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STRATEGIES FOR DIFFERENTIATION AND QUASI-RENT APPROPRIATION IN
AGRICULTURE: THE SMALL-SCALE PRODUCTION
Presentation........................................................................................................................................................4
PART I ................................................................................................................................................................. 10
HOW TO GAIN SUSTAINABLE COMPETITIVE ADVANTAGES?......................................................... 10
CHAPTER 1 ........................................................................................................................................................ 10
FOUR THEORETICAL APPROACHES ........................................................................................................ 10
1.1 Focus on the product market: Strategic Positioning Analysis (SPA) ................................................ 10
1.2 Focus on the market of factors: a Resource-Based View (RBV)....................................................... 17
1.3 Focus on coordination: Transaction Cost Economics (TCE) .............................................................. 26
1.4 Focus on the entrepreneur’s judgment: Knight’s Theory of Profit (KTP) ....................................... 36
CHAPTER 2 ........................................................................................................................................................ 44
AN INTEGRATIVE VIEW OF THE STRATEGIC APPROACHES........................................................... 44
2.1 The integration of the approaches in the economic literature............................................................. 45 2.2 An integration of the strategic views: An analytical proposal................................................... 53
Part II................................................................................................................................................................... 65
RENT CREATION AND APPROPRIATION IN THE SUPPLY CHAIN: FOUR EXPERIENCES IN THE COFFEE AIS ............................................................................................................................................. 65
CHAPTER 3............... ......................................................................................................................................... 66
THE COFFEE MARKET DYNAMICS ........................................................................................................... 66
3.1 Agricultural segment: competitive markets and ephemeral profits ................................................... 66
3.1.1 Transaction costs in coffee production: the immobility of the factors............................................ 68 3.1.2 Transaction costs in coffee production: crop specificity .............................................................. 71
3.2 Income distribution in the supply chain................................................................................................ 74
3.3 The specialty coffee industry and the rural segment............................................................................ 82 3.3.1 Categories of specialty coffees ....................................................................................................... 86
CHAPTER 4 ........................................................................................................................................................ 95
VALUE CREATION AND APPROPRIATION: DIFFERENTIATED COFFEES..................................... 95
4. 1 Introduction............................................................................................................................................. 95
4.2 Joint interdependence: Cooxupé taking strides on the path of network economics......Erro! Indicador não definido.
4.2.1 Incorporating the advantages of scale ........................................................................................... 96 4.2.2 Vertical integration ....................................................................................................................... 101 4.2.3 Gains in horizontal cooperation ................................................................................................... 102
4.3 Sequential interdependence: illycaffè high quality brand ................................................................. 103 4.3.1 Supply coordination ...................................................................................................................... 104 4.3.2 Gains with vertical coordination.................................................................................................. 108
4.4 Mutual interdependence: sustainable coffee from Baturité and Poço Fundo.................................. 109 4.4.1 Baturité’s sustainable coffee......................................................................................................... 110
4.4.1.1 Producers’ location ................................................................................................................... 111 4.4.2 The experience of Poço Fundo’s producers ................................................................................ 116
4.4.2.1 Partnerships and commercialization hindrances ................................................................... 118 4.4.3 Gains from horizontal and vertical coordination ....................................................................... 120
4.5 Strategic choices, governance structure and value adding ................................................................ 121 4.5.1 Producers’ performance: an empirical comparative analysis................................................... 122 4.5.2 Conditions of rent appropriation ................................................................................................. 126 4.5.3 Considerations about the results.................................................................................................. 132
Conclusion ......................................................................................................................................................... 134
ILLUSTRATIONS Figure 1 -Structure–Conduct–Performance Model ............................................................................................... 11 Figure 2 - Classical Monopoly Model and Competitive Advantages in the SPA ................................................. 15 Figure 3 - Ricardian Rents .................................................................................................................................... 20 Figure 4 - Sustainable competitive advantages in Barney and Peteraf.................................................................. 23 Figure 5 - Negotiation zone and buyer’s and seller’s reserve prices..................................................................... 32 Figure 6 - Second negotiation round and quasi-rent ............................................................................................. 33 Figure 7 - Analytical scheme of value creation and appropriation........................................................................ 60 Figure 8 - Joint Interdependence........................................................................................................................... 61 Figure 9 - Sequential interdependence .................................................................................................................. 62 Figure 10 - Mutual interdependence ..................................................................................................................... 62 Graph 1 - World and Brazilian coffee production (bags per hectare) ................................................................... 70 Graph 2 - World production (million 60-kg bags) and Brazilian coffee prices New York Stock Exchange - 1901 to 2004 .................................................................................................................................................................. 72 Graph 3 - World production of Arabica and Robusta coffee (thousand 60-kg bags)............................................ 75 Graph 4 - Arabica and Robusta coffee closing quote - New York Coffee, Sugar and Cocoa............................... 76 Graph 5 - Revenues from world coffee exports in all forms (billion US$)........................................................... 77 Graph 6 - Distribution of gains along the coffee chain ......................................................................................... 78 Graph 7 - Prices paid to Brazilian producers of Arabica coffee beans and prices of roasted coffee..................... 80 Graph 8 - Percentage of retail price of one cappuccino in a coffee shop .............................................................. 81 Graph 9 – U.S. domestic coffee consumption – Regular and Gourmet ................................................................ 84 Graph 10 - Exports of certified organic coffee per origin ..................................................................................... 91 Graph 11 - Arabica coffee market: New York Stock Exchange and Fairtrade - 1998-2006................................. 93 Graph 12 - Comparative analysis of the cases .................................................................................................... 108 Graph 13 - Participation of each type of coffee in Minas Gerais’ total production ............................................ 133
Picture 1 - Attributes of the hiring process ........................................................................................................... 29 Picture 2 - Solutions for each type of knowledge search ...................................................................................... 52 Picture 3 -Main features of the SPA, RBV, KTP and TCE views ........................................................................ 54 Picture 4 - Value creation and appropriation......................................................................................................... 63 Picture 5 - Categories of specialty coffee.............................................................................................................. 86 Picture 6 - Comparative analysis of the cases ..................................................................................................... 128
Table 1 - Coffee producing countries and coffee growers: main features............................................................. 68 Table 2 - Stratification of coffee holdings ............................................................................................................ 69 Table 3 - Stratification of coffee holdings ............................................................................................................ 69 Table 4 - Average production of main producers (in thousand 60-kg bags) ......................................................... 75 Table 5 - Distribution of gains along the coffee chain ......................................................................................... 86 Table 6 - Average premium: Organic, Fairtrade and shade-grown in the U.S., 2000 (US$/lb) ............................ 92 Table 7 -Coffee exports by Brazilian exporting.................................................................................................. 100
STRATEGIES FOR DIFFERENTIATION AND QUASI-RENT APPROPRIATION IN AGRICULTURE: THE SMALL-SCALE PRODUCTION
PRESENTATION
The general declining trend in the agricultural sector’s share of national income generated by
supply chains is a challenge for both private sector and public policies. The issue is not new;
it was exhaustively debated in the 1950’s, giving rise to theoretical and ideological
controversies. Historically, the question permeating all this discussion focuses on
opportunities for the development of poor countries. The debate highlights the deterioration of
the terms of exchange between poor nations—producers of agricultural goods with low
income elasticity, and the rich ones—producers of industrialized goods with high elasticity
(PREBISCH, 1950; CALO; JONGENEEL, 2004; DAVIRON; PONTE, 2005).
Decades later, the problem lingers on. Significant productivity gains in the field mean price
decreases in a typically competitive market place. The debate, however, moves beyond the
dichotomy between poor and rich countries. Although it is more pressing for non-developed
countries, the issue of declining income in the agricultural sector is not the prerogative of poor
countries’ producers.
In non-developed countries, this declining agricultural income by and large is conducive to an
impoverished economy, since the latter basically depends on resources coming from
agriculture. For developed ones, although this problem is solved with the allocation of large
resources provided by public policies, the ill-fated results of these transfers and the
dissatisfaction of society, which pays for the inefficiencies of the regulation, raise the issue of
the unsustainability of artificially maintaining producers’ income.
As of the 1990’s, two different movements started to be included in the agendas of
agricultural policy makers and private agents. On the one hand, actions against agricultural
subsidies became frequent tools within the World Trade Organization. Though the gains
arising from these actions are still inexpressive, they already point to the problem of how to
maintain the income of producers from rich countries. In developed countries, on the other
hand, consumers concerned with poverty and social justice are actively engaged in the
fairtrade movement sponsored by non-governmental organizations and private companies,
which see in these movements new market opportunities.
Thus, the relevant issue in the discussion on income decline does not lie in the dichotomy
between poor and rich countries; rather, it resides within the scope of agroindustrial chains.
Whereas there is a trend of sophistication and differentiation in the UPSTREAM stages of the
supply chain, agricultural products usually remain, in the rural segment, as commodities, the
characteristics of which are low entry barriers and strong price-competition. The strategies
aimed at productivity gains, such as increased scales and cutting-edge technology, do nothing
but accelerate the decline of prices (KONING; CALO;JONGENEEL, 2004). This situation
evokes the image of a race on a treadmill at increasingly higher speeds: such strategies are
adopted only to allow remaining at the same position. Excluding from activity those who
cannot follow the innovation and productivity pace leads to the well-known problems of
poverty and the swelling of urban slums.
De-commodifying through product differentiation attributes is a way to avoid price-
competition, allowing the agricultural sector to obtain extraordinary rents (FITTER;
KAPLINSKY, 2001). The possibility of de-commodifying agricultural goods mainly arises in
developed countries, fueled by trends on consumer demands for food quality and safety and
socio-environmental sustainability. An emblematic example is water. From a product with
almost no differentiation prior to the last decade it is now part of a sophisticated market, with
several attributes. The increased consumption of single-origin, organic and socially-responsible
products also illustrates the capacity of the agricultural production to differentiate. De-
commoditization may also be realized through the introduction of a new technology able to
explore new attributes of a commodity, as in the case of the production of colored cotton.
