small and medium-sized retail ﬁrms, however,
is the reliance in many cases on private administration of the public standard for bulk
produce. That is, due to the relative and informal nature of the de facto public standard,
ﬁrms are left to administer the standard on the basis of their own relations with
suppliers—generally through the creation of long term supply relations in which trust and
mutual interdependence play an important role. Failure to privately administer the public
standard would put the buying ﬁrm at risk of opportunistic behavior by suppliers, and
increase the frequency of conﬂict with suppliers over the quality of produce that is
delivered.

Finally, the third group of retailers, the specialized ﬁrms, were found to rely on
private standards to a greater degree than other small and medium ﬁrms that target the
popular market. In terms of bulk produce purchases, these buyers have an incentive to
promulgate private standards in order to accommodate their specialized product needs,
and are able to uphold these private standards through the cultivation of personal
relations, supported by either formal or informal contracts. Mutual interdependence
between buyers and sellers helps to support the transaction in these cases. This group,
unlike the other two, shows a willingness to rely on private (informal) standards even for
organic produce, again revealing the importance of administrative capabilities that are
rooted in personal, trust-based relations with both their clientele as well as their suppliers.
Furthermore, in many cases, these ﬁrms are partially vertically integrated in production
and/or processing. Given the importance of the products in their activities, the ﬁrms must

make signiﬁcant investments in the execution of these activities, but this is compensated

74

for through reduced transaction costs and increased conﬁdence in the quality of the

product.

5 Discussion of results

The research shows that across the different product types, a variety of public and
private G&S regimes are in use, with varying patterns of adoption on the basis of several
contextual and ﬁrm-speciﬁc variables. In general, strategic purpose, institutional
environment, and product and market characteristics were conﬁrmed to be important
contextual variables. Case study results supported hypotheses that non-mainstream
product requirements, the importance of the product in the ﬁrm’s activities, bargaining
power, investment in brand capital and reputation, and scale of operations are key
determinants of individual ﬁrms’ decisions to invest in private G&S regimes.

Drawing from these results, a further issue can be considered. Are public and
private G&S substitutes or complements to one another? What interactions exist in the
administration of public and private G&S?

Considering the substitutability of public and private G&S regimes, it can be
argued that if ﬁrms are establishing private G&S regimes because public regimes are not
relevant to their needs, then it is important to consider the extent different efﬁciency and
welfare outcomes and their distributions resulting from the use of private regimes over
public ones. An important issue to resolve is to what extent private ﬁrms would like to
see public regimes modiﬁed so that they can use them as substitutes to the private
regimes, and to consider the distribution of potential efﬁciency and welfare gains of

promoting adoption of public regimes over private ones. Modifying the public regimes to

75

better reﬂect retailers’ needs could help to stay the movement towards reliance on private
regimes promoting the maintenance of broader supply chains with lower barriers to
mobility among them. However the question then arises, drawing from the Sic Paulo
case study, why one such “improved” public regime for bulk produce (the de jure
Brazilian Program for Improved Standards and Packaging) has not been adopted more
broadly. This regime was established and instituted as law with the intention that it
replace the de facto relative regime which fails to ensure the provision of consistent
quality produce to retail buyers. Although the new de jure G&S regime is held to be
relevant to retailers’ quality requirements for bulk produce, it has not taken over as a
substitute for private G&S among any group of buyers. Why has this public regime that is
held to be relevant to the needs of both small, medium, and in particular large retailers
not seen broader adoption, especially among the large retailers who currently rely on
private regimes?

Several explanations can be offered. First, it could be that the de jure regime is
not in reality relevant to the retailers’ needs, despite attempts to make it so. The
speciﬁcations of this regime are held to be equivalent to the privately promulgated G&S
in their essential aspects; however, it could be that some key elements (for some retailers)
are not accounted for by the public standard. For example, large retail chains have
mechanized systems for loading and unloading produce that require palletization,
provisions for which are not included in the dejure public G&S regime.

Second, even if the speciﬁcations are equivalent, the larger retailers who
promulgate private regimes may not have incentives to substitute public regimes for

private. The argument that retailers may prefer public regimes because they permit the

76

creation of a broader base of suppliers implies that large retailers want a broader base of
suppliers. This may not be true. For example, the logistical methods that the large
retailers use are dependent on tight coordination involving scheduled deliveries by
suppliers. The efﬁciency of such operations could be compromised by expanding the
pool of suppliers. Furthermore, a signiﬁcant gap already exists in the quality of produce
furnished to the largest retailers by their registered suppliers relative to the produce
supplied under the de facto standard in the public market. The largest retail buyers may
not be conﬁdent that adopting a more stringent public standard will induce the provision
of produce meeting that standard from suppliers.

Similarly, while small and medium retailers also recognize the shortcomings of
the de facto regime, they likewise haven’t tended to adopt the de jure regime. The fact
that small and medium retailers who rely on the public de facto standard for bulk produce
tend to administer it through personal relations offers insight into this result. These
personal relations are important not only for ensuring that the produce delivered meets
buyers’ quality needs, but also for the performance of other aspects of the transaction
such as ensuring that suppliers will make produce available and protect them from price
increases during market shortages. Thus, once again, it could be that the maintenance of
the relationship and selection of suppliers inﬂuences the decision of what G&S regime to
adopt for many of the smaller and medium sized retailers, as has been argued for larger
retailers. A counterpoint, however, is that the competition presented by the increasingly
powerful large retail chains is forcing smaller retailers to ﬁnd ways to reduce their costs,
and that one way to do this is to increase their own scale through the formation of buying

clubs and other collective actions. To date, the emergence of such institutions has been

77

precluded by the lack of clear and enforceable grades and standards in the fresh produce
market, however the incentive to create these (or to adopt the de jure regime) is likely to
grow given the changing competitive requirements.

These observations lead to the conclusion that public and private G&S are not
seamlessly substitutable due to the embedded nature of the standard in the overall
relationship between buyer and supplier, and especially its relation to the means by which
the transaction is administered. The question remains, then, in what circumstances public
and private G&S might be complementary. A manifestation of the complementarity
between public and private G&S regimes is seen in the case of small and medium
retailers, who tend to rely on the de facto public standard, but administer these through
private relations, in effect creating “private” standards that they administer informally
using the public standards as a foundation. Such private standards, if they exist, are thus
very informal, even implicit, emerging from working experience and mutual
interdependence between buyer and seller. An important aspect of them, then, is that they
are likely borne of relatively more equal negotiation between buyers and suppliers
(relative to large retailers with large market shares who rely on private G&S), given the
mutual interdependence between the two parties. Some of the largest retailers, on the
other hand, drew from the de jure public standard in deﬁning their own private standards
but ﬁnd it economical to administer them formally.

The above case points not only to the potential for complementarity where a
public standard lays the foundation for employment of a private standard, but also of

complementarity in the inverse sense. The possibility that these retailers can ﬁne-tune

78

their input supply by “tweaking” the de facto public standard likely contributes to its
persistence despite the apparent beneﬁts of the dejure standard that seeks to replace it.
Finally, another factor that points to complementarity between public and private
G&S is the conﬁdence that consumers place on different regimes. This is particularly
relevant for input standards whose key attributes are marketed to consumers, for example
organic and fresh cut produce. As shown by Spers et al (2003), consumers tend to value
food quality information when it is communicated by public and private standards in
conjunction with one another, further increasing the potential complementarity between

them.

6 Policy Implications

These considerations offer insight into policy issues, particularly regarding the
deﬁnition and administration of public G&S. First, there is a need to clearly identify the
target adopters of a public G&S regime, particularly as large and smaller retailers diverge
in terms of the technologies and organization methods that they employ, and
consequently their input needs. For example, if the public G&S regime isn’t adopted by
large retailers because it doesn’t reﬂect the product attributes they value, then one option
would be to further modify the speciﬁcations to better reﬂect large retailers’ needs. Doing
so, however, would entail a tradeoff—on one hand it could successfully encourage
adoption by the largest retailers, on the other hand, it might simultaneously make the
public regime less relevant to the needs of smaller retailers.

Second, it is crucial to consider the interrelation between the choice of G&S and

the choice of suppliers and administration of relationships with suppliers. The decision of

79

what G&S regime to use must be considered as part of a complex of decisions, rather
than assumed to be an independent choice or a leading choice with the choice of suppliers
and administration of the supply relationship following. The interplay of the different
aspects of the decision will likely differ among retailers on the basis of variables such as
the strength of their relations with suppliers and the extent to which quality issues are a
constraint to their business, as well as on the type of standard being promulgated.

Third, research is needed on the dynamics of adoption of public regimes—
particularly to understand when reliance on an extant public regime might preclude the
adoption of a potentially better regime.

Fourth, it is key to consider the efﬁciency and welfare tradeoffs between reliance
on public and private regimes, and the distribution of the costs and gains that are
experienced as a result of their promulgation. The widespread shift towards reliance on
public standards is common worldwide, and in many respects reﬂects ﬁrms’ efforts to be
responsive to changing industry conditions. At the same time, the exclusionary effects of
private regimes have also been documented. It is important to consider to what extent
scarce private resources might be directed to encouraging broader use of public regimes
versus helping ﬁrms that are at risk of being excluded from competing.

The issues that have been raised in this concluding section highlight the
complexity of the public versus private G&S issue. The model that was put forth in the
paper provides a basis for understanding the decision, and a point of departure for ﬁrrther
research. Exploration of issues such as the interplay between choice of G&S regime,
administration of the relationship with suppliers, and choice of supplier may help to

provide more insight into the question. It is also important for policy makers to

80

understand that there will be a tradeoff between the relevance of G&S regimes to
different types of buyers, as well as the ability of different suppliers to produce to
standard. A better understanding of the factors affecting the emergence of public and
private G&S regimes might be achieved by examining the evolution and patterns of G&S
adoption from a historical perspective—for example whether the emergence of public
regimes before private (or vice versa) encourages path dependency, and what the
implications are of G&S regimes being oriented to different levels of the marketing chain
(for example for supplier-retailer transactions versus consumer-retailer transactions) or
being promoted by different actors in the market (powerful retailers, oligopsonistic

wholesalers, concerned consumers, etc.).

81

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Caswell, J. A., M. E. Bredahl and N. H. Hooker (1998). “How Quality Management
Metasystems Are Affecting the Food Industry.” Review of Agricultural Economics 20(2):
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Codron, J .-M., J. A. Stems and T. Reardon (2000). Consumer Preferences, Experience
and Credence Issues and Their Strategic Implications for French and US Fresh Produce
Sectors. Contributed paper for the 2000 International Food and Agribusiness
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Farina, E. M. M. Q. (1999). "Padronizacio em Sistemas agroindustriais." Cinco ensaios
sobre gestdo de qualidade no agribusiness. D. Zylbersztajn. Sio Paulo, PENSA: 5-15.

Farina, E. M. M. Q. and C. Leles Rezende (2001). Changing Competition Patterns in a
Weak Regulatory Environment: The Case of Organic Products in Brazil. Intemational
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Farina, E. M. M. Q. and T. Reardon (2000). “Agrifood Grades and Standards in the
Extended Mercosur: Their Role in the Changing Agrifood System.” American Journal of
Agricultural Economics 82(5): 1170-6.

Giovannucci, D. and T. Reardon (nd). "Understanding Grades and Standards and How to
Apply Them." A Guide to Developing Agricultural Markets and Agro-enterprises. D.
Giovannucci. Washington DC, World Bank.

Henson, S. and J. Caswell (1999). “Food Safety Regulation: An Overview of
Contemporary Issues.” Food Policy 24(6): 589-604.

Henson, S. and J. Northern (1998). “Economic Determinants of Food Safety Controls in
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Jones, E. and L. D. Hill (1994). Re-Engineering Marketing Policies in Food and
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Krislov, S. (1997). How Nations Choose Product Standards and Standards Change
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Reardon, T. (2000). The Interface Between the Rapidly Changing Global Agrifood
Economy, and the Small Poor Farmer: Strategic Implications for the CGIAR. Special
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Reardon, T. and J. Berdegué (2002). “The Rapid Rise of Supermarkets in Latin America:
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Reardon, T., J .-M. Codron, L. Busch, J. Bingen and C. Harris (2001). “Global Change in
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Reardon, T. and E. M. M. Q. Farina (2001). The Rise of Private Food Quality and Safety
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Spers, E. E. (2000). "Qualidade e seguranca em alimentos." Economia e gestc'io dos
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Spers, E. E., D. Zylbersztajn and S. G. Lazzarini (2003). Consumers Perceptions over
Complementarity or Substitution of Private and Public Mechanisms of Regulation in
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CHAPTER 4
Coordination Strategy Decisions in Sio Paulo’s Fresh Produce Markets:

An Empirical Test of the Peterson, Wysocki & Harsh Framework

1 Introduction

Transaction cost economics revolutionized economists understanding of coordination
strategy decisions, bringing into the economic equation questions of how the attributes of
a transaction affect the governance decision, particularly given the reality of bounded
rationality and possibility for opportunism among partners in an exchange. Despite the
explanatory power of transaction cost models, they have been criticized on theoretical
grounds and for operational shortcomings. Speciﬁcally, Dow points out that in order to
compare transaction costs across different governance structures, the characteristics of
the transaction must be constant regardless of the governance structure in question (Dow
in Dietrich 1994 p 4). This is rarely the case in reality. In fact, the characteristics of both
the transaction and production tend to shift between coordination strategies, which makes
it more difﬁcult to assign solely transaction cost explanations to governance structure
decisions. Related to this is a further important criticism: implicit in the transaction cost
framework is the assumption that costs are the primary driver of transaction cost
decisions, while beneﬁts, particularly strategic beneﬁts (which can not be written off
merely as negative costs), playing an insigniﬁcant role. Several operational shortcomings
of the transaction cost model have also been named. For one, transaction cost economics
has been criticized as providing such a general explanation of coordination strategy
decisions that one can always ﬁnd what one is looking for, making it impossible to reject

hypotheses related to their determinants. Another criticism concerns the lack of

85

discussion in transaction cost literature of the cognitive process by which transaction
costs are taken into account. Together, these criticisms point to the need for an approach
to analyzing governance structures that is both theoretically consistent and operationally
sound. The need for such an approach has been felt not only in economics but also in the
strategic management ﬁelds, where there have been appeals for a business literature that
not only offers insight into strategic decision-making but also offers general theoretical
insights into coordination issues for use in research and hypothesis testing (e.g.
Zylbersztajn 1996).

In their 2001 article, Peterson Wysocki and Harsh (PWH) (2001) address these
issues, offering a theoretical decision-making model of the frrm’s coordination strategy
decisions. This paper applies the PWH model to the analysis of coordination strategy
decisions among ﬁrms in Sio Paulo Brazil’s fresh produce markets. The objective is to
test the model’s explicative power and to explore the unique contributions that it lends to
research on ﬁrms’ coordination strategy decisions. Data is drawn from case study
analyses of the evolution of coordination strategy decisions of three retailers and one
processor. The case study approach is a suitable method of analysis in situations where a
small sample permits in-depth consideration of the complex and interdependent factors
entering into a decision (Yin 2003). A survey of the ﬁrms’ fresh produce marketing and
procurement strategies was implemented and interviews with open and structured
questions were conducted with each ﬁnn’s management. A total of eight coordination
strategy outcomes are analyzed.

The paper proceeds as follows. After an introduction to PWH’s coordination strategy

model, the case study context and ﬁrms are introduced. Then the coordination strategies

86

of each ﬁrm are analyzed using the PWH framework. The paper concludes with a
discussion of the results focusing on the unique contribution that the PWH model lends to

the analysis of coordination strategy decisions.

2 Conceptual Framework: The PWH Framework

The main objective of the PWH theoretical framework is to identify the decision-
making process by which ﬁrm managers (decision makers) accommodate issues of asset
speciﬁcity, complementarity and coordination strategy feasibility in their coordination
strategy choices. PWH present a continuum of coordination outcomes that range from
low to high levels of intensity of control. At the level of least intense control are spot
market transactions, which rely entirely on control methods that are ex ante to the
transaction. Ever-increasing intensities of coordination control are seen in speciﬁcations
contracts, relation-based alliances, and equity-based alliances, with accompanying shifts
towards reliance on ex post rather than ex ante transaction coordination. At the far
extreme of the continuum is vertical integration, in which one organization has complete
control over the coordination transaction. Vertical integration occurs in situations where a
single ﬁrm owns production resources at consecutive levels of the marketing chain.

The key variables that determine the costliness of different coordination strategies
are asset speciﬁcity and complementarity. Asset speciﬁcity is the degree to which an
asset can be redeployed to alternative uses and by alternative users without sacriﬁce of
productive value. Complementarity exists when individual activities produce more in
combination than in sum across a speciﬁc transaction interface, so that the marginal

productivity of each input can’t be measured. Asset speciﬁcity and complementarity are

87

affected by private institutional arrangements or public institutions including those that
govern transactions, by technology, and by the structure of the marketing chain. Asset
speciﬁcity and complementarity can be experienced differently by individual ﬁrms. As
asset speciﬁcity and complementarity increase, the optimal coordination strategy shifts
from low intensities of control to higher intensities of control. The issue of
complementarity is distinct from that of asset speciﬁcity. In the case of complementarity
it is in the interest of both buyer and seller to achieve smooth coordination. In contrast
where asset speciﬁcity is an issue, there are incentives for one to proﬁt at the expense of
the other, for example through holdup and re-negotiation of the terms of exchange. Put
succinctly, the concept of asset speciﬁcity emphasizes opportunities for gains through
opportunistic behavior, while the concept of complementarity emphasizes opportunities
to gain through cooperative behavior.

PWH use results of inductive research to outline a decision process by which ﬁrm
decision makers synthesize issues of asset speciﬁcity and complementarity with
consideration of the ﬁrm’s characteristics and enviromnent to determine a beneﬁcial
coordination strategy. The decision process consists of four sequential decisions, each of
which must be answered in the afﬁrmative in order for a shift in strategy to be made. The

decision-making process is depicted in Figure 1.

88

Figure 1 PWH Decision-making Process

 

 

Q1 Q2 Q3 Q4 .
% Yes _ Yes - Yes A Yes # Shlﬁ
strategy
Maintain current strategy

Q1: 15 current strategy too costly?
Q2: Does a potentially less costly alternative strategy exist?
Q3: 15 potential alternative feasible?

Q4: Are costs, beneﬁt and risk tradeoffs of alternative
strategy acceptable and preferable to current strategy?

 

 

 

Initiating the decision process is the subjective question of whether the current

strategy is too costly. Costliness can be judged on an absolute scale (for example the

current strategy is too costly if it is causing coordination failures that are driving it to

bankruptcy) or on a relative scale (where the coordination strategy is considered too

costly relative to some perceived alternative). A strategy may be too costly if it causes

costly coordination errors, or if the cost of operating the strategy is too high, which can

occur in situations where complementarity and asset speciﬁcity are present. An

afﬁrmative response to the question of whether the current strategy is too costly will lead

the ﬁrm to initiate the process of considering speciﬁc alternative coordination strategies.

Next is the question of whether an alternative strategy exists that might be less

costly than the current one. Determining a potential alternative is a matter of matching

89

the intensity of control offered by an alternative strategy to the combined levels of asset
speciﬁcity and complementarity inherent in the transaction.

The third question5 is whether an alternative strategy that the ﬁrm has identiﬁed
is feasible for the ﬁrm to implement and sustain. Four aspects of this feasibility question
can be discerned, two internal and two external to the ﬁrm. These are 1) capital
availability (including ﬁnancial, labor, and other resources necessary to the successful
implementation of the alternative strategy, 2) control competence (in terms of the ﬁrm
managers being both willing and able to manage the coordination strategy effectively), 3)
availability of willing and able trade partners consistent with the alternative, and 4)
institutional acceptability e.g. whether the alternative is considered a “fair” business
practice under both cultural and legal views.

Finally, having ascertained the feasibility of the alternative strategy, the ﬁrm must
reconsider the beneﬁts, costs and risks anticipated to result from its implementation. If
these risks and returns are expected to be favorable relative to the current strategy, the
ﬁrm will choose to implement it. Given this evaluation, the ﬁrm decides whether to

implement an alternative strategy or maintain their current one.

 

5 PWH include programmability as a third decision (addressed before the feasibility question) in their
model. Here this step is omitted, as it was not found to be signiﬁcant (PWH also did not ﬁnd it to be
signiﬁcant in their own work). It is expected that ﬁrms will only seriously consider coordination strategies
that they consider to be programmable, so that programmability is addressed implicitly in the range of

alternatives that the ﬁrm initially chooses to consider.

90

3 Background to Sio Paulo fresh produce markets

From the early 19805 to about 1994, the Brazilian economy was in a state of
instability and stagnation. Inﬂation rates were high and consumers were extremely price
sensitive. Correspondingly, there was little proﬁtability in food retail markets. In the
fresh produce sector, there was consequently little specialization at the production level,
and there were large ﬂuctuations in the volume, price, and quality of produce available in
the market.

Beginning in 1994 with the Real Plan, the economy stabilized and disposable
incomes grew for consumers across all income strata. The potential to proﬁt through
investment in the food industry increased, drawing new retail entrants and increasing
competition. Mergers and acquisitions increased the market share of large retailers——
supermarkets currently account for 75% of retail food sales in Brazil (Farina 2002 p3).
The emergence of supermarkets as major players and their competitive strategies
stimulated investments upstream in the marketing chain, leading many suppliers to invest
to expand, modernize, and specialize their operations. This brought some reduction in the
variability of prices, quantities and quality of fresh produce available in the market.

Fresh produce markets are one area where large retail chains have had a signiﬁcant
impact on the structure and organization of the market, yet have not come to dominate in
terms of market share. Currently, fresh produce markets in Sio Paulo exhibit a
remarkable diversity in terms of the nature of the retailers and their competitive
strategies. Five coordination strategies for fresh produce procurement are common in Sic
Paulo’s fresh produce markets. Their places along the spectrum deﬁned by PWH are

depicted in Figure 2, and they are explained in greater detail below.

91

Figure 2 Coordination Strategies

PWH C oprdination Strategies

Spot Market Relation- Vertical
b d I te at'o
Speciﬁcation ase Equity-based n gr In
Alliance .
Contract Alliance

 

 

 

 

Sa'o Paulo FF V Coordination Strategies Observed

 

 

Supplier
Regis‘ry Vertical
Spot Market Contract .
Integration
Informal
Relations

The coordination strategy reﬂecting the lowest intensity of control that is
observed in Sio Paulo is spot market coordination, as deﬁned by PWH. Two more
coordination strategies, supplier registries and ongoing informal exchange relationships,
are observed lying between the spot market and speciﬁcations contracts. Supplier
registries are lists of approved suppliers that retail buyers maintain. In applying to be
listed on the registry, suppliers are apprised of basic parameters that will guide all
transactions, such as product speciﬁcations, methods for price formation, and other rights
and responsibilities of each party. Thus, they serve as an explicit foundation on which
repeated at-will transactions take place, but do not actually include product orders or any

commitment to buy or supply produce.

92

Informally-governed exchange relationships are based on familiarity between
buyer and seller, and a sense of mutual beneﬁts to be gained from the continuance of the
relationship though no explicit commitment for these relationships to continue exists. In
this situation, actors do not make relationship-speciﬁc investments on behalf of the other
party, so that they maintain their autonomy and ﬂexibility to leave the relationship with
minimal losses. Thus these relationships do not reach speciﬁcation contracts in terms of
levels of commitment and control.

Showing an even higher intensity of control are formal contracts between retail
buyer and supplier. These include explicit provisions for exchange (for example a
commitment to buy or sell produce at regular intervals), in addition to the guidelines
found in supplier registries.

Furthest to the right along the spectrum is vertical integration. Vertical integration
is most commonly observed directed downstream, e. g. by a farmer who decides to market
his own produce; and involves single-ownership of production resources involved in
several stages of the supply chain.

In fresh produce markets, a number of factors give rise to asset speciﬁcity and
complementarity throughout the production, processing and marketing process, with one
of the above coordination strategies being chosen as a consequence. The major factor
bringing about asset speciﬁcity is the perishability of fresh produce, which causes a loss
in the value of the product if there is a time-delay in its delivery, for example as might be
caused by a transaction falling through (Farina and Machado 1999). Investments that are
speciﬁc to the needs of a buyer, such as greenhouses or cultivation of special varieties are

also asset speciﬁc. The primary factor inducing complementarity in fresh produce is the

93

heterogeneity of supply and demand (Codron et al. 2000), particularly given the
perishability of the product. Large variations in the quality of what is produced and what
is sought by consumers, and the fact that once it is produced it must move quickly along
the marketing chain to the consumer so as to not lose value through natural processes of
degradation, make it important for buyers and sellers to have some means of coordinating

the product ﬂow with one another.

4 Case analyses

4.1 First case: Companhia Brasileira de Distribuicio

Companhia Brasileira de Distribuicio (CBD) is the largest food retail ﬁrm in Brazil
with approximately 15% of market share. With more than 400 retail outlets among three
supermarket and hypermarket chains, CBD offers a broad line of food and general
merchandise to consumers of all income categories. Perishables, including fresh produce,
account for 33% of CBD’s sales and are their most important sector strategically. Among
perishables, fresh produce can contribute anywhere from 4% to 16% of each individual
store’s revenue depending on the clientele served and product line carried. Though they
offer a broad range of fresh produce items, the focus here is on CBD’s procurement of

bulk produce.

Phase 1:
Table 1 summarizes the case facts leading to CBD’s ﬁrst procurement strategy
shift. CBD’s challenge is to coordinate procurement of sufﬁcient volume of consistent

quality produce to serve their 400+ stores, and to distribute it among these stores in an

94

efﬁcient and timely manner. In the 19805, CBD bought produce at the traditional
wholesale market from a registry of approved suppliers. Procurement was decentralized,
with each store undertaking its own procurement activities. Quality was controlled by
inspections of produce prior to purchase and subsequent sorting at the store level.

With economic stabilization, consumers’ incomes increased and consumption
patterns began to change, with an increase in demand for fresh produce. At the same
time, in part responding to new opportunities in food retail sales, CBD began to grow
both through increased sales per store and mergers and acquisitions that increased the
number of stores. At this point, CBD’s management was faced with the initiating
question: Was their current coordination strategy too costly? The answer to this question
was afﬁrmative. They had difﬁculty obtaining adequate quality and volumes of produce
and experienced high rates of waste. Furthermore, quantity and quality ﬂuctuations in the
market made planning difﬁcult and they had to compete with the rest of Sio Paulo’s
retailers for what produce was available in the market. Furthermore, they saw an
opportunity to reduce costs and improve quality by constructing centralized purchase and
distribution centers for produce that would offer economies of scale and scope. They
knew, however, that investment in a centralized procurement and distribution (P&D)
center would only yield good results if they were able to assure a constant ﬂow of
produce throughput. This made them vulnerable to re-negotiation and holdup by suppliers
that they also could not control effectively under their current coordination strategy.

CBD took an alternative strategy which was to make entry onto their registry of
suppliers more demanding, and to seek more services such as classiﬁcation and delivery

from suppliers of produce. At the same time, they could vertically integrate the assembly

95

part of the wholesale function using the centralized P&D centers as a base. CBD
anticipated that these changes could reduce their coordination costs—tighter relations
with suppliers would facilitate planning and the better product classiﬁcation would
improve the quality of incoming produce and reduce waste. Likewise, a smaller cadre of
suppliers with whom they had more regular relations would help to ensure a constant
supply of produce throughput for their centralized procurement activities.

The feasibility of the strategy seems apparent. Construction of a centralized P&D
center would require much ﬁnancial capital, but as a large ﬁrm that was well reputed in
ﬁnancial circles, CBD had adequate access to such capital. They also had the managerial
sophistication (demonstrated in other areas) necessary to coordinate the logistical and
contractual functions associated with a more intensely-controlled supplier registry and
centralized P&D. CBD anticipated that they would have an adequate number of suppliers
who would be willing and able to serve their needs—suppliers would beneﬁt from the
smoother ﬂows of information and product too, and appreciated the large volumes of
product that CBD needed. Institutional acceptability of the alternative options also
presented no challenge.

Given its feasibility, CBD apparently evaluated positively the risks and returns of
making these large shifts in their strategy. The potential beneﬁts—improved control over
quality, and savings of from 20-30% on procurement costs through centralization—were

clear, and CBD opted to make the shift.

96

Table l PWH analysis of CBD cases facts in lst stage of evolution

 

PWH Variable

Realization in Case

 

Initial strategy:

Informal supplier registry with individual store purchases from

wholesale market. CBD then processes goods as needed.

 

15 initial strategy too

costly?

Yes. Quality and volume requirements not met. Issue heightened

by increasing demand and competition during decision period.

 

Does an alternative
exist that is
potentially less

costly?

Yes. Alternative is centralized purchases direct from producers
informal supplier registry with enforced quality standards.
Supplier does processing. Alternative trades off low asset
speciﬁcity of conducting decentralized purchases in wholesale
market in favor of high asset speciﬁcity of investing in
centralized facilities. Complementarity is high due to increased
proﬁt opportunities from having volume and quality demands
met through tighter chain coordination. In balance, alternative is

expected to be less costly.

 

15 alternative

Yes. CBD has ﬁnancial capacity to make investment.

 

 

 

feasible? Sophisticated management ensures control competence. Tighter
relationship beneﬁts producers ensuring availability of willing
suppliers, and alternative is legally and culturally acceptable.

Favorable Yes. Anticipated risk & return of alternative deemed preferable

risk/return? to current strategy.

Outcome Alternative adopted as predicted by PWH—all decision process

 

answers “yes”.

 

97

 

Phase 2:

Table 2 summarizes the case facts relevant to CBD’s next shift in procurement
strategy. Several years after making a shift to vertically integrated assembly functions
and a more tightly-controlled supplier registry, CBD found itself facing new challenges
that made it once again reconsider the costliness of its coordination strategy. CBD’S
managers felt that the strategy of vertically integrated assembly operations was working
well and felt no need to change. They saw, however, that the supplier registry as working
sub-Optimally given current market conditions. Consumers had become increasingly
sophisticated and were concerned with issues like food safety. At the same time, CBD
suspected that there were opportunities to increase their proﬁtability by further improving
the quality and regularity of their produce supplies, and this was difficult under the
current coordination strategy because some suppliers still lacked loyalty in times of
product shortages. Moreover, the shift in coordination enacted in the previous period had
increased the level of investment required for suppliers to qualify for the registry, and
there were complaints from suppliers who perceived power imbalances in the registry
system—particularly their having made investments to qualify for the registry without
CBD making any commitment to buy from them on a regular basis.

CBD considered contracts with suppliers as an alternative coordination strategy
for input procurement. These contracts could resolve the asset speciﬁcity and
complementarity problems that were present in the existing strategy. A commitment on
the part of CBD to purchase output from suppliers could pacify suppliers’ current
frustrations, and also provide them the security they needed to make even more

specialized investments, for example in greenhouses and sophisticated irrigation systems,

98

that would improve the quality and regularity of the produce they supplied. At the same
time, contracts would help CBD to weed out those suppliers who were not willing to
conunit to supply them regularly, regardless of market conditions.

Instituting such a shift would require investments to form the contracts, as well as
additional managerial expertise to manage them, but these did not present a barrier to
CBD given its large size, ready access to investment capital, and highly sophisticated
managerial expertise. Likewise, it was anticipated that there would be an adequate
number of experienced suppliers who would be willing to make investments to improve
the quality of their production provided they could be assured of a buyer. Institutional
acceptability was also not gauged to be an impediment. The anticipated return and
perceived riskiness of the shift was favorable to CBD, as increased sales and lower costs
of coordination were anticipated. Thus, at the time of data collection, CBD was beginning

to undertake activities to make this change.

Table 2 PWH analysis of CBD cases facts in 2nd stage of evolution
PWH Variable Realization in Case

 

 

Initial strategy: Alternative adopted in ﬁrst stage (centralized purchasing direct
from producers, formal supplier registry with enforced

standards; supplier does processing)

 

15 initial strategy too Yes. There is insufﬁcient assurance of food safety given
costly? increasing consumer safety concerns, and a lack of loyalty

exists among suppliers given their perceptions of a power

imbalance with CBD.

 

 

 

 

99

 

Does an alternative
exist that is
potentially less

costly?

Yes. Speciﬁcation contracts—build on registry to include
commitment to buy/sell. Asset speciﬁcity is high for
suppliers-ﬁxed investments to join registry and respond to
new demands but contracts guarantee purchase.
Complementarity is also high due to additional opportunities
for farmers to proﬁt if they respond to food safety demands but
need to more tightly coordinate supply to realize these

opportunities.

 

15 alternative

Yes. Capital to institute contracts is available. Sophisticated

 

 

 

 

feasible? management ensures control competence. Buy/sell
commitments now make asset-speciﬁc investments by
suppliers worthwhile. Alternative is legally and culturally
acceptable.

Favorable Yes.

risk/return?

Outcome Alternative adopted as predicted by PWH—all decision

process answers positive.

 

4.2 Second case: Sapori

Sapori markets premium quality preserves and fresh produce items to the upper-

income strata of metropolitan Sic Paulo’s consumers through independent retail outlets

(i.e. ones not owned by Sapori) . Sapori has a 30 item product line, oriented to consumers

who seek the healthfulness and novelty of premium and exotic products, such as mini-

100

 

eggplant, mini-com, and recipe-of-the-week combinations. The ﬁrm has also developed

some of its own varieties for some of the exotic vegetables it markets.

Phase 1:

Table 3 summarizes the case facts leading to Sapori’s ﬁrst shift in procurement
strategy. In order to market premium-quality, specialized fresh produce products, Sapori
needs moderate volumes of a highly specialized input. When Sapori began operations,
they were able to meet these special needs through vertical integration of their production
and processing operations. As demand for their products grew, however, they found this
strategy to be too costly—though they had tight control over the quality of their produce,
their volume and variety needs came to outstrip their production and managerial
resources. Acquiring all the produce they needed in this manner was too costly in terms
of the ﬁrm-speciﬁc resources that it required.