However, this type of strategy serves only to increase the complexity of the relations among
players at the first stage of the supply chain, since differentiation strategies must be aligned
with the interests of the subsequent steps. Furthermore, how to ensure that the rent created is
really appropriated by producers, particularly those who do not have scale to compete? That
is, are there feasible and sustainable strategies able to reverse the decline in agricultural rent
when growers’ planting areas do not allow significantly growing returns from scale11? Under
what conditions is it worth investing in differentiation? What are the implications of such
investment in terms of the relations with the upstream stages?
Within the scope of the Pensa (Program of studies on Agroindustrial System Businesses)12,
studies on the competitiveness (FARINA; ZYLBERSZTAJN, 1998) of several agroindustrial
systems 13 have shown a trend toward differentiation of agricultural products across the systems
analyzed. The presence of more complex relations among the segments of those systems was also
observed, a complexity arising from the creation of diverse contractual forms that have allowed
gains in competitiveness and investments in technology. Nevertheless, this trend has not
prevented the exclusion of producers, who cannot keep pace with the frenetic rhythm of increased
productivity and fall of prices.
This is, therefore, the backdrop of the investigation of this study. The investigation process
chooses as a referential framework three theoretical perspectives that are the basis of the
studies conducted by Pensa (ZYLBERSZTAJN, 1996; FARINA; ZYLBERSZTAJN, 1998) and
which fall under the Economics of Organizations paradigms. These perspectives provide
frameworks for understanding the dynamics of Agro-industrial Systems (AISs)4.
The first perspective arises from research in the area of Industrial Organization. One of the best-
known studies that use the economic approach to understand entrepreneurial strategies is that of
Michael Porter (1985, 1998). His approach, called Strategic Positioning Analysis (SPA),
highlights the actions of firms in search of competitive advantages through monopolistic rents.
11 The present research considers small-sized producers in theoretical terms, i.e., those who cannot obtain significant returns from scale. It is worth observing that, in agricultural policies, the Brazilian Federal Government defines as small producers (rural workers) those who work on rural properties up to four “fiscal modules” of the respective region. Rural modules vary according to natural and socioeconomic factors. In other words, they concern the quantity of land necessary for one worker and his family (of four people) to be able to support themselves. Wherever production conditions require little space, the module is smaller, whereas in regions requiring wider space, the module is bigger (BRASIL, 2006). 12 Pensa is a program of studies on agroindustrial systems from the School of Economics, Administration and Accountancy of the University of São Paulo (FEA-USP), in which this authoress participates. 13 Coffee, sugar cane, soybean, rice, cotton, milk, wheat. 4 The concept of AISs originates in the works by Davis and Goldberg (1957), within a research program of Harvard Business School aimed at understanding the role of coordination among the segments comprising the agricultural chains in the United States.
The second theoretical line adopted aims at contributing to the analysis of the emergence of
specific non-replicable resources within the company. To that end, the Resource-Based View
(RBV) of the firm provides a context that allows understanding the origin of sustainable
competitive advantages and value creation based on ricardian rents (WERNERFELT, 1984;
RUMELT, 1984; BARNEY, 1991; PETERAF, 1993, FOSS and KLEIN, 2004).
The third theoretical view chosen seeks to understand the reason for different configurations
among the governance structures observed. The Economics of Organizations, more
particularly the concepts provided by the Transaction Cost Economics, makes it possible to
analyze the alignment between the transaction attributes affecting the different stages of the
production processes with governance structures adopted (COASE, 1937; WILLIAMSON,
1985; WILLIAMSON, 1996). The implementation of differentiation strategies, which
constitutes the focus of this study, requires investments in specific assets and should modify
the relations among the economic agents, as well as the market access strategy. Contracts
would tend to become relational 5, so as to enable incentives in specific assets. This theoretical
approach will guide the discussion on relations between rural producers and processing firms
in negotiations that require investments in differentiation.
Besides these approaches, the perspective of gains in conditions of uncertainty shall also be
incorporated in this study. The fourth perspective—Knight’s Theory of Profit (KTP) —
explains the appearance of positive rents resulting from market disequilibrium. This
theoretical line also emphasizes the role of entrepreneurs as agents of strategies, an important
element that has been forgotten with the development of the modern economic theory
(KNIGHT, 1964; WITT, 2000; CASSON, 2005).
As the object of analysis, we chose the case of the relations between Brazilian rural producers
of specialty coffee and the processing industry. The main reason for choosing this system
derives from the fact that it allows significant possibilities for differentiation in the rural
sector, thereby being very illustrative of the possibility of quasi-rent appropriation in this
segment.
5 Relational contracts imply that seller and buyer are identified to each other.
This study is divided into two parts, each containing two chapters. Part I discusses the theoretical
approach. Chapter 1 analyses the origins of SCAs, with a view to revising the four above-
mentioned theoretical approaches, i.e.: (a) Strategic Positioning Analysis (SPA); (b) Transaction
Cost Economics (TCE); (c) Resource-Based View (RBV); and (d) Knight’s Theory of Profit
(KTP). Based on the integration of these four theories, Chapter 2 seeks to develop a model to
analyze differentiation strategies in the Brazilian rural segment. Part II, Chapter 3, will
contextualize the coffee market dynamics, examining the problem of price behavior and the
emergence of the special coffee market. Chapter 4 will analyze four cases of differentiation in the
coffee SAG: the first case discusses the experience of Cooxupé, the world’s largest coffee
cooperative; the second analyzes the experience of Italian roasting company, illycaffè; the third
focuses on a Brazilian grower of shade-grown coffee from Baturité, in the state of Ceará; and the
fourth case is about sustainable coffee producers from Poço Fundo, in the state of Minas Gerais,
Brazil.
Part of the theoretical content of this thesis was developed while the author was participating in a
Visiting Scholar program at the Center for Strategic Management and Globalization (CBS) at
Copenhagen Business School, Denmark. And I wish to express here my special gratitude to
Professor Nicolai Juul Foss, with whom I had the opportunity to have rich and deep discussions
about how the Resource-Based View, Transaction Cost Economics and Knight’s approach interact
with one another.
I am also indebted to the members of Pensa for 17 years of constructive dialogues, and in
particular to Professor Decio Zylbersztajn, Professor Elizabeth Farina and Professor Samuel
Giordano. I am especially grateful for the unique forum for discussing the New Institutional
Economics that program has provided during all these years. The final version of this work
includes valuable contributions, in particular from my students at FEA and especially from the
following friends: Guilherme Fowler, Fabio Mizumoto, Bruno Varella Miranda, Christiano
França da Cunha, Roberto Pedroso Junior, Silvia Caleman, Maria Célia Martins de Souza and
Claudia Viegas. I am also grateful for the continuing support from Lucy Petroucic and Nice
Santana.
I could not forget to thank the entrepreneurs, representatives and producers from the coffee
agroindustrial system, in particular Professor Adalberto Alencar, Dr. Carlos Alberto Paulino, Sr.
Luís Adauto de Oliveira and Prof. Sérgio Pedini. I would also like to pay homage to Dr. Isaac
Ribeiro Ferreira Leite da Costa and Dr. Ernesto Illy, two significant personalities, who, in their
own way, have transformed Brazilian coffee production while adding value to rural producers.
Finally, I want to express acknowledgement to my parents, Erini and Paschoal, for their
encouragement; and to Flávio, Xixo, Bibi and Paulinha for interesting and challenging discussions
about my research topic.
PART I
HOW TO GAIN SUSTAINABLE COMPETITIVE ADVANTAGES?
CHAPTER 1
FOUR THEORETICAL APPROACHES
How do entrepreneurs choose a strategy that creates and captures value? What could prevent
value creation? How can the competitive economic balance be supplanted? How does the
literature on entrepreneurial strategy position itself in relation to these questions?
The questions above permeate the discussion of the present item. It presents four different
approaches pertinent to the Economics of Organizations: (a) Strategic Positioning Analysis
(SPA), focused on the product market; (b) Resource-Based View (RBV)6 , mainly focused on
internal firm factors; (c) Transaction Cost Economics (TCE), concerned with the coordination
of entrepreneurial activities; and (d) Knight’s Theory of the Profit (KTP), which explains the
appearance of rents in a situation of disequilibrium. Once that is accomplished, an endeavor is
made to integrate the four approaches presented.
1.1 Focus on the product market: Strategic Positioning Analysis (SPA)
The theoretical foundation of the strategic analysis of firms can be traced back to the 1930’s,
when the Industrial Organization (IO) theory emerged. The dominant framework in IO is the
Structure–Conduct–Performance (SCP) paradigm, the market analysis model developed by
Edward S. Mason and formalized in the 1950’s by Joe Bain (1959) (SCHERER, ROSS,
1990).
In the SCP model, the firm is seen, firstly, from its external components, both regarding offer
(mainly technology) and demand (price-elasticity), which determine the structure of the
market in which it is inserted. The structure, encompassing the characteristics of market
6 The RBV entails several ramifications and concepts, such as: “dynamic capabilities” and “core competencies”. This work aims to approach the “Pure” RBV, or the traditional Chicago-UCLA approach, originated in Barney (1991) and Peteraf (1993).
organization (number of firms, absolute and relative size and entry barriers), determines the
conduct or the practices of the firm, notably its price, production and advertising strategies
(besides R&D expenditures and investment plans). These competitive practices result in the
firm’s performance.
The SCP model interprets results in terms of social well-being and possesses two key
variables: (a) Allocative efficiency, which means prices equal to the marginal cost of
production, so that consumption levels can be viewed as socially desirable; and (b) Technical
advances, which refer to the competitive ideal. Competition would lead to a decrease in profit
rates, motivating firms to innovate constantly in order to obtain monopoly rents, even if
ephemeral.