An alternative coordination strategy that was available to Sapori was to make
purchases from the local wholesale market using spot market relations. Sapori hoped that
purchases from the local market would be able to provide them with the volumes and
types of produce that they needed, permitting them to specialize their ﬁrm resources on
the value-added processing activities that were key to their success.

This option seemed very feasible—it carried virtually no capital requirements and
little control competence was needed to make such purchases. Likewise, there were
numerous suppliers already situated in the wholesale market who would be willing to
supply them, and it was institutionally acceptable. Given the costs that they were facing

at that point, the risk/retum tradeoff of implementing the alternative seemed favorable,

101

and Sapori took the step to vertically dis-integrate their production activities in favor of
spot market purchases of raw material inputs. It should be noted, however, that
consideration of asset speciﬁcity and complementarity issues in the PWH framework
brings into question the adequacy of Sapori’s chosen strategy to accommodate the highly

speciﬁc input requirements.

Table 3 PWH analysis of Sapori cases facts in lst stage of evolution
PWH Variable Realization in Case

 

 

Initial strategy: Vertical integration of production and processing activities

 

15 initial strategy too Yes. Growth in sales over-extends Sapori’s production
costly? capabilities. Managerial capital and space became inadequate

to meet scope and volume requirements for inputs.

 

Does an alternative Yes. Informal (spot market) purchases of raw material from
exist that is local wholesale market would satisfy volume and scope
potentially less requirements. [PWH model would question beneﬁts of spot
costly? market purchases given high asset speciﬁcity and

complementarity of input (which are accommodated through
current strategy of vertical integration) but actual decision
makers expect alternative to be less costly given need to meet

volume and scope requirements]

 

15 alternative Yes. Alternative has low capital and control requirements.
feasible? Willing suppliers exist and the alternative conforms to

common business practice. Alternative is legally and culturally

 

 

 

 

102

 

acceptable.

 

 

Favorable Yes.
risk/return?
Outcome Alternative adopted as predicted by PWH given all decision

process questions answered “yes” by decision-makers, but
PWH analysis brings into question ability of new strategy to

accommodate asset speciﬁcity and complementarity.

 

 

 

 

Phase 2:

Having made this shift, Sapori came to realize that in resolving some of their
coordination problems, they had generated others! They were now able to get the
volumes and types of produce that they needed, but they found that they were having
trouble getting the quality that they were looking for. The day-to-day nature of spot
market transactions meant that there was no advance planning, and Sapori could only
purchase what was available in the market. They needed produce with special
characteristics, however, such as “baby” cuts (harvested when still immature) and they
were also developing their own varieties of exotic produce and needed to be able to
coordinate in advance if farmers were to grow these. As it was, with spot market
purchases, suppliers were unwilling to accommodate these special needs because there
was no guarantee that Sapori would be there to purchase from them, and the value of
produce grown to meet Sapori’s needs was low for alternative buyers. Thus, the new
strategy was generating costly coordination errors. Table 4 analyzes case facts relevant to

Sapori’s second shift in procurement strategy.

103

To combat this problem, Sapori considered another change in strategy—they
could establish relationships with a subset of highly qualiﬁed farmers, with speciﬁc
transactions being guided by written purchase orders. The advance purchase orders,
permitted growers to plan their planting activities with the expectation of having a buyer
for their output. This facilitated complementarity in moving high-value products more
smoothly along the marketing chain, beneﬁting both Sapori and its suppliers. The
ongoing relationships would assure suppliers of a buyer for their product, and permit
them to make investments that would enhance their production for Sapori.

An assessment of the feasibility of this alternative was positive. The strategy
carried moderate capital needs that Sapori could meet, and Sapori anticipated being able
to maintain adequate control by providing technical assistance to their suppliers by a full-
time agronomist they employed. There were suppliers available who were able and
willing to specialize their activities to meet Sapori’s needs, and they had the incentive to
do so given the premium prices that Sapori was willing to pay. Institutional acceptability
likewise did not present any problems.

Given the apparent feasibility of the alternative and its potential to alleviate the
costly coordination problems that they were facing, Sapori’s managers perceived the risks
and returns on the project to be favorable. The anticipated beneﬁts were clear—making
the shift could ensure Sapori was the quality, scope, and volume of input that they
required. Sapori thus ceased to make spot market purchases from the local wholesale
market and instituted a system of ongoing purchases from a core of highly qualiﬁed

suppliers.

104

Table 4 PWH analysis of Sapori cases facts in 2nd stage of evolution

 

PWH Variable

Realization in Case

 

Initial strategy:

Alternative adopted in ﬁrst stage (spot market purchases of

input)

 

15 initial strategy too

costly?

Yes. Volume and scope needs met through shift, but advance
planning of purchases precluded by spot-market nature of
transaction. Sapori can’t get special input needs met (early
harvest, exotic varieties). Failures to accommodate asset
speciﬁcity and complementarity make current strategy too

costly.

 

Does an alternative
exist that is
potentially less

costly?

Yes. Informal relation-based alliances with provision of some
inputs (e.g. seeds), technical assistance. Asset Speciﬁcity and
complementarity will still be high, but the new strategy offers a

better chance of accommodating them than the spot market.

 

15 alternative

Yes. Alternative has low capital requirements, and control is

 

 

 

 

feasible? facilitated by full-time agronomist employees and Sapori’s close
proximity to most growers. Capable suppliers familiar with
Sapori’s needs exist. No challenges to institutional acceptability
anticipated.

Favorable Yes.

risk/return?

Outcome Alternative adopted as predicted by PWH—all decision process

answers positive.

 

105

 

Phase 3:

The shift in strategy improved Sapori’s raw material procurement results
remarkably. Eventually however, they once again had to face the question of whether
errors and operational costs incurred under their current strategy were too costly. Two
issues led them to consider this: First, like CBD, Sapori became aware that their end
consumers were increasingly concerned with the safety of the food they ate, and the level
of control offered under the current coordination strategy (based on ongoing informal
relations with suppliers and written product orders), seemed insufﬁcient to truly
guarantee a safe product. Second, they had become aware that some of the suppliers to
whom they had provided seed (for exotic varieties that they had developed) had sold the
product of this seed to buyers other than Sapori. It seemed that those growers who had
done this lacked commitment to the relationship, as they were apparently willing to
compromise it for short-term opportunistic gain. Table 5 summarizes the case facts
relevant to Sapori’s ﬁnal shift in procurement strategy.

The next change that Sapori contemplated for their coordination strategy was to
institute written contracts with their suppliers, that would that specify the rights and
responsibilities of each party, deﬁne planting schedules, and make other aspects of the
relationship clear. Sapori’s managers felt that by forrnalizing the relationship with
suppliers, they would increase complementarity in the relationship—especially as it
related to the marketing of a safe product—by further tightening coordination. They also
hoped to protect the asset speciﬁcity of their investments in varietal development by

making it explicit that they had the right to all of the output from the seed they provided.

106

Consideration of the feasibility of this strategy yielded encouraging results.
Relatively little capital was required to deﬁne and establish the contracts, and Sapori had
the managerial competence required to successfully implement them. It was anticipated
that suppliers with whom Sapori already worked would be amenable to the change, as it
carried little implication for actual operations, facilitated their planning, and strengthened
their market. Institutional acceptability was not expected to be a problem.

The beneﬁts that were anticipated in instituting a contract seemed apparent, and at

the time of data collection Sapori was poised to initiate this shift in strategy.

Table 5 PWH analysis of Sapori cases facts in 3rd stage of evolution

 

PWH Variable Realization in Case

 

 

Initial strategy: Alternative adopted in second stage (informal, relation-based

alliance with producers)

 

 

15 initial strategy Yes. Consumer concerns for food safety increase coordination
too costly? requirements for input acquisition, and a lack of commitment on
the part of some suppliers (who divert seeds to other uses)

threatens the value of investments in exotic varieties.

 

Does an alternative Yes. Formal contracts with some input provision and advance

exist that is purchase commitments. High asset speciﬁcity faced by suppliers
potentially less (specialized production) is already accommodated through
costly? current strategy, however Sapori’s asset speciﬁc investments in

exotic varieties are threatened by some farmers’ diversion of

these to other uses and Sapori anticipates formal contracts might

 

 

 

 

107

 

quell this, increasing long term proﬁtability. Furthermore, they
anticipate formal contracts will increase farmers’ willingness to
investment in traceability and other food safety assurances,

increasing complementarity.

 

15 alternative Yes. Capital is available for the deﬁnition and implementation of
feasible? contracts and little change to control needed. Suppliers of proven
availability are already working with Sapori. No problems with

institutional acceptability are anticipated.

 

 

Favorable Yes.
risk/return?
Outcome Alternative adopted as predicted by PWH—all decision process

answers “yes”.

 

 

 

 

4.3 Third case: Sacolio FLV

Sacolio FLV (SF) is one of metropolitan Sio Paulo’s government-promoted
discount green grocers. Established in 1992, SF is oriented to lower income consumers
and sells a range of about 80 fresh produce items at a uniform price per kilogram. SF falls
into the class of “small” food retailers for Sio Paulo with a sales area of approximately
500 square meters (all of which is used for fresh produce sales). Though privately
administered, the government supports the ﬁrms through provision of space in which to
operate and basic services (c. g. light and water), in exchange for which SF must adhere to

the municipal government’s price guidelines.

108

SF ’5 primary challenge is to obtain a consistent volume and quality of fresh
produce so that it can meet its clients’ needs. A key constraint is the single price—per-kilo
format and the need to keep the costs below that despite characteristically ﬂuctuating
fresh produce supply and prices.

When the ﬁrm opened in 1992, SF purchased fresh produce in Sio Paulo’s
wholesale market, relying entirely on spot market coordination. Each day a buyer would
compare prices and inspect products, and choose a supplier on the basis of the day’s
product availability. This was an appropriate strategy for the time——economic instability
meant that fresh produce was a relatively unproﬁtable sector, and although SF’s
procurement would have been facilitated through tighter coordination in order to mitigate
the high variability in prices, volumes and quality of produce that was available in the
market, the low proﬁtability of the sector left neither SF nor suppliers with incentive to
do so.

Gradually market conditions shifted and SF considered the costliness of their
strategy given current market conditions. With economic stabilization, demand for fresh
produce had grown and this had stimulated greater levels of production and investment in
specialized production by many suppliers who were now able to offer consistent quality
produce on a regular basis. SF’S management suspected that they could have better
control over supplies lower costs if they updated their strategy to reﬂect these changed
conditions. Table 6 summarizes the case facts relevant to SF’s shift in procurement
strategy.

As an alternative to their spot market coordination strategy, SF considered forging

ongoing, informal relations with a relatively small number of suppliers. An informal

109

alliance could permit mutual familiarity between SF and a limited number of regular
suppliers, providing beneﬁts of cooperation from longer-term “preferred supplier-
preferred buyer” relations. The give-and-take of the relationship would increase
complementarity, beneﬁting both buyer and suppliers. The provision of services such as
protection from price ﬂuctuations and responsiveness to the speciﬁc quality and price
needs would make the acquisition of fresh produce easier and less costly. At the same
time, neither ﬁrm would need to make any relationship-speciﬁc investments, so that they
could maintain their autonomy and exit the relationship at will.

This shift in strategy seemed feasible to SF—it required no explicit capital
requirements and there was an increasing number of specialized suppliers in the market
who would be interested in having a relatively assured outlet for their product on a long
term basis. Control competence was not a problem as it required little change in
management, and institutional acceptability was not anticipated to be a problem, given
that such relationships were common.

The risk and return assessment was likewise favorable—SF expected to beneﬁt by
having easier access to produce and lower price ﬂuctuations, without having to incur any
signiﬁcant costs in making the transition. Thus, the strategy was implemented as

envisioned.

110

Table 6 PWH analysis of Sacolio FLV Case Facts

 

PWH Variable

Realization in Case

 

Initial strategy:

Spot market purchases from many suppliers in wholesale market

 

15 initial strategy

too costly?

Yes. Gradual increases in supply in market, reductions in price,
volume, variety variability cause difﬁculty getting consistent

volume, quality of input needed.

 

Does an
alternative exist
that is potentially

less costly?

Yes. Purchase from the wholesale market but rely on informal
relations (speciﬁcation contract) with fewer specialized suppliers.
Asset speciﬁcity is low—only perishability of product. Initially
little complementarity because suppliers proﬁt by playing market,
however complementarity increases because increased market
supply makes having pre-arranged outlet preferable and buyers

wants quantity, quality and availability needs to be responded to.

 

15 alternative

Yes. Alternative has no explicit capital requirements. Little change

 

 

 

feasible? in management needed for control competence. Willing partners
exist in specialized suppliers who will beneﬁt from having an
assured buyer. Alternative is legally and culturally acceptable.

Favorable Yes.

risk/return?

Outcome Alternative adopted as predicted by PWH—all decision process

 

answers “yes”.

 

lll

 

4.4 Fourth Case: Galeria dos Pies

Galeria dos Pies (GP) is an upscale self-service restaurant and supermarket located
in one of Sio Paulo’s most afﬂuent neighborhoods. Established in 1992, GP enjoys a
strong reputation for the provision of fresh, premium-quality food through both its
restaurant and retail sectors. The supermarket specializes in perishables, bakery items,
and imports, and contributes approximately 50% to GP’s RSI million monthly revenue.
Many of the supermarket products are produced on-site in complement to the restaurant’s
activities guaranteeing that maximum quality and freshness are consistently maintained.
FP sells approximately 200 fresh fruit and vegetable items in the 100 square meters of its
fresh produce department. The marketing strategy emphasizes its premium quality,
variety and convenience to its demanding clientele with a small area dedicated to the
presentation of each item and quick turnover. GP doesn’t sell any bulk produce items—
approximately 50% of its sales are of select-quality pre-packaged produce, with the
remaining 50% divided among sales of organic, hydroponic, and pre-processed produce.
Proﬁt margins for individual products can reach over 30%.

Galeria dos Pies is an interesting case in that it has not enacted any signiﬁcant shift
in its procurement strategy since its inception in 1992, nor do they plan to alter their
current strategy. This case analysis tests the PWH hypothesis in an alternative manner,
however, by comparing GP’s coordination strategy for two different types of produce—
pre-packaged produce (which is sold whole in Styrofoam trays with plastic wrap
coverings), and fresh-cut and organic produce, which present coordination challenges

given their holding high-value attributes—convenience and food safety, and production

112

with organic processes respectively. The ﬁrm has signiﬁcantly different coordination
strategies for the procurement and marketing of each of these.

Pre-packaged produce: Table 7 presents case facts relevant to the PWH analytical
model. GP’s strategy for the marketing of pre-packaged produce is to use a hybrid of a
spot market and speciﬁcations contract (reﬂected in ongoing informal relations with
suppliers, much as SF has) for the assembly of produce, and then to process it (sort and
package) at its own site. Ongoing relations with suppliers permits GP ready access to
high qualities of produce in the market—they intentionally buy from relatively small
suppliers in order to encourage complementarity present in two ﬁrms selling to one
another on a regular basis, and suspect that if they bought from a larger supplier it would
not appreciate their business so much and complementarity would be lost. The asset
speciﬁcity inherent in purchases of fresh produce is low, and moderate in processing
though by conducting their own processing operations it is minimized because they have
relatively small investments in equipment, and use produce that is not sold in their
restaurant operations. The strategy is highly feasible because it is relatively simple and
has little managerial requirements, and because it takes advantages of resources that GP
readily has at hand, such as a large labor force for the processing activities. There are
numerous trade partners willing to supply them and beneﬁt from the ongoing
relationship, and the strategy is acceptable institutionally.

Though alternative coordination strategies are also available that are feasible and
would serve GP’s needs, the current strategy is judged to be efﬁcient and effective, and
so no alternative strategy would surpass it given the perceived good returns that are

accrued with the current strategy.

113

Table 7 PWH analysis of Galeria dos Pies Case Facts for Pre-packaged Produce

 

PWH Variable

Realization in Case

 

Initial strategy:

Spot market — speciﬁcation contract hybrid for coordination of

purchases; Vertical integration of processing.

 

15 initial strategy too

costly?

No. Asset speciﬁcity and complementarity are accommodated

through cn-site processing. Operational costs are low.

 

Does an alternative
exist that is
potentially less

costly?

No.

 

15 alternative

feasible?

 

Favorable

risk/return?

 

Outcome

 

 

No change to coordination strategy.

 

Fresh-cut and organic produce: Fresh-cut and organic produce present a different
challenge to GP. They present a high degree of complementarity in that their highly-
valued attributes (food safety in the case of fresh-cut, and organic production in the case
of organic produce) are highly specialized and need to be marketed effectively (for
example identity to be preserved) in order for their value to be realized. Vertical
integration of production would not be in GP’s interests as it requires substantial
managerial competence and investment, and because if they are not sold their high value

is forfeited. There is also a relatively competitive supply of these products in Sic Paulc’s

114

 

market. A summary of case facts for the PWH analysis of GP’s organic and fresh-cut

produce coordination strategy is presented in Table 8.

Table 8 PWH analysis of Galeria dos Pies Case Facts for Fresh-cut & Organic
Produce

PWH Variable Realization in Case

 

 

Initial strategy: Suppliers (vertically integrated downstream) responsible

for production, processing & management activities.