Figure 1 -Structure–Conduct–Performance Model
Source: SCHERER; ROSS (1990, p. 5)
Supply localization of raw material; technology;
product durability; value/weight; attitudes in Business; unionization.
Structure numbers of sellers and buyers; product
differentiation; entry barriers; cost structure; vertical Integration; diversification.
Conduct price determination; product strategy and
advertising; investment in plants; legal tactics; R&D.
Performance allocative efficiency; technical progress; full
employment; equity.
Demand price-elasticity; substitute goods; demand
growth rate; cyclical and seasonal character; purchase methods; types of
commercialization.
As this research line developed, the reality of the markets started to chip away at the
deterministic character evoked by SCP. Possible feedback effects of the internal components
of both the structure and conduct of the industry were introduced, so that they could reflect
the relations of causality and allow a dynamic view of the firm’s development. Individual
efforts of the firm while engaging in R&D activities and product differentiation contribute to
transform the competition pattern in a given industry.
Even though the theoretical tools of IO clearly presented strategic implications for the firms,
its constructive proposal was nevertheless centered in public policies, particularly those
relative to the regulation of non-commercial sectors. For this reason, the field of Industrial
Organization failed to develop arguments of interest to managers. Still, its research on
industrial sectors brought important advances in understanding the competitive strategy.
In the 1960s, business schools started to integrate the management theory 7 with the IO
theory. At Harvard Business School, Ken Andrews and Roland Christensen introduced the
competitive environment in the managerial analysis of the firm, at a time when such analyses
were centered in individual actions such as marketing, production and finance. In other words,
the managerial analysis still moved in opposition to IO, attributing a successful performance
of the firm to managerial capabilities. The work of Andrews and Christensen incorporated
economic analysis tools and proposed that managers should examine the firm’s economic
environment, determine the essential characteristics of the industrial sector, observe their
development and trends, and evaluate their future opportunities and risks (MONTGOMERY;
PORTER, 1998).
Therefore, the origin of the concept of competitive strategy is based on the relation between
the firm and its surrounding environment (external environment) which, if on the one hand
represents a restriction to the activities of the firm, on the other, offers opportunities to be
explored. Thus it was this relation between the organization and its external environment
(industry) that brought sense to the concept of strategy (ANSOFF, 1965; KATZ, 1970).
7 The so-called Management Theory is characterized by a strong emphasis on the practical aspects of administration. It seeks to develop concepts in a practical manner, which is normative to administrative action.
Several years later, a host of authors, chief among whom were Chandler (1998) and Porter
(1985, 1986), gave further thrust to this line of thought, which incorporated economic analysis
in its formulation in a systematic manner, in particular the tools of the IO theory.
Although the focus of the latter is more centered in the competitive environment than in
firms’ strategies, the economic analysis contained in the model served as an analytical
instrument for Chandler’s work, which demonstrated, through a historical analysis, the
relations between corporate strategy and organizational structure. In his book “The enduring
logic of industrial success “(1998), Chandler (p. 272) concludes that dominant companies are
those whose founders and senior executives understood the logic of growth and competition
that drives modern industrial capitalism. For him, "the logic of managerial enterprise begins
with economics—and the cost advantages that scale and scope provide in technologically
advanced, capital-intensive industries”.
Porter’s model, considered to be a landmark work in strategic planning analysis, is also
methodologically founded on IO. Porter (1985, 1986) argues that entrepreneurs create and
capture value while choosing a strategic positioning vis-à-vis the forces that shape the
structure of the industry. For Porter, there are competitive forces that are more important than
rivals established within a given sector. Such forces arise from clients, suppliers, potential
entrants and substitute products. All these agents are competitors who may be more or less
relevant or active, depending on the industrial sector in which they are inserted. These forces
make the so-called “Porter’s Diamond” and determine, in the long run, the profitability of
firms pertinent to a given industrial sector.
In rescuing Bain’s contribution, Porter (1998) states that one of these forces is influenced by
many factors, the most relevant of which are the economic barriers to entry. The six major
sources of economic barriers to entry that he identified are: (a) Scale economies, which act as
a barrier to new entrants by forcing them to either compete on a large scale, or accept a cost
disadvantage; (b) Product differentiation through brand, which forces new entrants to spend
time and money to gain customer loyalty to existing brands; (c) The need for high
investments, which create barriers, particularly if resources are required for irrecoverable
expenditures (such as publicity and R&D); (d) The disadvantages of costs independent of
size, which appear from learning curves, proper technology, access to better sources of raw
material, favorable location, government subsidies, among others; (e) Access to channels of
distribution: New products have to fight for space or dislocate others in the distribution
channels. At times this barrier can be so high that entering companies have to create their own
distribution channels; and (f) Government policy which, by regulating the market, either
prevents new companies from entering industries through licensing requirements, or favors
those already established through subsidies.
Thus, once the sectoral structure within which the firm is inserted and the way this structure
changes over time are known, the competitive strategy can be built. Therefore, the task is to
examine each competitive force and forecast the magnitude of each underlying cause so as to
build an image of probable profit potential of the sector.
Competitive strategy is, therefore, the search for a favorable competitive position in an
industry, the fundamental arena in which competition occurs. In other words, competitive
strategy aims to establish a profitable and sustainable position against the forces that
determine competition in industry.
SPA proposes three different types of strategic positioning for firms: (a) Cost leadership,
which consists of keeping prices below competitors’ and generating a barrier to new entrants;
(b) Differentiation, related to the positioning of a product deemed by clients as unique in its
industry, allowing firms to charge a premium price, and thereby enjoy a higher margin than its
competitors; (c) Focus, which presupposes that a firm concentrates on a particular segment
(target) more efficiently or efficaciously than its rivals. The focus-positioning strategy may
have several dimensions, such as a group of clients, a line of products, a distribution channel
or a geographic area. Each of these strategic positionings must be sustained by relations
among the agents in the supply chain to which the firm belongs (PORTER, 1980, 1985).
In taking the rural segment as the object of analysis, the application of Porter’s proposal of
strategic positionings is no simple task, particularly when it refers to small-scale firms. Cost
leadership in this segment always has the appeal of using family labor, which would indicate
competitive gains for the production of more labor-intensive goods if compared to more
technified ones. As for differentiation, the agricultural firm, individually, experiences
significant difficulties to make this type of strategy work. It is practically impossible for an
agricultural firm to modify the demand curve of its product so as to make its consumer loyal
to it regardless of price variations, even small ones. Differentiation, however, can be thought
of as being based on three strategies: (a) Vertical integration: the rural segment starts to
produce a processed good with a brand; (b) Contracts: the rural segment contracts with a
processing firm to produce a good with a brand; (c) Joint actions: a group of producers
explores differentiation characteristics of a given region. The focus strategy, in the case of
agricultural production, bears a strong relation with joint actions. The relations between
strategies and the rural segment, as well as their consequences in terms of value creation, will
be further examined in Part 2.
It is worth highlighting that, according to Porter’s view, the strategic analysis orients
entrepreneurs to obtain monopolistic rents. Thus it presupposes that, while considering the
industry structure, managers can strategically format and explore market features aimed at
creating market power (or building barriers to rivals) thus preventing (or mitigating) the action of
competition forces (ANTÓNIO, 2001; NICKERSON, 2003). In the words of Foss (2005, p. 3),
“The core model of the Porter approach is the good old monopoly model”, as portrayed in Figure
2.
Figure 2 - Classical Monopoly Model and Competitive Advantages in the SPA
Mp
Monopoly profit = source of competitive advantage in the SPA APE
MgC
MgC
MgR
Demand
Notation: Mq = monopoly quantity; Pm = monopoly price;
MgC = marginal cost; Rmg = marginal revenue.
The SPA became dominant in the field of strategy, particularly in the 1980’s, and was shown
to be particularly useful, according to Davis and Eisenhardt (2004), in markets with a well-
defined industry structure, with clearly recognizable defense positions and when there is enough
time to build positioning strategies and explore them. Nevertheless, these authors pose that SPA is
not adequate to analyze markets whose industrial structure is in transformation, insofar as, within
this context, the strategic positioning that generates more value may not exist or may be, a priori,
difficult to measure.
Thus how can managers chose a specific strategy when there is no method to evaluate or at least
contrast alternative activity systems and their organization forms? For this reason Nickerson
(2003) argues that SPA is not enough to answer about which activities should be carried out by
the firm (i.e., internalized) and which should not. Moreover, the history of firm decisions, i.e., the
trajectory adopted and the dependencies it generates (path dependence) do not matter in this
approach.
Bridoux (2004) adds two more criticisms of the SPA. The first refers to the unit of analysis.
Due to the fact that this unit is the industry rather than the firm, a clear difficulty is observed
in identifying the reasons accounting for the different performances among firms within the
same industry. The problem is that, empirically, a given degree of concentration of an
industry may harbor varied distributions of sizes of firms. Or, in other words, even if a
positive correlation is accepted between degree of concentration and excessive profits within
an industry, not all firms of a concentrated industry share excessive profits equally among
themselves.
The second criticism made by Bridoux (2004) concerns the focus of the SPA on competition
rather than on cooperation. His analysis of the relationships with consumers, suppliers and
rivals is conducted only in light of the conflicts arising from the search for monopoly profits,
without approaching the emergence of cooperation among the agents.
Langlois (2006) also presents a critical view of SPA, based on the historical analysis of the
industrialization process. He points out that the so-called Third Industrial Revolution, or
Electronic or Information Revolution, requires a different interpretation that that provided by
the SPA, particularly by the Chandlerian one, which attributes to economies of scale and
scope the main factors of success of firms. Langlois defends that the movements of the
Electronic Revolution—which more recently involve computers and the Internet—act to
decrease the role of multi-divisional firms as generators of innovation and creators of
economic capabilities. The author does not deny the existence of large firms in the so-called
“new economy”, which aggregate knowledge in economies of scale and scope, but observes
that these firms are less vertically integrated than the “old” firms of the Second Industrial
Revolution. He also argues that the development of knowledge occurs on different bases: less
related to meeting specific demands and more associated with the way learning takes place
within organizations, making scale and scope less of a priority for a firm’s success.
Teece entertains the same appreciation (1997). While dealing specifically with knowledge assets,
he asserts that the competitive advantages of firms in the New Economics do not arise from their
market positioning, but from the difficulty of replicating such assets. The dimension of
development encompasses both strategic and managerial elements and may be in the domain of
individuals, research laboratories or autonomous business units. Such dimension does not require
a complex organization; on the contrary, it may take place in small organizations.
Although the criticism made by Langlois (2006), Davis and Eisenhardt (2004) and Teece
(1997) do apply to sectors of the new economy, learning can, however, become an important
means to obtain competitive gains, particularly for the object of analysis of the present
research—small-sized rural firms, which cannot count on gains of scale. The reason for that is
that gains of scale do not belong in the set of viable strategies. The discussion of competitive
advantages based on the creation of resources, among which knowledge, will be presented
next.
1.2 Focus on the market of factors: a Resource-Based View (RBV)
From the observations of the strategies of large international corporations, Prahalad and
Hamel (1998), in their article titled “The Core Competence of the Organization”, claim that in
the short run, a company’s competitiveness derives from the price/performance relation.
Nevertheless, they admit that, in the long run, there is a convergence toward similar standards
for product cost and quality, implying that competition barriers would have little importance
as sources of differentiated advantages. On criticizing SPA, these authors argue that in the
long run, competitiveness derives from an ability to build, at lower cost and more speedily
than competitors, the core competencies that create products/services impossible to be
anticipated by competitors. “The real sources of advantage are to be found in management’s
ability to consolidate corporatewide technologies and production skills into competencies that
empower individual businesses to adapt quickly to changing opportunities” (p. 297).
With the emergence of the RBV, initiated by Wernerfelt (1984) 8 Rumelt (1984), Barney
(1991), Peteraf (1993) and Conner (1991), the strategic approach presents a new version that
looks at the firm and not at the industry, as proposed by the SPA. Though recent, the rapid
acceptance of this new approach in the mid 1980’s, according to Foss (2005), is mainly due to
the lack of evidence that monopoly power is an important source of profit.
In fact, in the 1980’s, the Theory of Contestable Markets brought trenchant criticisms of the
argument that monopolist rents are a sine qua non result of concentrated structures. Proposed
by Baumol, Panzar and Willig (1982), the theory predicts that, regardless of the structure, a
market (or a monopolistic firm) will be perfectly contestable when potential competitors are
able to prevent the adoption of practices of extraordinary prices by firms (or monopoly )
established in the sector.
The RBV focus is on the factors market rather than on the products market (SPA’s focus).
Inspired by Penrose’s (1959) “The Theory of the Growth of the Firm”, RBV argues that the
main origin of a firm’s competitive advantage is the possession of strategic resources. For the
8 The literature on VBR recognizes that Wernerfelt was the first author to introduce this approach inspired in the works by Penrose. In his 1984 article, “A Resource-Based View of the Firm”, Wernerfelt characterizes the firm as a collection of resources. This text was later selected as the best article published by Strategic Management Journal, in that year (ISHIKAWA, 2006).
author, the firm is an administrative unit that manages the set of tangible and intangible9
resources necessary to produce goods and services. Managers have an image of the
environment and of the result of the external resources to be used. This image is built by
means of a learning process and determines the change in the collection of productive
opportunities of the firm. Or, in other words, the firm is a collection of knowledge resources,
which are involved in routines and processes.
Resources are, therefore, what enable the firm to reach its objective of gaining sustainable
competitive advantages. The firm uses resources to conceive and adopt strategies, which will
determine its weaknesses and strengths. Thus advantages appear because firms develop or
acquire a set of resources that are superior to those of their competitors (WERNERFELT,
1984).
It is worthwhile noting that some authors make a distinction between resources and capacities
or capabilities, the latter referring to abilities based on human competencies and the former to
any other assets.10 In line with Barney and Peteraf’s definition, the concept of resources, in
this present work, is used so as to encompass both resources and capabilities.
According to the RBV, the essence of the firm, therefore, is its ability to create, transfer,
reunite, integrate and explore these resources. Such resources will be used in a distinctive
manner in each organization, in consonance with the different perceptions and strategies of
administrators. And therein arises the heterogeneity of the firms, and, consequently, different
profitability among them.
It can be thus inferred that the main sources of the different profitability among firms set at
the equilibrium level arise from rents in the Ricardian sense11, i.e., as return in excess of a
9 For a definition of resources, see Castro (2004). 10 Concerning the terminology, the pertinent scientific literature in this area has been very prolific. Prahalad and Hamel (1990) adopt the concept of core competence, which consists of collective learning and the coordination of the different competencies in the organization. Langlois (1992) uses the term capabilities. Teece, Pisano and Shuen (1993) define dynamic capabilities as the key assets of a firm. There are also authors who use the term knowledge-based view (KOGUT; ZANDER, 1992). Scholars using these nomenclatures have the same perspective and similar approach (ANTÓNIO, 2001, NICKERSON, 2003). 11 The concept of monopoly rents derives from the works of David Ricardo, The Principles of Political Economy and Taxation from 1981. In his analysis of agricultural production, Ricardo observed that land is a fixed production factor that cannot be quickly increased in response to a demand increase. Thus, the price of the
resource owner's opportunity cost. Or, in other words, economic rents in efficient firms are
assumed to derive from scarce inputs and are enabled by the imperfections of the factors
market. Imperfections arise from managerial abilities, the unique language used within the
firm and from the firm’s organizational culture. They also arise from fixed assets and
innovations, protected by patents or organization competence or intangible assets such as
consumer’s trust, brand image and reputational capital. Barney and Arikan (2001) argue that
these production factors are perfectly inelastic, since their qualities offered are fixed (unique)
and do not respond to changes in prices.
Figure 3 illustrates advantages of ricardian rents, in terms of the conventional supply and
demand curves. Firm 2 also obtains sustainable competitive advantages from non-imitable
heterogeneous resources with greater efficiency. To that end, there should be ex-ante
immobility and barriers. However, should there also be ex-post barriers, the firm can
appropriate above normal rents. Barney and Arikan (2001) point out that at least two events
might threaten a higher performance of Firm 2: (a) a shift of the demand curve to the left and
down; and (b) if the firms of the industry found new ways to reduce their prices. For instance,
considering the monopoly of fertile lands, the use of new fertilization techniques and/or
higher productivity cultivars might reduce costs, thereby neutralizing a competitor’s strategy.
Figure 3 - Ricardian Rents
agricultural product will be determined by the land offer and its fertility. The higher the fertility, the higher the income for the producer who has fertile land. It is worth noticing that for Ricardo, while the producer would obtain the competition price, the rent would be destined to landowners (rent-seekers) who have no participation in production. Producers would only get the rent if they owned the fixed resource (land) (RICARDO, 1985).
Abbreviations: MgC = Marginal cost; AC = average cost; p = competitive price; q = quantity.
Barney and Arikan (2001) ponder that economists have traditionally assumed the existence of
few production factors with inelastic supply. Most economic models presuppose that if prices
increase to a certain factor, offer reacts positively, ensuring normal profits. For the RBV,
however, several resources used by the firm have highly elastic supply and originate
economic rents. For instance, in the case of labor, though its offer is not inelastic, creativity
and ability are so. In the agricultural segment, one productive unit, even if inserted in a
competitive market, could differentiate when benefiting from unique natural resources (source
of water, for instance) or even from specific learning.
Firms, therefore, control a set of a set of productive resources, which vary from firm to firm.
A resource may be valuable in a specific firm at a specific moment, and yet not be in another
industry or in a different temporal context. The heterogeneity of resources among firms
occurs due to several factors, those standing out being the tacit knowledge involved and the
impossibility of using it in an isolate manner, since its value may be related to its connections
with market forces.
Barney (1991) is one of the authors of reference in this approach. His analytical model is built
based on the foundations of the economic theory. According to him, the starting point to gain
sustainable competitive advantages is the adoption of a value-creating strategy that involves
Industry at competitive equilibrium
Firm 1 Firm 2
MgC MgC
AC
AC
Demand Offer
q q q
(a) Market offer and demand
(b) Firm 1’s performance with trivial resources
(a) Firm 2’s performance with higher, non-imitable
efficiency
p
resources which are not simultaneously used by current competitors or when firms are
incapable of duplicating the benefits of this strategy. If strategy is the analysis unit, for
Barney, the adoption of an exclusive strategy in the product market is a necessary condition
for the firm to obtain sustainable competitive advantages.
To understand the origins of sustainable competitive advantages, Barney builds a theoretical
model standing on two assumptions: (a) Firms in the industry are heterogeneous regarding
strategic resources that they control, and (b) resources do not have a perfect mobility, which
may mean the perpetuation of heterogeneity for quite a length of time. Given that there is no
perfect mobility because not all external factors of the firm can be acquired on the factors
market, the possibility of the creation of economic rents appears. Therefore, the heterogeneity
of resources is sustainable if there is not perfect imitability or transferability 12 (BARNEY,
1991; BARNEY; AKIRAN, 2001).