 

15 initial strategy too costly? No. GP does not bear risks in carrying fresh-cut and
organic produce line. Suppliers accommodate asset
speciﬁcity and complementarity through vertical
integration, bear risk of participation in market, but this

strategy allows them access to the market.

 

Does an alternative exist No.
that is potentially less

costly?

 

15 alternative feasible? —

 

Favorable risk/return? —

 

Outcome No change to coordination strategy.

 

 

 

 

The relatively high risk in their production and marketing, high managerial
requirements, and high level of complementarity result in an interesting coordination
strategy, in which suppliers vertically integrate downstream, conducting not only

production and processing operations, but also taking responsibility for much of the

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marketing operations, for example deciding how much and what to stock in GP’s shelves,
and even stocking it. They are also responsible for the value of any produce that is not
sold (though it is purchased by the retailer, rather than sold on consignment).

GP is not presented with an incentive to change this coordination strategy. It allows
them to offer a high-value product that their consumers value, with little risk in either
marketing or liability (for example in the case of a food safety failure) as their suppliers’
take on virtually all of the responsibility. The suppliers beneﬁt by the complementarity
that is achieved—they overcome the barriers to market access by carrying out their own

marketing activities and taking on risk inherent in these activities.

5 Discussion and conclusions

Analyses of the evolution of the three ﬁrms’ coordination strategies appear to
provide powerful evidence supporting the determinants and processes of decision-making
that PWH posit in their model. The case study results provide considerable insight into
issues of incentives and feasibility, as well as the inﬂuence that asset speciﬁcity and
complementarity have on coordination strategy decision.

What insights have the case analysis lent into general questions of coordination
strategy decision-making? Several points can be drawn. First, with only the exception of
those ﬁrms that began with a vertical integration strategy and subsequently de-integrated,
ﬁrms in each case consistently tended to shift their strategies toward ones offering greater
intensities of control. In general, this does not necessarily indicate that the ﬁrms initially
made the “wrong” coordination strategy choice. Instead, there are suggestions that both

retailers and suppliers beneﬁted from the gradual intensiﬁcation of coordination control,

116

over which period they learned to better work with one another and adjusted to the
greater levels of interaction and interdependence, while incompatible partners were
identiﬁed and weeded out. There were also important driving forces, namely the shifts in
underlying demand and supply conditions faced by the ﬁrm that also drove these strategic
shifts towards ever-increasing levels of control.

Second, differentiation between issues of complementarity and asset speciﬁcity
permit a considerably richer insight into issues of coordination than a single-minded
focus on asset speciﬁcity. The deﬁning difference between the two concepts highlights
that coordination can be costly even where there is no reason to anticipate opportunistic
behavior on the part of either party, i.e. in situations of complementarity where both
parties will beneﬁt from the successful completion of transactions.

Third, it seems that as one moves from lesser to greater degrees of control intensity,
one can observe early shifts rightward to be oriented to resolving issues of
complementarity, with the resolution of these leading to gradual increases in the levels of
asset speciﬁcity implicit in the transaction; and this in turn leading to the need for
additional shifts in coordination strategy. For example, in the ﬁrst phase of CBD’s
coordination strategy, they sought to facilitate the achievement of complementarity
beneﬁts by tightening control through the supplier registry, doing which led to
relationship speciﬁc investments whose asset speciﬁcity later needed to be
accommodated through further shifts in coordination. This observed phasing needs to be
tested with additional cases to see if it can be generalized.

In conclusion, it is argued that the case study analyses provide signiﬁcant support for

the PWH model, as well as new insight into the ﬁrms’ coordination strategy decisions

117

that might be forgone when analyzed using a model that lacks the operational approach

and consideration of incentives and feasibility guiding the PWH model.

118

REFERENCES

Alchian, A. A. and H. Demsetz (1972). “Production, Information Costs, and Economic
Organization.” The American Economic Review 62(5): 777-95.

Codron, J .-M., J. A. Stems and T. Reardon (2000). Consmner Preferences, Experience
and Credence Issues and Their Strategic Implications for French and US Fresh Produce
Sectors. IAMA Conference, Chicago.

Farina, E. M. M. Q. and E. L. Machado (1999). Brazilian Fresh Fruit and Vegetable
Chain Coordination. IAMA Conference, Florence.

Milgrom, P. and J. Roberts (1992). Economics, Organization, and Management.
Englewood Cliffs, NJ, Prentice-Hall.

Peterson, H. C., A. Wysocki and S. B. Harsh (2001). “Strategic Choice Along the
Vertical Coordination Continuum.” Intematicnal Food and Agribusiness Management
Review 4: 149-66.

Yin, R. K. (2003). Case Study Research: Design and Methods. Thousand Oaks, Calif,
Sage Publications.

Zylbersztajn, D. (1996). "Governance Structures and Agribusiness Coordination: A

Transaction Cost Economics Based Approach." Research in Domestic and Intematicnal
Agribusiness Management, JAI Press. 12: 245-310.

119

CHAPTERS

Fresh Produce Procurement Strategies in a Constrained Supply Environment:
Case Study of Companhia Brasileira de Distribuicio

(Teaching case & notes)

The General Manager of Produce Operations was in the midst of considering the
challenge that he faced in the coming months. His ﬁrm, Companhia Brasileira de
Distribuicio (CBD) had seen several years of growth and high proﬁtability, and fresh
produce had been a key contributor to this success. Yet he felt that a shift in strategy was
due if CBD’s fresh produce sector was to continue on its path of expansion and high
performance. To begin with, he sensed both the potential and the need to revise
relationships with suppliers in order to improve the level of service. Moreover, as in
many countries, food safety had become an issue of concern for consumers in Brazil and
he suspected that if CBD could provide the safest and most consistent quality in the
market, then even more consumers would respond by becoming loyal customers of CBD.

But how would he make such a shift? What changes should be made and how?

1 Background

Sic Paulo is the largest city in Brazil. Its population of 18 million has seen
remarkable changes over the past decade. Since the early 19905, a time when Brazil’s
economy was in shambles, Sic Paulo’s residents have beneﬁted from economic
stabilization and growth that increased their incomes and permitted higher levels of

consumption across all income strata. Concurrent with these changes, large modern

120

retailers have grown in importance—between 1994 and 2000, the market share of the ten
largest retail chains grew from 24% to 47%. In competition with other retail giants like
the French Carrefour and American WalMart, CBD has earned the place of Brazil’s
largest retailer, with sales of US$45 billion in 2002.

CBD had its beginnings in 1948, when Valentim dos Santos Diniz, a Portuguese
immigrant to Brazil, opened his ﬁrst supermarket in Sic Paulo. The ﬁrm, which evolved
into a group of food retail chains collectively called Companhia Brasileira de
Distribuicio, survived the ﬁnancial turmoil of the late 19805 and early 19905, and after
restructuring in the 19905, gained its current place as Brazil’s largest retailer in 2000.

Today, CBD has more than 300 stores in Sic Paulo and nearly 500 nationwide.

2 The Role of Fresh Produce in Retail

Fresh produce is a key strategic sector for modern retailers worldwide. Though it
maintains a relatively low overall share of supermarket revenues in Brazil—only 6% on
average—proﬁt margins tend to be quite high. Price/cost ratios exceed 130% for some
products, particularly for the highest-value produce lines such as pre-processed, pre-
packaged, organic and hydroponic produce. Furthermore, though per capita consumption
of fresh fruits and vegetables is relatively low on an absolute level in Brazil (40 kg per
year relative to 143 kg per year in the US), and consumers spend only 2.5% of their
incomes on vegetables (compared to about 4% in the US. for example), fresh produce
represents a rapidly expanding market. Demand for higher-value products, such as
organics and pre-processed produce, is especially dynamic as consumers increasingly

seek foods that are healthy, novel and convenient.

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Fresh produce also plays an important role in attracting clients and generating
customer loyalty. It serves as each store’s “calling card,” lending an immediate
impression of the quality of merchandise that is offered in the store. Consumers typically
purchase fresh produce items several times a week, spurring more visits to the
supermarket and higher levels of total spending. Given its strategic importance, the fresh
produce sector must be administered effectively to be an asset to the store—freshness,
quality, variety, novelty and convenience should always be maintained even as prices
must remain within consumers’ reach and competitive with other retailers. In Brazil,
supermarkets and hypermarkets supply approximately 50% of the demand for fresh
produce. In Sic Paulo, supermarkets’ market share is relatively smaller at 28%. This is
due to consumers’ heterogeneous buying patterns resulting ﬁ'om large disparities in
income distribution, an ethnically diverse population, and some consumers’ preferences

for more traditional retail outlets for fresh produce (e. g. the weekly open-air fair).

3 The Fresh Produce Supply Chain

The fresh produce sector is one of the most challenging to manage, particularly for a
ﬁrm as large as CBD. First, CBD must decide what products it will provide to its
clientele. This requires knowledge of the market, including consumers’ preferences and
priorities among quality and price tradeoffs, their willingness to pay for value-added
features, and trends in the market. Second, once these patterns of demand are ascertained,
CBD must acquire produce that meets this demand, a difﬁcult task given the

characteristics of the market and a risky business environment.

122

Sic Paulo state has more than 60,000 vegetable growers, working on an average of
just under ﬁve hectares each. Small farmers who work on small plots of land in the
“green belt” surrounding the city grow most fresh produce consumed in Sic Paulo.
Commonly grown items include tomato, lettuce, onion, squash and eggplant. More than
ﬁfty-ﬁve different vegetables are grown and marketed in the state. The level of
technological sophistication is relatively low. For example, few farmers use greenhouses
or other means to protect their crops from weather ﬂuctuations. This increases variations
in the quality and quantity of produce that they grow. Meanwhile, the infrastructure
linking producers to buyers is also weak—poor roads and non-specialized vehicles and
shipping containers lead to high rates of waste—more than 30% of many vegetables are
spoiled between the farm and retail shelf. Even communication with suppliers can be
difﬁcult—telephone calls are frequently misdirected or cut off—though this situation has
improved with the recent proliferation of cellular telephones and the intemet.

The characteristics of fresh produce further increase the risks and costs of trade in
fresh produce: (1) fresh produce is a very perishable product, and sensitive to post-
harvest handling conditions; (2) damage to fresh produce products does not always show
up at the time it is incurred, making it difﬁcult to attribute responsibility for damaged
merchandise; (3) it is difﬁcult to create objective measures of quality that can be
consistently applied and that adequately reﬂect the range of product attributes sought in
the market; and (4) some high-value products, such as organic produce and hydroponic
produce, have attributes that require special treatment and coordination along the

marketing chain.

123

These factors, combined with the difﬁcult supply environment, create risk for both
suppliers and buyers. For example, a buyer who receives a shipment of bruised tomatoes
will not know whether the damage was incurred en route (a reasonable explanation given
the rough roads) or whether the supplier is trying to cheat the buyer by delivering a
damaged product. Similarly, if a buyer wants to renegotiate the price on a delivery
because of a damaged shipment of lettuce, the supplier can’t be sure that the lettuce really
is in as bad condition as the buyer claims, or if the buyer is simply trying to take
advantage of the uncertainty to accrue some savings. The weak judicial system and lack
of cultural limits to this type of opportunistic behavior further increase the risk inherent in
these transactions, as it is difﬁcult for a buyer or seller who has been cheated to redress
these grievances and recoup the loss.

There are four major types of retailers that sell fresh produce in Sic Paulo. First are
large supermarket and hypermarket chains, like CBD. Second are small and medium-
sized supermarkets which operate as independents or in small chains, generally
comprised of less than ten stores. Like the large chains, these are general line
merchandisers. The third type of fresh produce retailer is the discount green grocer that is
specialized in the sale of fresh produce (and sometimes other perishables like eggs or
ﬁsh), and often relies on some version of an “all for a dollar” marketing scheme6 to move
large volumes of staple produce items. Finally, there is the open air fair, in which

independent vendors come together in different neighborhoods on a weekly basis to sell

 

6 More speciﬁcally, these retailers sell almost all different fruits and vegetables at the same price per

kilogram.

124

fresh produce and a variety of other items. These fair vendors generally compete on the
basis of quality, service, and tradition.

Sic Paulo’s fresh produce retailers employ several different strategies to acquire
their fresh produce inputs. Some buy from wholesale markets where a large number of
buyers and sellers meet to exchange produce. Others purchase directly from the growing
regions either from farmers themselves or from specialized intermediaries, and have the
produce shipped directly to their distribution facilities or individual stores. There are also
many strategies for the management of relationships with suppliers that are designed to
minimize the risks and costs of buying fresh produce. Buying at the public wholesale
market generally involves either (1) spot market relations where the buyers and sellers
are effectively unknown to one another and there is no expectation of a continued
relationship once the sale is made, or (2) informal relationships that are sustained over the
long-term and where the buyers and sellers become familiar with one another’s needs and
business practices. Alternatively, some retailers use supplier registries and contracts when
they purchase from the producers in the growing regions. These registries and contracts
establish of a mutual set of expectations regarding the responsibilities and rights of both
the buyers and suppliers, which facilitates the maintenance of ongoing relationships

between them.

4 CBD and its Fresh Produce Activities
CBD manages three different retail chains, each of which has a different competitive
focus. The ﬁrst, Pic de Acucar is a chain of small and medium-scale neighborhood

supermarkets that seeks to compete on the basis of quality differentiation and provision

125

of services and products to higher income consumers. Barateiro is a chain of medium-
scale supermarkets that targets clientele in lower income areas. Extra is a chain of
hypermarkets (a hypermarket is a large scale retail store that sells a full line of
merchandise from perishable foods to consumer durables) that targets all consumer
groups, with attendance differing on the basis of the location of each individual store.

Some basic statistics on these three chains are provided in the Table 1.

Table 1 Holdings of the Companhia Brasileira de Distribuicio

 

 

 

 

2001 revenue Number of Average sales area
Target market
(U SS billion) stores per store (sq. meters)
High Income
Pic de Acr’rcar 1.06 176 1500
Consumers
Low Income
Barateiro 0.44 150 1 300
Consumers
Extra Dependent
1.57 55 7500
Hypermarkets on location

 

 

 

 

 

Source: Grupo Pic de Acucar Annual Report 2001
http://www.grupopaodeacucar.com.br/site_ri/ingles/downloads/pdf/Relatorio_anu200l

_ing.PDF

 

 

 

For CBD, sales of perishable foods (including meats, dairy and fresh fruits and

vegetables) generate 33% of revenue and are strategically the most important sector.

126

Among perishables, fresh produce can contribute from anywhere from 4% to 16% of an
individual store’s sales revenue, depending on the clientele and product lines carried.

Following an extensive internal reorganization in 2001, responsibility for the
administration of CBD’s fresh produce sector was divided between Category
Management and Procurement divisions which are responsible, respectively, for
determining what products to stock and for supplying those product needs.

When it comes to serving its clientele, the fresh produce product lines and
competitive strategies of CBD are reﬂective of the client focus of each of the three
individual brands. Pic de Acucar’s fresh produce section, with its upper-income clientele
orientation, offers a full range of produce including premium-grade bulk (i.e.
unpackaged), organic, hydroponic, pre-processed and fresh-cut produce which meets its
customers’ demand for convenient, healthy, novel products. Barateiro stores, oriented to
a clientele that is cost conscious and less willing to pay for differentiated products,
typically offer only bulk produce, generally of lower grades. The offerings of Extra
Hypermarkets differ depending on the income strata accommodated by each individual
store.

Beyond this general division of product lines between each chain, CBD’S
Category Management division draws on store-level and customer-level information
(made possible in part through data collected from customers using Customer Loyalty
Cards) to determine clients’ preferences and tailor product availability to meet this
demand. A Category Management team for each chain is based at the CBD headquarters,

and is responsible for a number of tasks including deﬁning product lines for each chain,

127

deciding on price margins, new product development, and training technicians to work in
individual stores’ fresh produce departments.

Once the product needs are determined, CBD must acquire fresh produce meeting
this demand, and coordinate the logistical task of distributing it among its stores in a
timely and cost efﬁcient manner. Fresh produce procurement involves at least ﬁve
different tasks, each of which can be accomplished through either centralized (i.e. by the
headquarters which acts on behalf of all its stores) or decentralized (i.e. at the individual
store level) activity. The ﬁve tasks are l) the decision of what and how much to buy, 2)
the selection of suppliers, 3) the submission of the order to the supplier, 4) the delivery
and distribution of produce among stores, and 5) payment to the supplier.

CBD uses a centralized system is used for all fresh produce items, although the
procurement and distribution of products sold in smaller volumes (such as organic
produce) and those that are highly perishable (such as leafy greens) contains
decentralized elements. A centralized purchase and delivery system allows for separate
treatment of procurement (i.e. the acquisition of fresh produce supplies that consistently
meet quality, volume, etc. needs) and distribution (i.e. the logistical challenge of
receiving shipments of produce and distributing them among stores after they are
received). In those cases where procurement has decentralized aspects, individual stores
can choose among the suppliers that are registered with the head ofﬁce, and submit their
orders directly to them. Suppliers then make deliveries to individual stores. Other key
aspects of the transaction are still centralized, however, including the selection of

suppliers who will be registered with the ﬁrm, establishment of price margins, and

128

payment to the supplier. The decentralization and centralization of different procurement

tasks for different product lines is summarized in the Table 2.