Barney (1991) distinguishes two kinds of resources from the strategic viewpoint. The first
type concerns those that do not create sustainable competitive advantages because they are
abundant, accessible to all, imitable, substitutable and relatively easy to be negotiated on the
market. Those that allow the company to acquire sustainable competitive advantages due to
the fact that they are: (a) Valuable, in the sense that they allow exploring the opportunities
and/or neutralizing threats of the environment external to the firm; (b) Rare, regarding current
or potential rivals; (c) Imperfectly imitable, like the commercial secrets, specialized
productive equipment and employees’ accumulated experience; and (d) Non-substitutable.
Firms that control rare and valuable resources have competitive advantages, but for the firm to
obtain sustainable competitive advantages resources they need to be inimitable (or costly to be
imitated) and non-substitutable (BARNEY; AKIRAN, 2001; FOSS, 2005). In other words,
Barney suggests that if the factors market is always perfectly competitive, it is impossible for
the firm to capture economic rents. Barney’s analytical structure is shown in Figure 4.
12 Thus, efficient firms can sustain this type of competitive advantage only if their resource cannot be expanded freely or imitated by other firms (PETERAF, 1993, p.181).
Figure 4 - Sustainable competitive advantages in Barney and Peteraf
Source: FOSS, 2005, p. 64.
Foss (2005) observes that the relations between heterogeneity and non-mobility of resources
and the four conditions to obtain sustainable competitive advantages shown in Figure 2A are
not clearly explained in Barney’s model. The reason for that is that if the four conditions were
present, non-mobility and heterogeneity would also be obtained. However, as Foss posits, the
four conditions are not all necessary, whereas non-mobility and heterogeneity are. In other
words, having valuable, rare and costly-to-imitate resources does not ensure the attainment of
sustainable competitive advantages, whereas if resources meet the criteria of non-mobility and
heterogeneity then competitive gains will be obtained.
Using an approach different from that of Barney, Peteraf (1993) assumes the analysis unit of
individual resources within a firm, and not that of strategies (FOSS, 2005; ISHIKAWA,
2006). This author specifically examines the conditions of resources that ensure sustainable
competitive advantages, i.e.: (a) Superior resources (heterogeneous within the industry), so
that the firm can generate efficient rents (or profits); (b) Ex-post limits to competition, so that
the rent is not eliminated by competition (presupposing difficulty of imitation due to the
possession of a set of efficient resources); (c) Non-mobility of resources, which allows the
Valuable Rare
Non-imitable Non-replaceable
Heterogeneous
Non-mobility
Ex-post barriers to competition
Ex-ante barriers to competition
Sustainable competitive advantage
Sustainable competitive advantage
(a) Barney’s structure (1991) (b) Peteraf’s structure (1993)
appearance of differential rents; (d) Ex-ante limits to competition, meaning that the market of
factors is not appropriating all the rent generated (Figure 3B).
The comparison of Barney’s and Peteraf’s approaches leads Foss (2005) to the questioning of
whether RBV is a theory dealing with sustainable competitive advantages in equilibrium in
terms of exclusive strategies in the product market (Barney’s proposition) or in the sense of
differential rents/profits (Peteraf’s proposition), or even both. This issue has special interest,
insofar as Barney’s approach—exclusive strategy—does not necessarily imply gains of rent in
equilibrium (Peteraf’s approach) and vice-versa.
Foss (2005) points to the limits of Barney’s perspective based on two examples. The first
concerns an industry in which not all firms use an identical strategy. In this case, by virtue of,
for instance, a learning advantage, an industry leader will have SCAs despite not having an
exclusive strategy. In other words, a firm will have SCAs if it is more efficient in some activity
of value creation than its current or potential competitors. It can thus be inferred that the criterion
of a single strategy, proposed by Barney, does not need to be met. The second example is about an
industry in which the firm adopts an exclusive strategy. If this strategy involves resources
acquired in a competitive and informationally-efficient market of factors, the firm will not gain
SCAs. That accords with Peteraf’s view, but not Barney’s.
Given that the central issue for the RBV is to explain long-term performance differences in
terms of the presence of efficient rents in conditions of competition, Peteraf’s approach has
more consistent elements for the analysis of value creation.
Combs and Ketchen Jr. (1999) ponder that a firm’s ability to hold resources that have the
criteria presented by Peteraf and Barney also depends on the characteristics of the industry
affecting the value of the resources. Brand reputation, for example, can be more valuable in
an industry that produces goods of experience or belief, than in one whose quality can be
determined before the purchase. The commentary of both authors shows the importance of the
complementarity between the RBV and the SPA views for the definition of the firm’s
strategies, as shall be seen in Chapter 2
Williamson (1999), Nickerson (2003), Barney and Arikan (2001), Argyres (1996) and Priem
and Butler (2001a, 2001b) make us reflect on the predictive power of RBV and its
tautological and non-formal nature. The authors argue that RBV’s proposition that resources
that are rare and costly to be replicated are important to generate rents says little about which
resources should be placed together—and how—so as to create and capture value. According
to the authors, the way the approach was built does not generate empirical predictions.
Explanations about sustainable advantages are always ex-post.
Moreover, RBV advocates the benefits of hierarchy without dealing with the costs involved in
the governance mode, which makes it impossible to foresee which one (market, contracts or
hierarchy) promotes more value creation. A rare resource, for instance, can translate into
services and products with little value or be so costly to govern internally that the firm would
ultimately capture little value. That means that it is difficult to create testable hypotheses
because this theoretical contribution only allows knowing ex-post the cause of the firm’s
success and/or the reason of its limit (FOSS, 2005). Priem and Butler (2001a, 2001b) go
beyond, stating that RBV does not predict, has no prescriptive power over what conduct firms
should adopt to attain competitive advantages 13.
Another hitch in the theory regards the analysis unit. Foss (1998) argues that some authors
adopt the individual resource as the relevant analysis unit. Nevertheless, this choice can only
be legitimated if the relevant resource is sufficiently well-defined and free from interrelations,
a rare thing to happen in practice.
Finally, the negligence of the external environment does not allow RBV to predict if the
competitive value of a resource can be eliminated or enhanced through external changes, such
as technology or competitors’ or consumers’ behavior. In other words, in situations of
significant uncertainties it becomes difficult to predict what combination of resources would
be valuable, rare, difficult to imitate and non-substitutable (DAVIS and EISENHARDT,
2004).
13 To define a strategy based on resources, consultants recommend that the firm identify and assess its resources base don intuitive tests, such as: “(a) Inimitability: is the resource difficult to copy (imitate)? (b) Durability: how fast does this resource depreciate? (c) Appropriability: who captures the value created by the resource? (d) Substitutability: can a unique resource be replaced by a different resource? (e) Competitive superiority: which of the resources is really the best?” (ANTÓNIO, 1996, p. 14).
The external environment is not contemplated in the analysis when resource creation is
considered based on horizontal and/or vertical cooperation. Ricardian rents can be generated
not only due to the ability to explore resources internal to the firms, but also based on
interactions among firms, an issue not explored by the SPA approach. Vertical cooperation,
whether through relational or formal contracts, allows generating and exploring values that
extrapolate the limits of the firms. Besides that, firms, embedded in the same business can
sustain relations among themselves based on a mixture of collaboration and competition,
making a category of analysis called networks. The main characteristic of networks is that
each firm has an integral part that depends on resources controlled by another one, and joint
gains can be attained while sharing these resources (DIEDEREN; JONKERS, 2001,
LAZZARINI; CHADDAD; COOK, 2001).
The next item aims to discuss the logic underlying the relations among the agents in the supply
chain to bring to light some issues not approached by the SPA and RBV.
1.3 Focus on coordination: Transaction Cost Economics (TCE) CE) The contributions of the economic theory to the field of strategic entrepreneurial analysis also
stem from the need to understand the nature of the firm. This approach, embedded in the
research line of Economics of Organizations (EO), is focused on identifying actions that
minimize governance costs, which leads to the maximization of firms’ performance.
The framework from EO known as Transaction Cost Economics (TCE) 14 appeared with
Ronald Coase, who, in his famous 1937 article, “The nature of the firm”, introduces a new
perspective to the understanding of entrepreneurial strategies, when he shows that there are
costs to using the market mechanism. In the article, the authors criticize the view of the firms
as a function of production, arguing that the firm is an organic relation among agents that
becomes effective through explicit contracts, like labor contracts, or implicit, like formal
partnerships. Coase shows that transaction costs are one of the most important factors shaping
modern economic relations in society.
14 Another view deriving from the efficiency framework of EO is the Theory of Agency.
A transaction revolves around the property right of the commercialization of a product or
service when this is transferred through an interface that is technically separable. The
transaction costs are the costs of changing, capturing and protecting property rights and
depend on the following factors: (a) contract elaboration and negotiation; (b) measurement
and enforcement of property rights; (c) monitoring of performance; (d) organization of
activities; (e) adaptation to changes in the economic system; (f) monitoring of transactions;
and (g) monitoring of the performance of the agents involved (MILGROM; ROBERTS,
1992).
To understand the importance of the transaction costs, it is observed that if they were null, the
problem of creating and protecting value would not exist. All governance structures in
transactions (market, contracts or hierarchy) would be good. The strategic action would be
trivial, i.e., the question to be asked would be, “What is the best way to generate rents, given
the conditions of the firm?” Besides, there would be no managers, since there would be no
problems regarding coordination and motivation.
However, when transaction costs are introduced (i.e., the market has failures) property rights
are not perfectly protected. Their protection becomes a costly activity. Resources will be spent
to appropriate property rights, therefore values are dissipated. Both managers and strategy
start to have a role to play: to create value while creating governance structures aimed at
reducing transaction costs.
The use of this theoretical framework in strategic planning is recent. As the strategic problem
consists in defining mission, scope, form and structure of a firm, the analysis of transaction
costs helps to assess whether the firm will depend on market suppliers, long term relations
with clients and suppliers, strategic alliances or vertical integration.
The firm arises as an optimized response from economic agents, when the costs to organize
activities via the market exceed internal transaction costs. Thus, decisions concerning the
minimization of transaction costs determine the boundaries of the firm.