Table 2 Organization of fresh produce procurement by task

 

Centralized Decentralized

 

All products (with input from
Decision of what and
central based on sales history and
how much to order
scheduled promotions)

 

Leafy vegetables, organics,
All bulk items, some
hydroponic, pre-processed
Choice of supplier specialized (all suppliers
(store chooses from supplier

 

 

part of supplier registry)
registry)
Delivery and All bulk items, some Leafy vegetables, organics,
distribution specialized hydroponic, pre-processed
Order of fresh produce All bulk items, some Leafy vegetables, organics,
to supplier specialized hydroponic, pre-processed

 

Payment to supplier All products

 

 

 

 

 

Centralization offers CBD a number of beneﬁts. One of the largest beneﬁts is
seen in cost savings of up to 30% that CBD achieves by using its own centralized facility
to perform many of the functions traditionally undertaken by wholesalers, particularly as

they achieve economies of scale and given their large volumes. They have also increased

129

their control over the quality of produce furnished by suppliers; and improved
coordination and targeting of produce to reﬂect the quality/price preferences of different
stores’ clientele.

Suppliers also enjoy some beneﬁts from centralization. It allows them to negotiate
less frequently with CBD and to deal with buyers who are specialized in fresh produce,
rather than having to negotiate with representatives of each individual store. They also
save on distribution costs because they can deliver large loads to the central warehouse
rather than to numerous individual stores dispersed throughout the city (though CBD
does capture part of those cost savings through a 4% discount on produce delivered to the
central warehouse).

Despite its clear beneﬁts, the centralized produce acquisition strategy does entail
some tradeoffs for CBD. The ﬁrm’s huge volume of purchases increases its vulnerability
to supply shocks and speculative behavior on the part of suppliers, and makes it more
likely that their purchases will affect market prices (although it also improves CBD’S
bargaining position). Also, CBD faces some tradeoffs between the efﬁciency that is
achieved through centralization and accommodating speciﬁc needs of some clients. For
example, when produce is channeled through centralized facilities, individual stores have
less control over selection of suppliers which means they can’t always respond to their
customers’ requests for speciﬁc brands of produce. Another aspect of this tradeoff is that
produce must be able to stand up to the additional handling involved in loading and
unloading at the central facility (rather than delivery direct from the production area to
the store), so that it is necessary to procure relatively less mature produce (that will

damage less easily) than many consumers like to buy. Likewise, longer-life varieties of

130

produce withstand centralized distribution better, but consumers do not tend to like these
varieties as much as the traditional varieties that are more ﬂavorful and familiar.

All of CBD’s suppliers, whether they deliver to the central warehouse or to
individual stores, must be registered with the headquarters. To become registered, a
potential supplier must submit an application and product sample, and receive a technical
visit from CBD in which the capacity of the supplier to consistently meet CBD’s
requirements is veriﬁed. The registry is intended to lay the foundations for a consistent
relationship between the supplier and buyer in which there exists a shared understanding
of rights and responsibilities. This includes, for example, suppliers’ obligations regarding
quality and delivery and the buyers’ responsibilities for making timely payment. Supply
by registered suppliers differs from supply by contracted suppliers in that there is no
commitment on the part of CBD to purchase speciﬁc volumes of produce or for particular
prices, and similarly, suppliers are not obligated to fumish produce to CBD. At the same
time, being a registered supplier beneﬁts suppliers by reducing the ﬁeld of competitors
seeking to supply CBD (i.e. competitors are other registered suppliers rather than the
universe of producers in Sic Paulo). Some suppliers complain, however, that they feel
that they have little power in the relationship if they want to stay on the supplier list and
must always respond to CBD’s requests without CBD reciprocating.

In choosing who to admit to their supplier registry, CBD seeks suppliers
reﬂecting three characteristics: quality of output, capacity (scale and infrastructure
adequate to consistently supply CBD with fresh produce that adheres to their quality,
timing, and volume requirements), and competitiveness (which is a function of

productivity and cost).

131

In addition to ensuring that CBD buys from the most capable suppliers, a multi-
faceted strategy is used to control for the quality of incoming produce. First, acceptable
parameters for incoming produce are deﬁned and distributed as technical standards that
specify grades on the basis of size, weight, coloration, and damage for each produce item.
Second, during the technical visit required for admission to the supplier registry, the
capacity of the supplier to comply with these quality standards is ascertained, and the
quality standards are explained. Third, each product order speciﬁes the grade of produce
that is being ordered, and the supplier is expected to have pre-sorted each delivery to
meet the speciﬁed grade parameters. Fourth, upon delivery, a technician examines a
sample of the shipment in the presence of a representative of the supplier to verify
adherence to the quality standards. For specialty items such as organic produce, these
steps are complemented by requirements for certiﬁcation from a recognized organization,
or by additional auditing by CBD’S food safety ofﬁce for items, such as fresh-cut
produce, for which the risks and costs of product failure (like microbiological

contamination that could cause consumers to get sick) are high.

5 CBD’s Procurement Strategy in Transition

The General Manager considered the challenges that they were currently facing.
Although they had built a strong supplier base and an efﬁcient logistical structure, he was
aware of some shortcomings in the current procurement strategy such as a lack of
supplier loyalty and price speculation on the part of suppliers in times of market
shortages, as well as perceptions of power imbalances leading to discontent among

suppliers themselves. Furthermore, food safety was becoming a major issue in

132

consumers’ purchase decisions, and he felt that if CBD could guarantee that the produce
they sold was free of microbiological and chemical contaminants, this would be a key
competitive point that could further differentiate CBD in consumers’ minds.

Resolving these procurement issues while ensuring a safe supply of fresh produce
would not be easy. It would require buying from suppliers with a strong technological
base, for example greenhouses and irrigation and packing sheds. Equally important
would be the suppliers’ managerial capacity and professionalism, which would be key
not only in producing a safe and high quality product, but also documenting it and being
able to trace its movement along the supply chain through activities like record keeping
and testing for the quality of water used in production and post-harvest activities.

The General Manager faced several options that might allow CBD to make the
improvements that he sought. One option was to open up their registry and purchase from
any supplier who was able to supply produce meeting CBD’s requirements. This option
could potentially help to resolve their current procurement problems by increasing the
number of suppliers that they had access to and creating more competition among
suppliers to sell to CBD. Compliance with quality and safety standards could be veriﬁed
through testing samples of all incoming produce shipments, and rewarded through
premiums on this produce.

A second option would be emulate what the General Manager had seen leading
retailers in other countries do when faced with similar challenges—CBD could tighten
relations with suppliers that were already on the registry, and implement contracts with
them that would assure purchases by CBD if they would make the investments needed to

provide a product that met CBD’s product needs. They could require their suppliers to

133

adopt practices such as Good Agricultural Practices that permit traceability of product
shipments from the farm to the consumer and make it easier to prevent and monitor and
likelihood of food safety problems. Periodic or random testing of produce for food safety
criteria could be used as a backup means to ensure compliance. This way, CBD could
create a base of suppliers with appropriate technologies that would have appropriate
technologies needed to reduce much of the variation in supply and quality, while ensuring
compliance with food safety guidelines. This option would not be easy to implement——
given the shortage of suppliers with the capacity and resources to adopt such practices
immediately, CBD might need to help their current suppliers upgrade to respond to such
requirements. For example, they could provide them with technical assistance, by having
their own technical auditors visit the farms and advise suppliers of what changes need to
be made and to help ﬁnd them resources to make them.

Either option would involve major shifts to CBD’S current procurement strategy, and
the success or failure of the strategy chosen would have major implications for CBD’s

performance in the fresh produce market.

6 Discussion questions

1. What are the advantages and drawbacks of each of the two options that have been

outlined for CBD? Which of the two options do you think that CBD should choose and

why?

134

2. Is the fresh produce procurement challenge that CBD faces unique to a developing
country environment? What similarities and differences exist between the environment
that CBD must accommodate in its procurement strategy and one that you are familiar

with (for example the US. market), and what importance do these differences make?

7 Teaching Notes

7.1 Purpose of the teaching case

This teaching case is intended for upper-level undergraduate and graduate student
audiences, in courses in microeconomic theory applications and agribusiness decision-
making courses. It draws from concepts in transaction cost economics, strategic
management and industrial organization to explore how the particular characteristics of
the ﬁrm, Companhia Brasileira de Distribuicio (CBD), combined with the features of the
market environment, inﬂuence CBD’s strategic decision making in the management of its
retail fresh produce sector, and looks at choices currently facing CBD as it seeks to
accommodate consumers’ food safety concerns and other weaknesses evident in the
procurement strategy. A teaching aid consisting of a Powerpoint presentation of
photographs from the ﬁeld, supply chain and different retail venues as well as CBD’s
own stores is available from the corresponding author. Instructors are also directed to
CBD’s home page where very speciﬁc information such as annual ﬁnancial reports and
strategic plans is available for download in English (www.cbd-

ri.com.br/eng/home/index.asp), should they be interested in deepening the analysis.

135

7.2 Case summary

Fresh produce is a key strategic sector for Brazilian food retailers, as it is
worldwide. Designing an effective and cost efﬁcient procurement strategy is difficult due
to weak infrastructure and institutions and reliance on small producers who are
geographically dispersed and who generally use low levels of technology, which
increases variability in the quality, volumes, and prices of produce supplied in the market.
Retailers use different strategies to meet their fresh produce needs. Some buy form the
public wholesale market, others buy direct from farmers. Relationships with suppliers
range from anonymous “spot market” relationships to informal long term relationships
and formal contracts with suppliers.

CBD holds three food retail chains—Pic de Acr’rcar Supermarkets, Barateiro
Supermarkets, and Extra Hypermarkets, each of which has a different competitive
strategy and target clientele. CBD separates the administration of the customer interface
and procurement aspects of fresh produce sector administration. The customer-focused
Category Management division seeks to identify and develop consumer demand. The
Procurement division is responsible for ensuring the provision of fresh produce supplies
responding to this demand. All aspects of procurement and distribution are centralized to
some degree. All suppliers must be registered, and must have a demonstrated ability to
adhere to CBD’s quality standards.

CBD’s management is poised to implement a shift in its procurement strategy in
order to resolve some longstanding problems with its current strategy, and also to take a
place as the leader in accommodating consumers’ concerns over the safety (i.e. absence

of chemical or bacterial contamination) of produce in Brazil. Two possible strategies are

136

outlined. In the discussion questions following the text, students are asked to recommend

a strategy.

7.3 Teaching objectives

0 Have students make decisions based on an understanding of transaction cost
economics and its impact on vertical coordination.

0 Help students appreciate the tradeoffs entailed in different supply chain management
decisions, e.g. centralization versus decentralization of procurement and different
ways of coordinating transactions with suppliers.

0 Have students appreciate challenges of supply chain management in a developing
country context and to be able to relate these challenges to supply chain management

issues in a country like the United States.

7.4 Theoretical applications

New Institutional Economics: The case illustrates several applications of New
Institutional Economics. The weak institutional environment, combined with product and
market characteristics, underlie problems of asymmetric information and moral hazard,
heightening transaction costs and risk (Williamson 1985). As a result, strict coordination
of CBD’s supply chain is required, as evidenced by their chosen procurement strategy
(Zylbersztajn and Farina 1999). The relationship-based governance methods that CBD
employs reﬂect its attempt to mitigate the transaction costs of fresh produce procurement:

suppliers must invest time and effort to be included on the registry of approved suppliers

137

which increases the stake that suppliers have in the relationship and responding to CBD’s
quality, volume, and pricing stipulations. Furthermore, the formal, relationship-based
governance methods also reﬂect CBD’s efforts to economize on the transaction costs of
fresh produce procurement through a redistribution (relative to the spot market), from 1)
ex post to ex ante costs, and 2) variable to ﬁxed costs, with the variable costs of sorting,
grading, and other quality control efforts shifted to the suppliers (Peterson, Wysocki, et.
al. 2001). The current transition reﬂects an intensiﬁcation of this approach rather than a

departure from it.

Industrial Organization: One of the salient characteristics of CBD that differentiates
it from other fresh produce retailers is its size. A large volume of through put provides
CBD with opportunities to save costs through economies of scale and scope. CBD has
found it economical to integrate the functions typically performed by wholesale
intermediaries—receipt, re-grouping, and distribution to retail vendors—for most of its
products. By building a centralized procurement and distribution facility, CBD cuts out a
level of the marketing chain, and thus can acquire fresh produce of better quality and a
lower cost than other ﬁrms.

CBD’s size and large volume of purchases in the fresh produce market also
provides it with market power that allows it advantages in negotiation with suppliers.
CBD can stipulate volume (and other) discounts from its suppliers, and maintain a large
selection of registered suppliers who are eager to gain access to such a large-volume
buyer. CBD’s independence from the wholesale market and large volume also lend it

more inﬂuence in price formation.

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Strategic Management: CBD faces the problem of modifying its current
procurement strategy to resolve some remaining problems while addressing the need to
obtain a supply of produce that meets food safety criteria. This is a strategic issue not
only in terms of coordination within the fresh produce sector, but also at the ﬁrm level,
due to the key role that fresh produce plays.

Analysis of CBD’s performance from a strategic management perspective shows
that its performance is inadequate in several areas. Customer satisfaction is ﬂagging due
to the increasing importance of food safety issues, and productivity and proﬁtability are
also sub-optimal due to several supply chain management issues such as a lack of
supplier loyalty and variations in the volumes and quality of produce supplied. Overall,
however, CBD is very competitive in the market.

The customer satisfaction and productivity/proﬁtability problems are strategic
issues to resolve due to the fact that fresh produce is an important sector for the whole
retail operation. A need to change the coordination strategy to resolve these issues is
evidenced. The key strategic issue that needs to be addressed is: How can CBD improve
its vertical coordination strategy for fresh produce in order to improve performance in the
areas that have been identiﬁed?

CBD is a proactive leader in the domestic retail industry. Its core strategy is to
grow by increasing its market share and expanding its geographic scope of operations. It
has a competitive advantage in both high and low end markets, with product offerings
differentiated for each store format. Thus it can be categorized as a ﬁrm that carries a

diverse product line with a high degree of market segmentation.

139

CBD’s vertical coordination strategy for the procurement of fresh produce is a
hybrid between the spot market and vertical integration, but does not qualify as a formal
contract in the sense of it not including speciﬁc provisions for the purchase of fresh
produce. The registry does, however, show some characteristics of a contract, in that it
establishes a foundation by which ongoing transactions can be conducted, with the rights
and responsibilities of each party being speciﬁed in advance.

CBD’s fresh produce activities do, however, show some elements of vertical
integration in terms of the organization of activities involved in the procurement and
distribution of fresh produce among individual stores—the centralized procurement and
distribution activities show a vertical integration of activities at the level of the ﬁrm,
compared to a decentralized strategy which would reﬂect an equity-based alliance

between individual stores and the ﬁrm.

7.5 Recommendations on teaching the case

Rather than dive right into the ﬁrst study question, it is useful to spend time being
sure that the students understand the problem faced by CBD. Their current procurement
strategy has been quite successful, but the new demands from consumers (most especially
in regard to safety and health) require more sophistication from all supply chain
participants than in the past. In other words, continuing to deliver customer satisfaction
and competitiveness will require further changes in strategy. Helping students
understand the causes of the current strategy’s success and its inability to meet the new
situation provides a sound foundation to a deep discussion of the pros and cons of the

options presented at the end of case.

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In working to answer study question 1, the teacher needs to continually work with
the students to use economic concepts and vocabulary to achieve a rigorous analysis.
Asset speciﬁcity, complementary, transaction costs, market power concepts, and strategic
management vocabulary all need to be focused on articulating the pros and cons as well
as settling on the best solution. Students have a tendency to want to argue from the pure
business facts of the case rather than apply sound theory to the discussion. Asking
students to rephrase their business observations in economic language is critical to an
effective analysis and resolution of the case. This effort is especially needed for
undergraduates, but even in the graduate classroom students need to be reminded to focus
on applying the theory to the real market facts found in the case. Our experience
suggests that it is not easy to get students to translate case facts into economic analysis.
However, this translation makes the case truly valuable as a teaching tool.

In working to answer study question 2, it can be useful to have students from
different country backgrounds (if such diversity exists in the class) share some of their
own experiences with food systems in their home country, whether it is a developed
nation or a developing one. In doing this, students will likely need some assistance in
being explicit about the characteristics of their own system in contrast to the one in Sao
Paulo. Drawing from students’ own experiences should help to sharpen the discussion of

similarities and differences.

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7.6 Suggested answers for discussion questions

1. What are the advantages and drawbacks of each of the two options that have been
outlined for CBD? Which of the two options do you think that CBD should choose and
why?

CBD faces the problem of modifying its current procurement strategy to resolve
some remaining problems while addressing the need to obtain a supply of produce that
meets food safety criteria.

From an analytical viewpoint, the two different strategies reﬂect opposing
tendencies in terms of vertical coordination strategies. The ﬁrst involves a shift toward
looser coordination and more focus on individual transactions, while the second involves
a shift toward tighter coordination between CBD and its suppliers, with more focus on
the relationship between buyer and supplier. The ﬁrst strategy will involve relatively high
variable costs per transaction, while the second involves high ﬁxed costs (to implement

contract, etc.) but lower variable costs.