Transaction costs are associated with the behavioral presuppositions of the model, i.e., limited
rationality and opportunism. Limited rationality indicates that individuals are rational, and
seek the maximization of satisfaction and profits, but are limited by informational problems.
In this sense, instead of an optimum response, the agent adopts the best decision possible,
given his or her limited knowledge. Opportunism is understood as self-interest seeking with
guile. It is observed that TCE adopts a connotation different from that of traditional IO,
which, though assuming the self-interest of the economic man, the latter will comply with
contracts and act according to what has been contracted (WILLIAMSON, 1985).
Incomplete or limited information may give rise to opportunistic actions: agents may use
privileged information for their own benefit. Also, not predicting all contingencies may result
in changes that enable gains from opportunistic actions. That creates potential for hold-up15,
the main determinant in the adoption of hybrid structures aimed at reducing value dissipation
in the Williamsonian view of TCE (WILLIAMSON, 1985; 1996; KLEIN; CRAWFORD,
[year?]; ALCHIAN, 1978).
In this sense, in Williamson’s view, TCE includes, besides the ex ante transaction costs of
making, negotiating and registering sale or service contracts among firms, ex-post costs,
which play a key role in defining firms’ strategies. Such costs are incurred to monitor
contracts and defend the interests of the parties involved when the terms agreed on ex ante are
not honored (WILLIAMSON, 1985). As agents will not presumably be able to predict and
process all alternative and future conditions concerning contracts, it is possible to conclude
that contracts are incomplete. Thus only the possibility of opportunistic behavior is enough to
justify the inclusion of safeguard clauses in contractual relations.
Williamson (1985) identifies three attributes of transactions that can guide decision-making
concerning the governance structure: (a) Frequency of transactions: the more frequent the
transactions, the lower the average fixed costs associated with information acquisition and
contract elaboration, as well as the easier to impose losses to transactors to avoid
opportunistic behavior. In other words, there is a higher probability that the partners will 15 Hold-up means that when one of the parties in a contractual relation forces the renegotiation aimed at appropriating quasi-rents resulting from investments made by the other party, which is possible due to the fact that the contract governing the relationship is incomplete (KLEIN, 2000, p. 124).
develop reputation, thus limiting opportunistic behavior; (b) Uncertainty: the higher the
uncertainty, the more complex becomes the development of long-term partnerships and the
higher the probability of misunderstandings in the recontrating phase. Uncertainty arises from
changes in the economic environment and the consumers’ preferences, and also due to the
complexity of the economic environment that hinders a precise evaluation;. (c) Asset
specificity: firms upstream or downstream the supply chain made investments to support a
particular transaction whose exchange value is higher when the transaction occur within
these firms than with others (PERRY, 1989).
In other words, specific assets, which may be tangible or intangible, are irrecoverable (sunk
costs) in the sense that the principal cannot be returned by the market if the relation is
discontinued (WILLIAMSON, 1985; KLEIN, CRAWFORD and ALCHIAN, 1978, p. 298).
The higher the asset specificity, the bigger the loss associated with an opportunistic action of
the other agent. If assets are not specific, transactions among agents can happen via the
market. As the level of specificity increases, transaction costs grow, making the governance
structure market inefficient. Vertical integration shall be more advantageous in the shape of
the market, as the specificity levels increase.
Picture 1 relates the attributes of the transaction with the hiring process. If agents have total
rationality, but are opportunistic, the elements pertaining to hiring are solved ex-ante, i.e.,
contracts are complete (or all contingencies are foreseen) and planning is a proper way for the
parties to relate. The presence of limited rationality and asset specificity, without
opportunism, require only the promise between parties for the hiring to be efficient. If there
are specific assets in the relation, and agents have limited rationality and opportunism, the
hiring process will lead to hybrid governance structures (contracts or hierarchy). That is when
what Williamson calls fundamental transformation occurs, in which case the identity of the
parties matters. When there is absence of specificity, even with the presence of opportunism
and limited rationality, hiring via the market is efficient, since assets are not exclusive of a
given transaction. Thus, in the light of the Neoclassical Theory, it is necessary to presuppose
the non-existence of specific assets.
Picture 1 - Attributes of the hiring process
Bounded rationality Opportunism Asset specificity Hiring process
0 + + Planning
+ 0 + Promise
+ + 0 Competition
+ + + Hybrid governance
Notation: “+” indicates presence of attribute, and “0” indicates absence of attribute.
Source: WILLIAMSON (1985, p.88)
The presence of specific assets creates quasi-rent, defined as the difference between the value
generated in the specific activity and its best alternative use. For this reason, the quasi-rent
reflects the decisions to exit a certain transaction. It is the portion in excess to alternative uses
that prevents agents from discontinuing the transaction. Thus, when specific investments are
made, exit costs are created, and thereby quasi-rent becomes an object of dispute between the
transactors (MILGROM and ROBERTS, 1992) 16.
Therefore, the decision of the quasi-rent between the agents in a contractual relation is one of
the key PIVOTS in negotiation disputes. That happens because it is impossible to specify
clearly in the contracts the division ex ante, since not all pre-contractual contingencies can be
foreseen.
Klein; Crawford; Alchian (1978) and Williamson (1996) argue that opportunistic behavior is
particularly favored in situations in which there is a large amount of surplus to be divided ex
post. That would happen because the contractual counterpart may try to capture the quasi-rent
generated, mainly if it counts on a higher bargain power, whether arising from economic or
informational reasons. In other words, the agent that invested in specific assets may not only
remunerate its opportunity cost but also be a hostage in the transaction, due to the exit costs.
It is worth observing that, according to Klein; Crawford;Alchian (1978, p. 298-299), the
appropriated quasi-rent is not confused with monopoly rents in its usual sense, i.e., the
difference between the value of a protected asset and the value it would have on an open
market. The appropriation of the quasi-rent can happen on an open market or even without
16 Income refers to the decision to enter
restrictions to the competition of rivals. Should there be open competition with free access to
the market, the specialization of the asset invested for a certain user (or more precisely, the
high cost of making it accessible to others) creates quasi-rent, but does not generate monopoly
rent or market power. At the opposite end, an asset can be transferable without costs to
another user and without any reduction in its value, whereas the entry of similar assets is
restricted. In this case, the monopoly rent would exist, but not the quasi-rent. Thus, it is not
about the usual monopoly created by governmental restrictions to entry either of a single
supplier, or a highly concentrated supplier. Due to mobility and transaction costs, market
power will exist in situations not commonly called a monopoly. There may be several
potential suppliers of a specific asset to a specific user. Nevertheless, once the investment is
made, the asset may be so specialized for a user that the monopoly or monopsonic market
power (or both) are created.
It is seen, therefore, that in the dispute over the division of the quasi-rent ex ante, there may
be a repositioning of the parties in the future, thereby allowing hold up.
Such a situation may be observed in Figures 5 and 6, which show the negotiation between
firm A (selling a good that requires specific investments) and firm B (buyer of this good).
Figure 5 shows the first negotiation round. The decision to enter the business depends upon
the relation between the specific investment firm A needs to make to enter the business and
the estimate of value it will receive by the final product from firm B. Because firm A needs to
make specific investments to enter business, this entry will depend on whether the price to be
received from firm B is within the negotiation zone, i.e., the price must be higher than or
equal to its reserve price. It is worth observing that as the investment specific to the relation
has not yet been made, the producer may take that cost into account to enter the business.
Any price between v (seller’s reserve price) and c (buyer’s reserve price) leads firm A to produce
the product. This solution set is known as the core of the game. In a game involving two
people there is a pattern solution developed by Nash, called Nash’s Bargain Solution (x*).
This solution divides the surplus in two equal parts (LIPPMAN, RUMELT, 2003). It is worth
Seller´s reserve price
Negotiation zone
Currency units X*
v C
Buyer’s reserve price
noting that this case uses a simplifying assumption according to which both parties invested
equally in specific assets thus creating a bilateral monopoly.
Thusif the marginal product is equal to that obtained under conditions of perfect competition, all
agents receive the marginal product. However, should the added value or marginal product be
higher, there would be a surplus to be divided between both parties.
Figure 5 - Negotiation zone and buyer’s and seller’s reserve prices
Source: adapted from Raiffa (1996)
During the following stages of the negotiation, when the firm already has irrecoverable costs
(sunk costs) the maintenance of the relation between firm A and firm B will be dependant
upon the exit costs, once the investments has already been made.
It is, therefore, the presence of investments in specific assets that creates the quasi-rent. The
other party can expropriate this parcel of resource, since the producer becomes hostage to the
transaction and, consequently, subject to opportunism from the counterpart. The division of
the surplus between the parties will depend on the value of option (opportunity cost) offered
to the agent (LIPPMAN, RUMELT, 2003).
Figure 6 illustrates the second negotiation round. As can be observed, firm B will include firm
B’s new reserve price since investments were made during the first round of the negotiation.
As a result, the paid price may be reduced, thus staying below x* (between x* and v’).
Figure 6 - Second negotiation round and quasi-rent
Source: adapted from Antiqueira (2005)
In “Firms, Contract and Financial Structure” Hart (1997) discusses who should keep the
decision residual right: firm A or firm B. Hart argues that the owner of the asset at hand
should hold the residual right of decision. The reason for that is that as the ownership of the
residual control rights influences the decisions about specific inversion, it is considered
efficient that the residual right remains with the asset owner. In other words, in general, the
possession of an asset is identified with the possession of residual control rights over the
same.
Ultimately, thus, it is the strong possibility of a hold-up situation that leads to complex contracts
or vertical integration. The firm appears in situations in which good contracts cannot be written
and in which the allocation of power control is relevant.
Another approach to TCE is that of Yoram Barzel (2002), called Measurement Cost, which is
strongly aligned with the literature on Incomplete Contracts. Based on the notion that goods
have multiple attributes, including different functionalities and services, the economic agents
engage in activities to protect the property rights of the attributes of the resources aimed at
appropriating value. Thus transaction costs are the variable that defines the relevant space for
opportunities to capture (or dissipate) the value of the attributes of a certain good. The degree
to which attributes can be protected depends on how property rights are established
(BARZEL, 1997).
Negotiation Zone
Currency units v c
x* v’
New Negotiation
Zone
The concept of property rights has two meanings embedded: that of a legal right over an asset,
which is guaranteed by the State, and that of an economic right over the asset, which means
the capacity agents have to use (or consume) the asset, obtain revenues or even alienate.
Economic right is characterized by having attributes with a higher measurement complexity,
and, for that reason, they affect directly the value of the assets (depending on transaction
costs). The attributes protected by economic property rights are not perfectly contractable,
therefore they become less defined, jeopardizing the incentive to invest or protect them.
Therefore, besides the hold up, moral risk and adverse selection are examples of other
phenomena associated with the difficulty to protect and preserve the value of the goods.
The most important implication of Barzel’s approach is that there will always be possibilities
to create strategies aimed at capturing on-specified attributes or those difficult to measure.
Thus, differently from Williamson, who defends that the rationality for the existence of the
firm lies in minimizing transaction costs, Barzel sees it as an organization capable of creating,
protecting and dissipating value.
In being so, there is an important distinction between Williamson’s and Barzel’s versions
regarding the issue proposed in this study, i.e., the understanding of SCAs. Williamson’s focus on
the alignment between governance structure and transactions allows an understanding of why
strategies involving idiosyncratic relations lead to complex arrangements among the agents of
certain production systems. Based on his analysis, we can understand that economic profits can
occur in the absence of entry barriers due to market frictions (transaction costs). In other words, it
is possible to obtain SCAs by economizing on transaction costs. That means that, in strategic
terms, governance structures mediating the relations between suppliers and clients will be chosen
so as to obtain gains in coordination (SPULBER, 1999).
Thus, according to Williamson’s view, TCE’s main contribution to strategy is the
incorporation of coordination in the analysis of firms’ performance (and competitiveness).
The more adequate the coordination among suppliers and clients is, (minimizing transaction
costs), the better the adaptation to changes in the environment, the fewer the conflicts
characteristic of supplier/client relation and the higher the capture of value. Besides,
coordination is directly related with strategy, since it is not a characteristic inherent in the
production system, but resulting from a deliberate action of the economic agents.
The cooperation strategy between rivals can also be seen from the view point of the
minimization of transaction costs. Cooperation relations seeking to integrate firms allow the
flourishing of network externalities, and the reduction of negotiation efforts and conflicts.
That means that the average costs decrease and the risk of hold up diminishes to the extent to
there is an expansion of users of the same rules (BROUSSEAU, RAYNAUD, 2006).
For Barzel, on the other hand, the possibility to create and capture value appears from the
agents’ capacity to exploit unknown attributes of goods. Agents would adopt proper
governance structures aimed at capturing the value of those attributes. In the case of the
integrated structure, Barzel (1987) indicates that the sense of integration of the firm—
forwards or backwards—will always be dictated by the activity that is more costly to measure,
so that value is not lost in the production process. Also, for the author, it is the individual who
contributes to the difficult effort of measuring the person who shall take over the position of
entrepreneur, employing and supervising the other parts. In other words, in possession of
residual decision rights, the incentive to act in an opportunistic manner (gaining rent at the
expense of one’s partners) disappears.
The above-mentioned approaches are considered as “negative” views of the boundaries of the
firm, since agents would strategically adopt integration to be protected against opportunistic
behavior in the future. Authors like Langlois (1998), inspired in the ideas of economist G. B.
Richardson from the 1960s, propose that the limits of the firm arise from gains in joint
production, which is seen as the “positive” view of vertical coordination. This way of examining
the limits of the firm allow making a connection between the theory of Transaction Costs and
the neoclassical theory of Production Costs, according to which the logic of the existence of the
firm lies in the productivity gains of cooperative production. That means that the governance
structure adopted would not be associated with the threat of hold up, but to inflexibility of the
specificity of the asset that induces contracting parts to organizational choices that enable the
distribution of quasi-rent ex-post17.
In fact, asset specificity is a key element in allowing the intersection among the three theories
already discussed, as shall be seen ahead. For the moment, it is important to realize that the
presence of a specific asset (or the exploration of new attributes of a resource) in a certain
relation leads, both under the “positive” and “negative” views, to the need for a specific
coordination that will result in the (re)definition of residual property rights with consequences for
the appropriation of the quasi-rent.
1.4 Focus on the entrepreneur’s judgment: Knight’s Theory of Profit (KTP)
The three views presented above have as a common characteristic the analysis focused on
long-term equilibrium. In contrast, a third view on strategy has appeared to deal with the
reality of very dynamic and turbulent markets. This view considers the market in a constant
process of disequilibrium, for which uncertainty has a key role in determining strategies.
One of the best-known authors discussing the role of economic disequilibrium and
entrepreneurial decision making in the economic theory was Schumpeter. In his “The theory
of economic development”, the author states that the entrepreneur is not just any entrepreneur,
but an innovator motivated by the possibility of profit18. It is worth noting that Schumpeter
explains that the entrepreneurial function does not need to incorporate only one person. In
every social setting there is a way to comply with this entrepreneurial function and this can be
done in a cooperative manner, as it happens in large corporations. It is the entrepreneur, or the
17 “In Richardson, it is not the threat of hold-up that leads to integration (or, significantly, to other possible institutional forms, including joint venture). Rather, it is the inflexibility of highly specific assets that leads the contracting parties to choose an organizational form precisely because it allows them to redistribute quasi-rents ex-post.” (LANGLOIS, 1998, p. 192) 18 According to Langlois (2002) in a later work, Capitalism, socialism, and democracy, from 1942, Schumpeter’s concern is with the general concentration process of markets, observed as of the early 20th century, and the role of corporations in the dynamics and development of capitalism. In his work, the author comments that the innovation of the large firms, which have dominated the world scenario as of this period, occurs routinely inside their research centers. For this reason, many authors interpret that there are two Schumpeters, with the ideas in Schumpeter's early writings being really quite different from those in his later work.
entrepreneurial function, that plays the central role in forming new business, through a
process called “destructive creation”.
The innovation process encompasses four cases: (a) extension of the product range; (b)
improved production processes; (c) creation of new markets; (d) conquering of new supply
sources; and (e) the launching of a new organization in the industry, like the creation of a
monopoly position.
A key element of the Schumpeterian approach is uncertainty, since business decisions made
in a world that is full of uninsurable risks (“uncertainty”) will in general produce results that
diverge more or less widely from the expected ones and thus lead sometimes to surplus gains
and sometimes to losses (SCHUMPETER, 1934, p. 66).
The uncertainty presented by Schumpeter also receives a special treatment in the approach
made by Frank Knight (1964), who builds his theory of profit, developed in “Risk,
uncertainty and profit” of 1921.
However, despite the importance given to the concept of uncertainty, both authors diverge
concerning the theoretical premises about the paths leading to value capturing. Schumpeter
defends that the monopoly practices resulting from innovation are what guarantee such rents.
These last until the moment that they start to be dissipated by the imitation of competitors.
For Knight, rents come from the capacity of the firm to allocate resources in a particular
manner, or, put differently, from ricardian rents. Thus, it is possible to state, concerning rent
capturing, that Schumpeter is aligned with SPA or top monopoly rents, whereas for Knight to
RBV, or ricardian rents.
Knight become famous for introducing two fundamental concepts to economic theory: Risk,
defined by the fact it can be estimated since the distribution of the outcome in a group of
instances is known, and uncertainty, which has no estimative since the situation dealt with is
in a high degree unique. This distinction is related to the notion of profit, whose outcome is
the pure residual rent after all contractual payments of the factors used in production have
been paid for. This gain is seen as an irreducible uncertainty affecting all businesses.
Commercial relations can mitigate the effects of the risks, but not those of uncertainty. In this
sense, the logic of TCE, which presumes that contracts are incomplete, is in line with the
Knightian perspective.
It is worth highlighting that Knight recognizes the affinities of his view with that of
neoclassical orthodox economics when stating that in equilibrium all excess returns, i.e., non-
contractual ones, are reduced to zero. In Knight’s words, it will be evident to anyone with a
rudimentary understanding of economic processes and analysis that profit…would be absent
under conditions of equilibrium with ‘perfect competition’ (KNIGHT, 2006, p. 102).
Nevertheless, for him the situation of equilibrium is impossible, being, instead, only a
theoretical model.
The centerpiece of Knight’s analysis is entrepreneurial decision, i.e., effective exercise of
judgment or opinion formation regarding the future, which will guide man’s conduct. The
expectation of profit depends, therefore, on judgment, which is a subjective evaluation or a
belief in the real possibility of gains. For this reason, Knight observes that moments of
economic uncertainty are cases of choice between a smaller reward more confidently reliable
and a larger one, less confidently anticipated. If a man submits himself to a sacrifice in the
present aimed at a future benefit, the expected reward must be sufficiently big to evoke such
sacrifice. If that reward is seen as contingent more than certain, it would have to be
proportionately larger to compensate for the degree of uncertainty anticipated.
Knight’s argument has a relevant and revealing implication for the Economic Theory and the
field of strategy: with uncertainty regarding the future, the firm is able to make positive
profits although it belongs to a long-term competitive equilibrium framework (term that only
exists in theory). The reason for that is that positive profits are earned in disequilibrium.