What are the advantages and disadvantages of each strategy?
First strategy advantages
0 More potential suppliers
0 More competition to be a supplier to CBD
- Resolve the issue of lack of supplier loyalty by reducing dependence on individual

suppliers

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Resolve the issue of suppliers’ speculative behavior by making them compete with
others

Low ﬁxed costs of procurement

First strategy disadvantages

The weak capacity of most suppliers in Sic Paulo means that even with more
potential suppliers CBD would, on average, be less likely to have its quality and
safety standards met.

Testing for safety is costly and will lead to high variable costs

Meeting quality and safety standards requires investments on part of suppliers
(packing sheds, irrigation, etc.). There are few enough demanding buyers in the
market (like CBD) that suppliers may not be willing to invest without assurance of a

buyer

Second strategy advantages

Reduces need for frequent food safety testing because capacity of suppliers is already
demonstrated—just need to test to verify compliance on a random basis.

Permits traceability of produce along supply chain

Suppliers have assured buyer so they will be more willing to make relationship-

speciﬁc investment

Second strategy disadvantages

More dependence on few suppliers

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0 High ﬁxed costs of deﬁning and monitoring performance of contracted suppliers
0 CBD will likely need to assist suppliers in making the transition to higher levels of

service due to most suppliers’ low capacity and constrained access to resources.

Which of the two options meets CBD’s more pressing needs?

The market for food safe products is very thin—currently CBD is one of the few
buyers actively seeking such attributes. Thus, investments necessary to comply with these
product standards will be very asset speciﬁc. Relying on spot market relations does not
allow the producer to adequately ensure himself against the risk of having the product not
meet standards for some fault other than his own.

There is also an issue of complementarity that is forgone under the spot market
relationship. The planning that is necessary to coordinate the transmission of the product
along the supply chain so that its value (based on freshness and tight control over quality

and safety) cannot be achieved using spot market.

Resolution of the decision: CBD chose to pursue the second option of tightening
their relations with suppliers and requiring higher levels of service from them. They have
used a multi-faceted strategy in its implementation. First is the implementation of
contracts with suppliers that involve a commitment for CBD to purchase from them on a
regular basis, provided they comply with CBD’s quality standards. Second, a new set of
processes and standards is being implemented that will ensure the quality, safety, and
traceability of produce supplied by CBD. New requirements of suppliers include

adherence to Good Agricultural Practices, Good Manufacturing Practices (for processed

144

 

produce), labeling and documentation that permits traceability, HACCP processes in
some cases, periodic labeling and microbiological tests, maintenance of detailed
production records particularly with regards to the application of chemicals, and
performance auditing. CBD is helping suppliers in the implementation of such processes
through the provision of technical assistance, particularly with regards to identiﬁcation of
permissible chemicals to be used on the crops and post-harvest activities, and is allowing
a phase-in period of approximately a year so that suppliers can get up to speed.
Furthermore, CBD is providing an incentive system that will reward suppliers’
performance in a number of areas including ﬁnancial rewards and eligibility to participate
in their private label program. This new system is expected to beneﬁt suppliers less
directly too, by encouraging them to upgrade their facilities, plan their activities more

easily, and reduce the market risk that they face.

2. Is the fresh produce procurement challenge that CBD faces unique to a developing
country environment? What similarities and differences exist between the environment
that CBD must accommodate in its procurement strategy and one that you are familiar

with (for example the US. market), and what importance do these differences make?

Similarities
o Reliance on personal relations (even with the Perishable Agricultural Commodities
Act, PACA, legal recourse is used as a last resort in the US. between produce buyers

and sellers).

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Similar trends among consumers’ demand in some segments, such as growing
demand for convenience, novelty, safety

Characteristics of fresh produ‘ce are largely the same

Differences

Lack of some legal protections for buyers and sellers (there is no legislation in Brazil
that is effective in providing protections to buyers and sellers like the US. PACA).
Different consumer segments—Even though there are similar trends among
consumers in some segments (particularly higher income), there are also more low-
income buyers, and a generally lower level of fresh produce consumption.

There is a larger diversity of retail formats in Brazil than in the US, with more
competition among them (and hence a broader distribution of market share among
them).

Supply environment differs—Suppliers generally have a lower capacity to make
investments and use relatively unsophisticated technologies.

Infrastructure differs—There are poor roads, communications and lack of specialized
transport equipment lead to high rates of damage and waste. These problems are more
severe and raise the costs of doing business in Brazil compared to a country like the
US.

Institutions differ—They are weaker in Brazil given a court system that is costly and
ineffective to use, no consistently applied grades and standards, a high rate of default

and opportunism, and the lack of legislation to protect buyers and sellers.

146

 

REFERENCES AND ADDITIONAL RESOURCES

Farina, E. M. M. Q. and E. L. Machado (1999). Government Regulation and Business
Strategies in the Brazilian Fresh Fruit and Vegetable Market. Segunda Workshop
Brasileiro de Gestio de Sistemas Agroalimentares, Ribeirio Preto, Programa de Estudos
Dos Negécios do Sistema Agroindustrial.

Mainville, D. Y. (2002). Fresh Produce Markets in Sic Paulo: Recent Developments,
Trends and Implications for Market Structure. Sociedade Brasileira de Economia e
Sociologia Rural, Passo Fundo/RGS, SOBER.

Peterson, H. C., A. Wysocki and S. B. Harsh (2001). “Strategic Choice Along the
Vertical Coordination Continuum.” Intematicnal Food and Agribusiness Management
Review 4: 149-66.

Williamson, 0. J. (1985). The Economic Institutions of Capitalism: Firms, Markets, and
Relational Contracting. New York, Free Press.

Zylbersztajn, D. and E. M. M. Q. Farina (1999). “Strictly Coordinated Food Systems:
Exploring the Limits of the Coasian Firm.” Intematicnal Food and Agribusiness
Management Review 2(2): 249-265.

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CHAPTER 6
Supermarket Market-Channel Participation and Technology Adoption Decisions of
Horticultural Producers in Brazil

1 Introduction

Supermarketsl in Brazil, as in other developing countries, have seen a rapid growth
in consumer demand for qualitative attributes such as food quality, safety, variety,
healthfulness, and convenience. At the same time, supermarkets compete on cost with
traditional retailers and with other supermarkets. Chains thus tend to have a dual
merchandising strategy for fresh produce (fruits and vegetables), focusing on low prices
for poorer consumers and quality for richer consumers, and have transformed their
procurement systems to be able to deliver these produce attributes to consumers. Thus
new market channels are emerging — with a particular channel deﬁned by a combination
of type of buyer, attribute requirements, and contractual relations with their suppliers.
The investments and practices required of suppliers differ over the channels, as do the
returns and risks. This is because supermarkets tend to set private standards that differ
from public standards, or from the requirements of informal markets without effective
standards. For example, see Berdegue et al. (2004) for the case of Central America.

The supermarket sector has grown quickly from a tiny niche in 1990 to a major and
often dominant share of food retail in Latin America in general (Reardon and Berdegue

2002), and in Brazil in particular (Farina, 2002). Yet there has as yet been little treatment

 

' We use “supermarkets” for simplicity to mean large-format stores, including
supermarkets, hypermarkets, discount stores and so on, and distinguish only where

necessary.

148

in the literature of the domestic market channels to supermarkets in developing countries,
in particular how private standards and other product and transaction requirements of
local supermarkets are transmitted to, and affect local growers. The few studies that
address this issue do so focusing on how developed country retailers affect developing
country farmers, such as US and European quality standards for horticulture producers in
Central America (Thrupp, 1995), or UK supermarket chains standards on Kenyan and
Zimbabwean horticultural producers (Dolan and Humphrey, 2000, McCulloch and Ota,
2002, Jaffee, 2003, and Henson, Boselie and Weatherspoon, 2004), or EUREPGAP
European retailers collective standards on developing country producers, such as voor
den Dag (2003) for the case of French beans in Kenya. More generally, research on how
changes in market structure (such as consolidation of the processing or retail sectors)
affects technology adoption by growers, is in incipient stages, with recent contributions
such as that of Heiman, McWilliams, and Zilberman (2000), examining effects of input
agribusiness marketing strategies on growers’ technology adoption in the US.

This paper aims at contributing to ﬁlling that gap in the literature, with a study based
on ﬁeld research in Brazil. After presenting a taxonomy of market channels, based on
distinct sets of requirements imposed by buyers on suppliers, and thus marketing choices
of suppliers, we address two research questions. (1) What determines the supplier’s
choice among those marketing channels? (2) What are the technology implications of the
market channel choice - that is, what is the relation between market channel choice and
technology use? The importance of these questions for agribusiness and rural
development is that the analysis reveals requirements and challenges facing

small/medium producers in accessing dynamic markets through modern retailers - and

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thus informs policy, agricultural research, and development programs in Brazil and
elsewhere. The research questions are addressed by analyzing data on tomato and lettuce
producers in the area supplying Sic Paulo. The data come form a survey of 55 tomato
and lettuce growers conducted from April-July 2002.

The paper proceeds as follows. Section 2 presents the conceptual framework. Section
3 presents the study context, focusing on the salient characteristics of market-channels, to
inform the implementation model. Section 4 presents the data, empirical model and

hypotheses . Section 5 reports and discusses results, and Section 6 concludes.

2 Conceptual Framework

The emergence of demand for food safety attributes in produce and corresponding
efforts by producers to supply produce with these attributes lead to the emergence of dual
supply channels. The ﬁrst is for what we can call “conventional attributes” and the other
for produce with “new attributes” (such as higher cosmetic quality and lower pesticide
and bacterial residuals relative to conventional). In this paper we ascribe demand for the
new attributes only to the supermarket market-channel.

Production of the new attributes (such as higher cosmetic quality and lower pesticide
residues than “conventional”) requires of the grower production technology, commercial
practices, and investments, which, in principle, differ from those required to produce
conventional attributes. For example, to produce the “new attributes” required by the
supermarket market-channel, the grower may have to follow an input use regime
(communicated in the contract from the supermarket or the specialized wholesaler),

speciﬁc production practices that require worker training, such as in pruning and

150

handling and packing that allow for speciﬁc organoleptic or cosmetic quality attributes in
the produce, certiﬁcation of water quality which in turn requires investments in and
maintenance of the wells and irrigation infrastructure, adoption of good agricultural
practices (GAPS) which can imply several additional expenditures such as in reporting,
relative to conventional, and post-harvest practices and investments such as in transport
and packing crates. These can be thought of as the vector of technological choices
implied by the attribute vector derived from the private standards for quality and safety of
the supermarket chain (Reardon et al. 2001).

Producing to meet these “new” attribute requirements presents new risks and costs to
suppliers—the costs of making the necessary investments to comply with the new
product standards, and the risks of failing to meet these standards or opportunistic hold-
up on the part of the buyer. Buyers who seek the “new attributes” must provide growers
with either a price premium or some other boost to revenues or lower risk or both,
relative to returns and risk of conventional market channels, to compensate them the
additional risks and costs incurred in the decision to supply them. . Using the example
here of the supermarket-channel, the supermarket speciﬁes the requirements of the
product and the transaction (including the speciﬁcation of quality and safety attributes of
the produce) and thus, implicitly, the costs to be incurred above those for the
conventional market. The supermarkets then either offer a price premium relative to
“conventional” or they offset the higher production costs with cost savings elsewhere
(such as transaction costs saved in marketing to few buyers who purchase a large share of
the suppliers’ total output, and also commit to purchase the product from the supplier

thus reducing the market risk of this channel.

151

The speciﬁcation of prices and services and other transaction terms between all
buyers and sellers constitutes a contract. We use the term “contract” here in the broad
sense used by Hueth et al. (1999), where a contract can be simply an informal
relationship, with written contract or not, but where there is some penalty implicit or
explicit, tangible or intangible (such as in loss of reputation) in non-compliance. Such
contracts are common in the produce industry (the world over) and applicable in the
present case for the “new attributes” market segment.

The proﬁt-maximization, risk-minimization choices of a supplier to supply produce
with “new attributes” to the supermarket market-channel, instead of to the conventional
market channel, can be characterized here as a set of recursive choices. (In practice the
choices might be recursive or simultaneous.)

The ﬁrst choice of the grower is the choice of supplying for (and thus producing for
the vector of required product and transaction attributes of) a given market channel. This
is simpliﬁed here as a choice between the supermarket market-channel, versus the
conventional market-channel (to traditional wholesalers). This choice can be modeled in
the same way as a technology adoption choice (Sadoulet and de Janvry, 1995) if modeled
as a function of a vector of output prices (P) (including produce j with new attributes and
produce k with conventional attributes, and other products), vector of input prices (w),
vector of risks (0) (including risk in the supermarket-channel versus the conventional
channel), a vector of quasi-ﬁxed capital other than that speciﬁc to the channel (K)
(including human, organization, and physical capital, as well as land, which can be own

or rented), and other shifters (Z):

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(1) Participation in supermarket market-channel = f(P, w, c, K, Z)

The second choice of the' grower is the choice of technology. Technology is
embodied in variable input use and capital investment decisions, contingent on choice of
marketing channel and thus the vector of product and transaction attributes required to
participate in that channel and the vector of net returns and risks. The technology choices
here are embodied-technology choices that are hypothesized to differentiate growers
producing and delivering to the buyer produce with “new attributes” by their use of
production and post-harvest equipment such as packing and cleaning equipment, cooling
chambers, refrigerated trucks, and communications equipment (intemet, fax, mobile
phones). The embodied-technology choice equations are again adoption equations similar

to (1); in implementation, some of the prices may be 0 because of non-variation:

(2) Use of embodied-technology j = f(P, w, 6, K, Z)

3 Context (Market Channel Characteristics and Categories)

In this section we identify the relevant categories for the left-hand side of the
adoption equations 1 and 2 presented in the previous section, that is, the channel and
technology choices. To do so, we analyze the salient characteristics of the Sao Paulo

region’s tomato and lettuce markets.

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3.1 Tomato market channels and marketing chain

The tomato supply chain is depicted in Figure 1. Tomatoes are produced in the
peri-urban area of Sic Paulo by farmers who are largely specialized in tomato
production, in some cases producing tomato in rotation with grains. Growers can sell
either to wholesalers based in the traditional wholesale market, wholesalers based in the
growing regions, or to several types of intermediaries who purchase tomatoes to re-sell to
wholesalers. The traditional tomato marketing chain, still used outside the supermarket
procurement channel, moves tomatoes from the farms to packing houses where they are
classiﬁed and packed into wooden crates, then to the traditional wholesale market. These
wholesalers sell the bulk (on average 48%) of their merchandise to small retailers and
fresh processors who visit the traditional wholesale market to inspect the product and
negotiate transactions.

The Supermarket Channel moves tomato from growers to wholesalers that have
packing houses in the growing regions for whom supermarkets are their primary buyers,
responsible for 68% of their sales. Given supermarkets’ stringent quality requirements,
the intermediaries who supply them have technologically sophisticated classifying plants
(that, for example, have optical scanners to differentiate tomatoes by color, and pack in
plastic or cardboard boxes that supermarkets prefer). Growers can thus choose among
three marketing channels: 1) the Traditional Wholesale Channel, 2) the Supermarket
Channel, and 3) and the Intermediary Channel which in turn sells to either the Traditional
Wholesale or Supermarket Channel. The contracts characteristically used for each type of

channel are discussed below.

154

Figure 1 Tomato Marketing Chain

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Modern
Growers .
Classrﬁer Supermarkets
Growers Assembler
Other Small
, , Wholesale Retailers
Growers Traditional Market
Classiﬁer

 

 

 

 

 

 

Intermediary channel with F ixed-price contract. Growers marketing tomatoes to
the Intermediary Channel sell their produce at the farm-gate to intermediaries who
purchase on behalf of wholesalers and classiﬁers. Purchase arrangements are made at
harvest time, and include transport of the tomatoes. Prices are discounted slightly to
account for the value of the services provided. These contracts do not offer forward
planning of sales, but once a sales agreement is made (at harvest usually) then payment is
immediately made. The most signiﬁcant entry barrier is that the Intermediaries seek to
purchase tomato in large volumes, which favors growers who are specialized in tomato

production (rather than those who produce a number of vegetable crops). (Unfortunately,

155

the nature of data collection did not allow for determination of to what extent tomato
purchased by these intermediaries enters the Traditional vs. Supermarket channels).

Supermarket Channel with Financing contracts. Financing contracts involve the
provision by the buyer of working capital to support production on a speciﬁc area of land.
In exchange, the grower commits to sell his output from that land to the buyer at harvest.
A ﬁxed deduction per box produced is agreed upon in advance and subtracted upon
payment following harvest. These contracts are offered by classiﬁers and wholesalers (in
combination with the consignment contract), though the focus here is on ﬁnancing
contracts offered by classiﬁers. Entry into these contracts requires one-on-one negotiation
between the classiﬁer and a proven capacity to produce. They are used increasingly as
classiﬁers increase in number and seek to ensure that they will have adequate throughput
to keep their plants working at efﬁcient levels of capacity. The contracts are
advantageous in that the grower is assured of a buyer for his harvest. They involve some
risk in that the payment is deducted from the ﬁnal payment (which is made at going
market prices) at a ﬁxed price per box. But depending on actual output and market prices,
the value of the ﬁnal payment is difﬁcult to predict (i.e. it will amount to a large payment
if the harvest is very large and prices low, but a small payment if the harvest is small and
prices are high).

Traditional Wholesale Channel with Consignment contracts. A consignment
contract involves the grower sending his product to an intermediary who then sells it and
gives the proceeds to the grower, minus a marketing commission (of approximately 17%)
and various other costs such as taxes, transport and other explicit fees. These contracts

are considered undesirable by growers, as they are used as a means for intermediaries to

156

shift price risk to growers, and also because the growers cannot verify the sales price that
the intermediary receives and are thus vulnerable to opportunistic behavior on the part of
the intermediary. There are very low barriers to entry with these contracts, and many
wholesalers will ﬁnance the operating costs of the crop. This market channel is also one
of the most accessible to the smallest growers who, due to their tendency to have
diversiﬁed crop portfolios, tend to have small volumes of tomatoes to sell, lessening

other buyers’ interest in them.

3.2 Lettuce market channels and marketing chain

The lettuce marketing chain is depicted in Figure 2. Lettuce is produced in the
green belt surrounding metropolitan Sao Paulo by small growers who typically produce a
fairly large mix of products. Growers can sell to a diversity of different buyers including
to intermediaries who buy at the farm gate, small supermarkets, large supermarket chains,
the wholesale market, to processors, direct to consumers. Most growers operate
individually, but there is also limited participation in marketing cooperatives. The high
perishability of lettuce, lack of a cold chain, and the non-existence of automated
classifying infrastructure make direct sales between growers and retailers much more
common than in the tomato market. Likewise, the traditional wholesale market plays a
relatively minor role, with only 8% of Sic Paulo’s lettuce production passing through the
main wholesale market in 1999 (a decline from 55% in 1990).

Growers can choose among three market channels, the ﬁrst two of which are
characteristic of traditional channels. These are 1) the Traditional Intermediary Channel

which moves the product from the production area to intermediaries who sell in turn to a

157

variety of small retailers and to a lesser extent at the traditional wholesale market; 2) The
Traditional Small Retailer Channel which moves lettuce directly from the grower to
retailers (without participation of intermediaries) who come direct to the farm gate; and
3) the Supermarket Channel, in which lettuce is purchased by Supermarkets directly from
growers, grower associations or ﬁrms that perform value-added services on lettuce that

they purchase from growers.

Figure 2 Lettuce Marketing Chain

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Growers Supermarkets
Intermediary
Growers and/or
Wholesale
Market
Growers - Other Small
Retailers

 

 

 

 

 

 

 

 

 

The Supermarket Channel has important organizational differences from the
traditional channel that moves produce directly from the grower to the retailer, however.
Principal among these are that the growers are responsible for providing a number of

services with the lettuce (such as delivery to individual retail outlets of the large chains)

158

as well as for meeting stringent product and process standards such as certiﬁcation of
water quality. The Supermarket Channel is “captained” by the large retail supermarket
and hypermarket chains which set the standards in terms of product requirements and
account for the most movement of produce. However it also includes the small and
medium-sized supermarkets, particularly those oriented to higher income clienteles and
who seek to provide many higher-quality attributes.

Lettuce contracts do not show the wide diversity that tomato contracts do with
neither the consignment nor the ﬁnancing contracts in evidence. Instead, a variety of
Fixed Price contracts exist. The Supermarket Channel contract is a Fixed Price Contract
with High Service Requirements. The Intermediary and Small Retailer Channels both
rely on Fixed Price Contracts with Low Service Requirements, but differ in terms of
negotiation and pricing methods. The characteristics of these contracts are summarized
below.

Supermarket Channel with Fixed price contracts and high service requirements.
Supermarket Channel buyers are very demanding of their suppliers in terms of the
provision of both physical services and services to guarantee the quality and safety of
their products. Physical services sought include product packaging, transport of the
product, and delivery among individual stores. Quality and safety assurance services
include water quality certiﬁcation, HACCP, and Good Agricultural and Manufacturing
Practices. It is interesting to note that only the largest chains explicitly demand the
quality and safety services (as opposed to all the ﬁrms that seek the physical services).
However, the fact that a ﬁrm qualiﬁes on these fronts to sell to the large chains is an

important point in gaining access to the smaller high-end supermarkets that generally do

159

not require them explicitly. These are ﬁxed price contracts; however, unlike the Low
Service Fixed Price contracts, the supplier has some degree of bargaining power, and
often provides the retailer with a price table on which negotiation is based. These
contracts have high entry barriers, particularly investments in advanced post-harvest
practices, investments to meet certiﬁcation requirements, transport and communications.
Intermediary Channel with Fixed price contract and low service requirements. These
contracts involve the provision of less service by the supplier. In many cases, the product
is collected at the farm gate on a regular basis. Ongoing long-term relationships between
buyer and seller predominate. Given the highly variable quality of lettuce, and the lack of
enforceable grades and standards, personal relationships and negotiation are important.
The above characterization is also true for the Small Retailer Channel with Fixed price

contract and low service requirements.

4 Empirical Model, Hypotheses, Methods and Data

4.1 Data

The data used come from a survey of retailers, intermediaries and farmers from
April to July 2002. Fifty-ﬁve farmers (32 lettuce growers and 23 tomato growers) in the
peri-urban region of Sao Paulo were interviewed. The sample was chosen as a "judgment
sample" (www.statpac.com/surveys/sarnpling.htm); the main producing areas of lettuce
and tomato (for the Sao Paulo market) were identiﬁed, and extension agents as key
informants were used to identify the sample of growers who reﬂected the heterogeneity
of growers in the population. While the non-random sampling method does limit the

ability to generalize results to the larger population it does allow for conclusions to be

160

drawn about differences among growers within the sample, which can be held to provide
insight into issues facing the overall population. Data was collected on farming activities
and resources, and trends in these over the past ﬁve years. Additionally, a survey of 15
tomato intermediaries was conducted, nine located in the traditional wholesale market in

Sao Paulo and six (with their own processing facilities) in the peri-urban area.

4.2 Market Channel Choice

Using the market channel categories identiﬁed in section 3 as a starting point, an
empirical analysis was made of growers’ participation in market channels and the speciﬁc
composition of these market channels. We used cluster analysis of the market outlets that
growers reported using. Partitional cluster analysis techniques using the k-means
algorithm and within group average measures to minimize the squared Euclidean
distances of all points between clusters were used to differentiate the market channels to
which growers belong. The mean points of the clusters became the market-channel
choices of the growers, with the growers’ selection of the channel determined by the
grower’s characteristics (in particular, the K vector in equation 1, because the P and w
vectors do not vary in the cross section analysis over the limited geographical scope of
the peri-urban area.

The growers’ characteristics variables used in the cluster analysis, representing
determinants of market channel choice, are as follows. Note that in general, given the
incentive to produce for the supermarket channel (price premium and lower risk through
contract), the main determinants are the capacities to meet the supermarket requirements,

communicated directly or via a wholesaler buying for the supermarket. These

161

requirements include, as noted in section 3, consistent delivery of high quality produce —
which implies having equipment and skills. The speciﬁc correlates and our hypotheses of
their relation to the supermarket channel choice are as follows.

First, we hypothesize that larger the farm, the greater the probability that the
grower will be in the supermarket channel cluster. It is commonly assumed, for example
by policymakers designing agricultural diversiﬁcation programs, that fruit and vegetable
production displays no economies of size or scale — and thus mere labor intensity (such as
small growers can supply in abundance) is sufﬁcient to be competitive in fruit and
vegetable production for urban markets. But, as signaled by Cook (2004), fruit and
vegetable production systems that consistently produce quality and sufﬁcient volumes for
supermarkets are technology-, capital-, non-labor input-, information system- and
infrastructure (packaging, pre-cooling, cold chain management)-intensive, and that
meeting these requirements involves economies of size. Moreover, evidence from
elsewhere (such as Berdegue et al. 2004) suggests that supermarkets and
specialized/dedicated wholesalers have a predilection, all else equal, to source from
medium/large farmers in order to reduce the number of suppliers and thus transaction
costs.

Second, other assets that we hypothesize to be important in participating in the
supermarket market-channel include human capital (own-education, skilled labor, and
specialization in horticulture in farming operations), off-farm sources of income to serve
as risk management mechanisms to balance the initial risk of selling to a non-traditional
market and also to provide ﬁnance for operations, and access to ﬁnance for working and

investment capital.

162

Specialization in agriculture is measured by the share of individual growers’
family budgets from agriculture; the share of their agricultural income from vegetables,
and the ntunber of different vegetables produced. Specialization in the production of
“high-value” products includes specialty produce such as organic, hydroponic, pre-
packaged, greenhouse-grown and pre-processed produce. The employment of skilled
labor is proxied using the share of total employees who are permanent on the farm, either
as hired or family labor. Having access to ﬁnancing for operational and investment
expenses is reﬂected by growers’ use of different sources of operational and investment
capital, including banks, special government programs such as PRONAF and FINAME,
input suppliers, business associates and family and ﬁiends. The level of education in
agricultural pursuits is indicated by growers’ completion of specialized educational
programs in agriculture, either at the university (such as an agronomy degree) or
technical schools.

Third, the use of modem production practices, such as regular employment of soil
analyses, also is expected to be correlated with participation in supermarket market-
channels. Growers’ market-oriented management practices are indicated by the extent to
which they purchase key inputs from the market, speciﬁcally whether they have a
greenhouse to produce their own seedlings or rely on the market for these.

Note that the use of cluster analysis allows us not to assume strict causality, but
rather general relationships, and hence obviates the need to have only exogenous

variables among the above correlates.

163

4.3 Technology Choice

Technology use was analyzed in two manners.

First, cluster analysis was also used to separate growers into high and low
technology groups. Here within-group averages were minimized using Jaccard measures,
drawing on growers’ dichotomous responses regarding their use of speciﬁc post-harvest,
transportation, communications and value-added (for lettuce only) technologies (Tan et
al.). The resulting clusters were then matched with growers’ participation in different
market channels using cross-tabs w/chi-square tests for statistical signiﬁcance.

Second, indices were created based on growers’ possession of speciﬁc equipment
(the same equipment analyzed in the cluster analysis). Growers’ possession of different
equipment was then analyzed with respect to their market channel participation using
comparison of means with analysis of variance to determine the statistical signiﬁcance of
the results.

The technology variable is modeled as dichotomous, reﬂecting that a grower
either has a package of needed equipment and other components that are necessary for
producing the requirements of the supermarket channel, or does not. The choice is thus
between traditional and “advanced” — “advanced” equipment and infrastructure includes
transportation, post-harvest communications, and value-added technologies. Speciﬁc
equipment included open, closed and refrigerated trucks for transportation and delivery of
produce; plastic crates, vegetable washers, and cold storage rooms for post-harvest
technologies; computer and intemet access for communications, and greenhouses and

pre-processing infrastructure for value-added technology.

164

5 Results

5.1 Cluster analysis results of market channel choice

Tomatoes. Cluster analysis of tomato growers’ marketing decisions (summarized in

Table 1) revealed consistent patterns of participation in the three market channels — the

Modern Classiﬁer channel (the most direct to the supermarket), the Intermediary

Channel, and the Traditional Wholesale Channel. Around 75% of the growers sold to the

Intermediary Channel, only 5% sold to the Modern Classiﬁer Channel, and the rest (20%)

sold to the Traditional Wholesale Market Channel.

Table 1 Cluster analysis results for market channel participation and composition

for tomato growers

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Supermarket Intermediary Traditional
Variable
Channel Wholesale
Participation in cluster 5% 75% 20%
Division of Sales by Buyer Type
Share of sales to Mean 7% 100% 5%
intermediary P-value .000
Share of sales wholesale Mean 3% 0% 91%
market P-value .000
Mean 27% 0% 2%
Share of sales to classiﬁer
P-value .039
Share of sales to retail Mean 64% 0% 2%
buyers P-value .000

 

165

 

Table 2 reports results on the tomato grower characteristic correlates of market
channel choice. As hypothesized, participants in the Supermarket Channel are more
likely to use more skilled labor (controlling for land), and have higher levels of
specialized education (Technical School), as compared to those participating in the other
channels. It is interesting that farm size did not have a signiﬁcant effect — whereas
physical capital and skills to produce quality and consistency do matter. Furthermore, the
use of greenhouses for production of seedlings was higher for growers in the
Supermarket Market-Channel than for others. Given the importance of quality in
producing for the Supermarket Market-Channel, it is possible then that one of the ways
that growers ensure high quality is by vertical integration of some of the key activities

that determine the quality of the product—such as the production of seedlings.

Table 2 Characteristics of tomato growers participating in different market
channels

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Supermarket Intermediary Traditional
Variable
Channel Wholesale
% Family budget from Mean 77% 73% 89%
agriculture P-value .567
% Agricultural revenue Mean 97% 73% 72%
from vegetables P-value .291
Number of different Mean 1 2 2
vegetables produced P-value .592
Mean 54 19 22

 

 

 

 

 

 

 

166

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Hectares vegetables Mean 54 19 22
cultivated P-value . 1 62
Share of permanent Mean 66 l l 10
laborers among total P-value .002

Mean 40 50 37
Age

P-value .496
Technical education in Mean 67% 7% 0%
agriculture (chi-sq) P-value .015
Outside sources for Mean 100% 100% 80%
operational capital .168

P-value
(chi-sq)
Days of credit for input Mean 120 99 119
purchases P-value .423
Outside sources for Mean 33% 57% 80%
investment capital P-value .412
Has greenhouse for Mean 33% 0% 0%
seedling production P-value .036

 

 

 

Lettuce. Cluster analysis of lettuce growers’ marketing choices (summarized in
Table 3) also showed consistent patterns of participation in three market channels.
Twenty-ﬁve percent of the growers sold to the Supermarket Channel, which was

comprised of large supermarket and hypermarket chains and small and medium-sized

supermarkets. Another 25% of the growers sold to a Small Retail Channel, comprised

167

 

Table 3 Cluster analysis results for market channel participation and composition

for lettuce growers

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

COIISLIITICI'S

 

 

 

 

 

 

Supermarket Traditional Market Channel
Variable
Channel
Intermediary Small Retailer

Number in cluster 25% 50% 25%
Division of Sales by Buyer Type
Share of sales to large Mean 34% 2% 0%
chains P-value .000
Share of sales to Mean 32% 1% 0%
small and medium

P-value .000
supermarkets
Share of sales to Mean 6% 71% 4%
intermediaries P-value .000
Share of sales to Mean 3% 18% 96%
small, non-

P-value .000
supermarket retailers
Share of sales to Mean 15% 2% 0%
wholesale market P-value .177
Share of sales to Mean 10% 6% 0%
processors or

P-value .485

 

168

 

primarily of small non-supermarket retailers such as street fair vendors and discount
green grocers. The remaining 50% sold to an Intermediary Channel. P-values show that
each market channel has statistically different levels of sales to different types of buyers
except for sales to the wholesale market and processors and consumers.

Table 4 reports results on the lettuce grower characteristic correlates of market
channel choice. It shows a consistent pattern of results in which the relatively more
attractive market channels are used by growers who are more specialized in agriculture,
produce a broader array of products, have larger farms, and for whom the production of
high-value “specialty” produce constitutes a larger portion of the revenue of those who
produce it. These growers also rely very heavily on skilled laborers (86% of their total
compared to only 8% for the other groups), are younger, and have highly specialized
training in agriculture as evidenced by 43% of the Supermarket Channel growers having
university educations in agriculture compared to none of the other growers. Interestingly,
while Supermarket Channel growers are not the most reliant on outside sources of capital
for operational expenses (though only half of the growers selling to Small Retailer
Traditional Channel only rely on outside capital for their operational expenses), those
Supermarket Market-Channel growers who do borrow for operational expenses are
extended credit for approximately twice as long as the other growers.

Why does farm size matter for lettuce growers but not for tomato growers? We
surmise that the reason is based on the structure of the marketing channel. All tomatoes
pass through mechanized classiﬁcation plants. However, there is no mechanized
classiﬁcation of lettuce, and a large proportion of it moves directly from producers to

retailers. Thus, the classiﬁers play two roles in the tomato markets that they do not play

169

Table 4 Characteristics of lettuce growers participating in different market channels

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Supermarket
Variable Traditional Market Channel
Channel
Intermediary Small Retailer

% Family budget from Mean 96% 98% 90%
agriculture P-value .230
% Agricultural revenue Mean 100% 99% 93%
from vegetables P-value .090
Number of different Mean 18 7 7
vegetables produced P-value .002
Hectares vegetables Mean 33 7 10
cultivated P-value .0 1 8
Produces “specialty” Mean 13% 13% 0%
produce (chi-sq) P-value .576
“Specialty” produce Mean 32% 7% 0%
share of produce sales

P-value .057
(for those who produce)
Share of permanent Mean 86% 8% 8%
laborers among total P-value .001

Mean 36 39 57
Age

P-value .036
University education in Mean 43% 0% 0%
agriculture (chi-sq) P-value .003

 

 

 

170

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Outside sources for Mean 88% 92% 50%
operational capital (chi-

P-value .054
sq)
Days of credit for input Mean 62 29 33
purchases P-value . 127
Outside sources for Mean 75% 56% 50%
investment capital P-value .558

Mean 88% 92% 63%
Conducts soil analysis

P-value .212
Has greenhouse for Mean 63% 71% 88%
seedling production P-value .543

 

 

 

 

 

in lettuce markets. First, they aggregate the production of numerous tomato growers in
order to meet demand. Second, they perform most of the operations that qualify tomatoes
for the Supermarket Market-Channels. That is, though it is crucial for tomato coming into
the plant to be of high quality, the value-added operations on the tomato such as sorting,
packaging and transport, take place at the plant. Thus, there is no inherent scale
advantage for tomato growers to sell to the Supermarket Market-Channel buyers. In fact,
given the increasing number of classiﬁers in the area and competition for adequate
volumes of throughput to meet demand and keep plants running at efﬁcient capacity
levels, it is likely that the classiﬁer-intermediaries do not currently seek to purchase
tomato from large-scale growers exclusively. In contrast to this situation for tomato, the

proportion of sales of lettuce direct from the grower to the retail buyer means that the

171

services and attributes that make lettuce qualify for the Supermarket Market-Channel
frequently take place at the farm level. Furthermore, Supermarket Market-Channel buyers
tend to require a minimum variety of produce (such as different varieties of lettuce or
value-added features) as well as a minimum volume, which creates a bias towards larger

growers.

5.2 Results of technology use analysis

As shown in Tables 5 and 6, there were no statistically signiﬁcant differences
between tomato growers in different market channels in terms of their technology use, in
terms of embodied-technology reﬂected in the equipment use shown. The explanation for
this lack of statistically signiﬁcant difference in technology use also lies in the structure
of the marketing chain. Again, it is key that a grower producing for the Supermarket
Market-Channel be able to produce a high quality tomato, but given the importance of
classiﬁers in the activities that qualify the tomato for the Supermarket Market-Channel, it

does not turn out to be crucial for the grower to possess these technologies.

Table 5 High and low technology holdings and market channel choice among
tomato growers

 

Supermarket Traditional
Variable Intermediary
Channel Wholesale

 

 

 

 

 

High Technology 100% 80% 79%
Low Technology 0% 20% 21%
Pearson Chi-square test for signiﬁcance .678

 

 

 

 

172

Table 6 Technology holdings and market channel choice among tomato growers

 

 

 

 

 

 

 

 

 

 

 

 

 

Supermarket Traditional

Variable Intermediary
Channel Wholesale

Possession of post-harvest Mean .91 .32. .40
equipment (0-1 index) P-value .141
Possession of advanced Mean .27 .18 .18
delivery equipment (0-1 index) P-value .561
Access to communications Mean 1 .62 .67
equipment (0-1 index) P-value .418

 

 

 

 

 

By contrast, Table 7 shows that there are sharp differences in technology use
among lettuce growers, over the market channels. Among lettuce growers, 100% of those
selling to the Supermarket Channel are in the “high technology group”, compared to 69%
of the Intermediary Channel growers, and only 38% of the Small Retailer Channel
growers. This pattern is as one would expect given the production and post-harvest

requirements of the different channels.

Table 7 High and low technology holdings and market channel choice among lettuce
growers

 

 

 

 

 

 

 

 

Variable Supermarket Traditional Market Channel

Channel Intermediary Small Retailer
High Technology 100% 69% 38%
Low Technology 0% 31% 62%
Pearson Chi-square .026

 

 

 

 

173

Table 8 Technology holdings and market channel choice among lettuce growers

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Variable Traditional Market Channel
Supermarket
Small
Channel Intermediary
Retailer

Possession of post- Mean 1 .45 .45
harvest equipment

P-value .028
(0-1 index)
Possession of Mean .55 .08 .06
advanced delivery
equipment (0-1 P-value .000
index)
Access to Mean .75 .58 .21
communications
equipment P-value .028
(0-1 index)
Possession of value- Mean .19 .03 .07
added equipment

P-value .112
(0-1 index)

 

Table 8 Shows that Supermarket Channel lettuce growers scored ranked
signiﬁcantly higher than any of the Traditional market channel growers in the possession
of post-harvest equipment, advanced delivery equipment, access to communications
equipment, and value-added equipment. Interestingly, with the exception of access to

communications equipment (for which Intermediary Channel growers rated almost three

 

174

 

times as high as Small Retail Channel growers), there was little difference, on average, in
the different Traditional Market Channel growers’ ratings on indices for equipment
possession in these categories.

There are two important implications of these results for tomato growers. First, they
point to the key role that intermediaries play in the tomato market channels in facilitating
the access of heterogeneous growers to the Supermarket Market-Channel. Second, they
point to the importance of the human capital dimension in determining the access of
growers to the Supermarket Market-Channel—while there are clear differences in the
characteristics of tomato growers producing for the different market channels, these
differences are not easily attributable to differences in their technology holdings or size.
Instead it is crucial that the tomato growers who participate in the Supermarket Market-
Channel be able to produce quality, but the results indicate that the ability to produce
quality is more a function of their having skilled labor and specialized educations (i.e. the
human capital dimension) than their using speciﬁc equipment portfolios. For lettuce
growers, however, the situation is very different—like tomato, the human capital element
is crucial. Unlike tomato growers, however, lettuce growers need to have access to
speciﬁc advanced technologies and be of sufﬁcient size to participate effectively in the

Supermarket Market-Channel.

6 Conclusions
This paper examined the relationships between growers' choice of market channel
(emphasizing the supermarket market-channel versus others), technology use, and grower

characteristics such as human capital and farm size. Three key ﬁndings emerged. First,

175

both tomato and lettuce growers selling to the supermarket market-channel had more
human capital than those not participating. Second, while farm size was important in
whether lettuce growers sell to supermarkets, it was not important for tomato growers.
While the latter was expected due to hypothesized economies of size, the latter was
surprising until one notes that the role of specialized/dedicated wholesalers is far more
important in interrnediating tomato growers (as opposed to lettuce growers) access to
supermarket channels. The wholesalers thus classify, grade and bulk from many smaller
growers and deliver to supermarkets, while in the lettuce channel larger, well-equipped
growers deliver that service and sell directly to supermarkets. Third, technology use was
signiﬁcantly more capital-intensive among lettuce growers selling to the supermarket
channels, as hypothesized given the product and transaction attributes demanded by the
supermarkets. However, that was not the case for tomato growers, except to note the
greater importance of greenhouses for quality-seedling production. Again, the
explanation lies in the intermediation point noted above.

These results are important to agribusiness researchers and policymakers interested
in technology design and research and extension to enable producers to adapt to the needs
of changing agrifood markets, with new requirements of attributes of products and
transactions, that in turn have implications for technology adoption and human capital
investment among growers. This is particularly pressing in places like Brazil where the
market for horticultural products is changing fast, conditioned by the rapid rise of

supermarkets.

176

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voor den Dag, T. 2003. Export Chain of French Beans from Kenya. Ph.D. Dissertation,
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Farina, E. M. M. Q. and E. L. Machado. 1999. Brazilian Fresh Fruit and Vegetable Chain
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Heiman, A., B. McWilliams and D. Zilberman (2000). “Marketing Institutions, Risk, and
Technology Adoption”.

Hueth, B., Ligon, E., Wolf, S. and S. Wu (1999) ‘Incentive Instruments in Fruits and
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Fresh Vegetable Trade in the Context of Emerging Food Safety and Other Standards.
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McCulloch, N. and M. Ota. 2002. "Export Horticulture and Poverty in Kenya," Paper
presented at Conference on Globalization and Inequality, Centre for the Study of
Globalization and Regionalization, University of Warwick.

Reardon, T. and J .A. Berdegué. 2002. The Rapid Rise of Supermarkets in Latin America:
Challenges and Opportunities for Development,” Development Policy Review, 20 (4),
September: 3 17-34.

Reardon, T., J-M. Codron, L. Busch, J. Bingen, C. Harris. 2001. “Global Change in
Agrifood Grades and Standards: Agribusiness Strategic Responses in Developing
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CHAPTER 7
Conclusion

The rise of supermarkets to prominence is a phenomenon in both deve10ping and
more developed countries worldwide. Their activities have been associated with profound
changes in agrifood systems including shifts in market structure, the participation of
diverse actors, levels of competition in the market and the welfare of both upstream and
downstream players. This dissertation addressed these issues within the context of Sic
Paulo Brazil’s fresh produce market.

The dissertation took as its point of departure the rise of large retail chains in the
Brazilian marketplace. The ten largest retail chains increased their share of the Brazilian
retail market from 24% to 37% between 1994 and 2000. Supermarkets (including both
chains and independents) currently account for about 75% of food retail sales.

The dissertation addressed three broad research questions: 1) What factors led to
the rise of large retail chains in Brazil and what effects have they had on the market
structure? 2) How have smaller retailers responded by altering their fresh produce
procurement strategies? and 3) How have growers responded in their market channel and
technology use decisions?

The ﬁrst section of the dissertation examined the factors led to the rise of large
retail chains in Brazil and their effects on the fresh produce market structure. The recent
evolution of the fresh produce market including the rise of large retail chains and their
effects on market structure can be understood within the SCP framework, looking at three

phases: economic crisis, economic stabilization, and post-stabilization.

179

The late 19805 to early 19905 was a time of economic crisis for Brazil. Stagnant
and falling incomes and high inﬂation depressed demand among consumers. The lack of
demand and uncertain investment climate meant that there was no incentive to produce or
market quality produce.

These conditions changed with economic stabilization that resulted from the Real
Plan in 1994. With economic stabilization, the basic conditions affecting ﬁrm behavior
shifted. Consumers’ incomes grew and there was an increase in demand for fresh
produce, not only the volume demanded but also quality and other attributes like
convenience and perceived healthfulness. Increased demand and a more favorable
investment climate affected ﬁrm'strategy. At the retail level, a number of retailers, the
“ﬁrst movers,” sought to increase their market presence through organic expansion and
mergers and acquisitions. Their efforts at expansion were facilitated by an increase in the
entry of international capital as international ﬁrms either entered the market under their
own names or bought into existing retailers.

As the “ﬁrst moving” retailers grew, they sought to take advantage of their
increasing scale to reduce the costs and increase the quality of their fresh produce through
innovations in their procurement strategies. Central among these innovations were the
centralization of procurement and distribution and an increase in purchases direct from
the production areas rather than through traditional wholesale channels. These retailers’
activities led to shifts in the market structure, particularly shifts in cost structures, scale
and scope economies and increased barriers to entry. They also led to a bifurcation of the
marketing chain into a “public” chain that was moves produce from the growing region

through the traditional wholesale market to retail buyers, and a “private” marketing chain

180

that moves produce directly from the growing region to retail buyers, by-passing the
traditional marketing channels.

The second section of the dissertation examined small retailers’ responses to the
changed market conditions, particularly in terms of alterations they may have made in
their fresh produce procurement strategies.

In addressing this question, it is necessary to move to the third stage of market
evolution, and to differentiate between three types of players in the market. The third
stage of market evolution is the post-stabilization phase. Diverse retailers exist in the
market at this point, these ﬁt into three categories: 1) large chains——for example
Companhia Brasileira de Distribuicio and Carrefour—that are the “ﬁrst movers” of the
previous stage of evolution, 2) independents including small and medium supermarkets,
and 3) traditional retailers such as open-air fair vendors.

Aggregate data shows that between 1994 and 2000 (from the economic
stabilization to the post-stabilization phase), traditional retailers lost market share while
independents have gained, and large chains, who represent a small percentage of the total
number of ﬁrms and occupy a very large share of the market, also declined somewhat in
importance. These numbers generated considerable surprise as popular wisdom held that
the large retailers would continually expand, driving other ﬁrms out of the market. The
dissertation considered how retailers’ changes in procurement strategies might have
contributed to their varying market performance.

Retailers are understood as forming their procurement strategies with the

objective of minimizing the cost of acquiring volumes, varieties, qualities of fresh

181

produce needed for their merchandising needs. These costs are the sum of purchase,
processing and transaction costs.

In deciding upon a procurement strategy, retailers have three choices to make.
They must choose how to organize their procurement, that is, whether purchases should
be centralized, decentralized or contracted out. They must choose the sources from which
they purchase produce, namely from the traditional wholesale market or direct from the
growing region. They also must choose how to govern the transactions and relationships
that they have with their suppliers, whether it be through formal or informal relations and
whether they should rely on public grades and standards to control the quality of produce
that they purchase or institute their own private standards.

These decisions must be made taking into account the characteristics of the fresh
produce market. Fresh produce is a highly perishable product, it is vulnerable to damage
from handling and transport, and any damage that might be inﬂicted may not be evident
until after a transaction takes place. Information asymmetries about market conditions
and the quality of the product prevail, and ﬁrms’ behavior in the market is not well
controlled by either formal (legislative) or informal (cultural) institutions. For example,
public grades and standards are ineffective in providing consistent quality produce, and if
opportunistic behavior does occur then the injured party has little recourse to redress its
grievances. The speciﬁc procurement decisions that ﬁrms must make further affect
information costs, asset speciﬁcity and uncertainty. For example, the centralization of
fresh produce procurement requires large ﬁxed investment costs, and the decision to
purchase from the growing area rather than from the traditional wholesale market

narrows the range of suppliers, increasing asset speciﬁcity and vulnerability to holdup.

182

The different types of ﬁrms showed different responses in terms of changes to
their procurement strategies over the past ﬁve years. Large chains, many of whom had
already centralized their procurement and begun to purchase from growing areas
completed the shift from decentralized to centralized procurement and further increased
their purchases of fresh produce from the growing areas at the expense of purchases from
the traditional wholesale market. They also relied on formal relations with suppliers,
generally in the form of preferred supplier registries, and private grades and standards.

Independent retailers were highly decentralized in their purchases of fresh
produce and this showed little change. They increased their purchases from growers, and
were heavily reliant on informal relations with their suppliers and public standards,
though some ﬁrms did, in fact, institute their own private quality standards.

Traditional retailers showed the least change in the organization of their
procurement. They did not make any changes to the organization of their procurement,
and they showed only a slight increase in their purchase of lettuce from growing regions
and no change at all in their sources of tomato. They continued to rely exclusively on
informal relations with their suppliers and public grades and standards. It is expected that
the lack of responsiveness on the part of traditional retailers is an important factor
contributing to their decline in market share and participation between the stabilization
and post-stabilization periods, as it likely indicates that they neither reduced their costs
nor improved the quality of their produce merchandise appreciably over that period.

The third and ﬁnal section of the dissertation asked how growers have responded
to the changed market conditions in their production and marketing strategies, and have

these changes have affected their use of technology.

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In the post-stabilization period, growers faced a radically different market
environment than they previously had. Retailers had responded to consumers’ increased
demand for food quality attributes, such as organoleptic quality, food safety and
convenience, in their merchandising strategies, and communicated new attribute
requirements through their product standards. This, along with shifts in the organization,
sources and governance of their procurement, led to the emergence of new market
channels. These market channels are characterized by the buyer types, their attribute
requirements, and the contractual relations they maintain with suppliers. Participation in
the new market channels implies investment requirements for suppliers, affecting their
risks and returns, while participation in the traditional market channels had low entry
barriers but lower returns and was increasingly marginalized in terms of the volume of
produce ﬂowing through it.

Growers were modeled as choosing the market channel and technology
(embodied in the combinations of equipment used to meet attribute demand for speciﬁc
channels) to use in producing for that market channel as part of a proﬁt maximization
objective. Two market channels were identiﬁed—the Supermarket Channel, consisting of
both large chains and small and medium-sized supermarkets oriented to more demanding
clienteles, and the Traditional Channel, including traditional wholesale buyers and small
traditional retailers. Growers participating in the supermarket channels had higher levels
of human capital and used more capital-intensive technology, except in the case of
tomatoes where market intermediaries played a major role in ensuring that supermarket
channel quality and service requirements were met, thus facilitating the participation of

growers with lesser levels of technology.

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In sum, the dissertation found that large retail chains gained prominence in fresh
produce markets due to changes in the incentives they faced as a result of economic
stabilization. The large retailers’ fresh produce procurement and merchandising strategies
permitted them to reduce their costs and improve the quality of their merchandise. As the
large retailers increased their share of the market, smaller retailers were in a position of
having to respond if they were to remain competitive. Independent retailers were most
proactive in changing procurement strategies to meet new market conditions, changing
the organization, sources and coordination of their fresh produce procurement.
Traditional retailers were less responsive, making few changes to their procurement
strategies. This was likely a signiﬁcant factor contributing to their decline in numbers and
market share over the past decade. Shifts in retailers’ competitive strategies led to
changes in the structure of the market, particularly the emergence of a Supermarket
Channel characterized by high quality and service requirements, as well as high returns,
risk and entry requirements for suppliers. Growers participating in the supermarket
channels had higher levels of human capital and used more capital-intensive technology,
except in the case of tomatoes where market intermediaries played a major role in
ensuring that supermarket channel quality and service requirements were met, thus
facilitating the participation of growers with lesser levels of technology. Human capital
and capital intensive technology were shown to be positively correlated with participation
the Supermarket Channels, however the role of intermediaries was also highlighted as
important in facilitating the access of more capital-poor growers to those channels as

well.

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