Disequilibrium therefore, is the space where entrepreneurs flourish, since it is in
disequilibrium that profits can be won (MATHEWS, 2006). This argument is key for the
object of analysis currently at hand. Theoretical models presented in text books deal with
agricultural products inserted in competition structures as mere price takers and serving no
strategic function.
In his article “Industry Structure, Market Rivalry, and Public Policy”, (1973, p. 3), based on
arguments quite aligned with Knight’s, Demsetz considers also that the industry structure is
not determinant of the firm’s performance. He posits that “superior performance can be
attributed to the combination of great uncertainty and plus luck or analytical insight by the
management of a firm”. Demsetz asserts that the cost of information must figure prominently
in the understanding of the theory of the firm. For him,
Even though the profits that arise from a firm’s activities may be eroded by
competitive imitation, since information is costly to obtain and techniques are
difficult to duplicate, the firm may enjoy growth and a superior rate of return for
some time.
Knight understands that at the apex of the uncertainty problem in economy lies the relative
nature of forecasting in the economic process. Two elements arising out of uncertainty are
placed before the entrepreneur (or the firm), corresponding to two different kinds of foresight
that must be exercised to produce goods aimed at satisfying consumers’ wants. The first
element concerns the need to estimate the end of productive operations from the beginning. It
is impossible to tell accurately what will be the result of a productive activity in physical
terms (quantities and/or qualities of goods) before the expenditure of given resources. The
second element involves the uncertainty involved in the need to predict the wants of
consumers for whom products are made. Producers must estimate (a) future demand which
they are striving to satisfy; and (b) the future results of their operations in attempting to satisfy
that demand (direction of technology and control of production).
Knight (1964, p. 243-4) still indicates five elements leading to the variety of judgments in
individuals: (a) different capacities to form judgments and infer as to the future course of
events in the environment. These capacities to predict are not homogenous. Especially
important is that related to human behavior, due to the great variability of their outcome, in
contrast with scientific judgment related to this phenomenon; (b) different capacities to
discern and plan steps to anticipate future situations; (c) different capacities to execute plans
and requisite and desirable adjustments; (d) diversity in conducting situations involving
uncertainty, due to different amounts of confidence that individuals feel while making and
executing judgments; and (e) distinct impulses to act in a given situation, in which a given
degree of trust in judgment is passed. Some individuals prefer certainty and will hardly take
chances, while others take risks based on their own intuition. Some act by taking their own
opinions into account and trusting their own luck.
Based on the same knightian premise, Witt (2000) admits that entrepreneurs have the
exclusive capacity not to share their judgment, i.e., each entrepreneur synthesizes different
information from different sources and, even when using the same ones, their interpretations
about gain expectations or their belief in the real possibility of gains are distinct. Casson
(2005) sums up those arguments when stating that information is a public good whereas
knowledge is always private.
For Baumol (1993), the relevant characteristics found in those engaged in innovative activities
are: the use of unlimited imagination, ingenuity, leadership and persistence. The author
defines the entrepreneur as someone who ingenuously and creatively seeks ways to add
wealth, power and position to him or herself.
The inclination to make investments is, therefore, guided by an opinion or belief in the real
possibility of gains. That explains why industrial firms have different configurations. Firms
are heterogeneous: none is like the other, since each has the printed mark of its entrepreneur’s
judgment (KNIGHT, 1964).
Should that not occur, i.e., if all entrepreneurs had the same judgment and were able to
evaluate in the same way and with complete information the attributes of the resources, then
all would follow the same strategy at a given moment. Thus, if the required resources to
pursue such strategy originated in a competitive market, all firms would reach a competitive
equilibrium. In other words, if the cost of information is zero, that which any firm does can be
done equally well by any other (DEMSETZ, cited by FOSS, 2002). On the contrary, if
resources were scarce, the simultaneous competition among firms for resources would prevent
the acquisition of the same. The increase in price would be instantaneous the moment all
agents designed the same strategy, and it would also drop instantaneously the moment firms
gave up the purchase due to the excessive price (price would be unstable). However, with
different judgment (perception and information) on the market, some entrepreneurs would fail
and some would succeed.
In the words of Foss & Klein (2004, p. 13), in a world of ‘true’ uncertainty, entrepreneurs are
unlikely to know all relevant attributes of an asset when production decisions are made. That
means that the attributes of the resources are neither inherent to resources per se, nor can
entrepreneurs have a full understanding by analyzing isolated resources.
Insofar as entrepreneurial judgment is subjective, it is not possible to objectively evaluate the
value entrepreneurs expect from their resources (sum of the discounted net present value), nor
is it possible to attribute a value to entrepreneurial judgment per se. Thus, it can be said that
the origin of competitive advantages for the Knightian Theory of Profit is judgment per se
and not resources per se. Only judgment is the source of competitive advantages and strategy
should be seen as a question of the entrepreneurial judgment of rent (ISHIKAWA, 2004).
Knight admits that individuals seek to reduce the uncertainty involved in adapting forecasts,
even knowing it is impossible to fully eliminate it. The possibility of reducing uncertainty will
depend upon five conditions that are much related. The first depends on the statistical
characteristics of the observable phenomenon: uncertainty is smaller in groups of cases than
in single cases. Uncertainty tends to disappear to the extent to which the group increases in
scope (in the same way the statistic probability occurs). The second refers to the possibility of
dealing with different perceptions (and reactions) from men with regard to uncertainty. In this
case, there are two ways of minimizing the effects of uncertainty: (a) by grouping events; and
(b) by selecting distinct types. The third depends on the possibility of controlling the future
and higher forecasting power. Technological advances and increased knowledge have the
effect of reducing uncertainty. The fourth depends on the diffusion of the consequences of
unfavorable contingencies. Finally, the fifth condition is due to the possibility of avoiding
being driven to an activity with a higher degree of uncertainty than to one with a smaller
degree of uncertainty.
One of the problems of the KTP, according to Coase (1937) is that Knight does not believe in
a possible scientific treatment to understand the configuration of the firm. The author
attributes the configuration of the firm (its boundaries and resources) to the entrepreneur’s
characteristics, such as personality and aspects concerning his or her life history. Thus, there
is no rational logic for the existence of the firm. The creation and capture of value will depend
solely on the entrepreneur’s judgment capacity over future businesses.
It can be thus said that the KTP provides a valuable proposition in terms of the implications of
the variable. uncertainty on the profitability of business. However, its formulation does not
allow building testable hypotheses; neither do they have predictive power. The creation and
capture of value, i.e., the firm’s competitive advantage, is totally under the influence of
random circumstances, as in a game of chance.
Over the last years, however, there has been a vast increase in literature on entrepreneurship,
which, while rescuing the presuppositions of the KTP, seeks to build a methodology of
positive analysis. This literature is generally presented under three major headings.
The first one, particularly interesting for this ongoing analysis, is inspired in Coase’s criticism
and is guided towards the understanding of the relation between the theory of the firm and the
logic of the entrepreneur. By inserting the KTP in the TCE’s analysis, the authors (FOSS,
KLEIN, 2004, LANGLOIS, 1992, 2002; GARROUSTE, SAUSSIER, 2005, SAES,
ISHIKAWA, 2006) defend that there would be reason related with transaction costs, which
would lead entrepreneurs to opt for the hierarchy in the outset of the venture or in the
adoption of an innovative idea. Reasons would result from the cost to transfer innovative
ideas and of measuring new attributes. A person creating or discovering new attributes is
motivated to use it directly because it is costly to transfer knowledge that is not easily
measurable. There are costs to discover what the relevant price is, costs for negotiating, for
measuring unknown attributes and for formatting contracts. Therefore, entrepreneurs usually
avoid negotiation costs in order to prevent value dissipation. They cannot become idea
“sellers”, since knowledge is susceptible to problems of moral risk and adverse selection20.
20 Once information is known, it is worthless; before it is known, it is not possible to assess it properly. It is not known whether it is a good idea. Besides, we could add two other problems: (a) In general, an innovative idea is only considered as such after its success; (b) Often, a creative idea is not properly conceived, is not easily communicated to the markets and depends upon a process of adaptation /experimentation that requires mainly the “mind” of the strategy creator.
However when contingencies can be properly specified or when the parts’ decision to
cooperate does not affect one another, contracts are possible and integration is unnecessary. In
essence, the transaction cost is, therefore, for Langlois (1992, p. 102), a short-term
phenomenon that loses importance in the long term. For him, long term is defined as a period
of time long enough for learning to occur so that adjustments can be small and appear only in
response to exogenous changes. For that reason, the boundaries of the firm cannot be
considered without also taking into account the learning process both within firms and in the
markets. This viewpoint associates competitive advantages with dynamic transaction costs
(LANGLOIS, 1992, 2002).
The second view seeks to understand the logic of the entrepreneur’s decision-making process.
It generally adopts experimental research as methodology, based on the works of Kahneman
and Tversky (1979). The studies aim to characterize entrepreneurs’ personalities in order to
test hypotheses through controlled experiments. Entrepreneurs, for instance, are considered
optimistic and risk lovers, besides having high self-esteem (CASSON, 2005). While
conducting laboratory experiments, Frederick (2006) concluded that people who score high in
tests measuring cognitive reflections (IQ tests) are less risk averse, which suggested that
entrepreneurs in activities requiring little risk aversion can by and large belong in the group
scoring high in this type of test (MARTINS, SAES, 2006). From this perspective, competitive
advantages are based on cognitive aspects, i.e., on the entrepreneur’s psychological
characteristics.
The methodology used in the third proposition is exploratory research. This view seeks to
understand the strategies adopted by successful entrepreneurs (or managers). Thus, based on
the reality of the companies, it seeks to create conduct norms for entrepreneurs. Davis and
Eisenhardt (2004), for instance, while studying high performance firms inserted in highly
dynamic markets, could observe that firms adopt simple rules of conduct as strategies. Such
rules allow greater flexibility, which allow dealing with the speed of changes, the complexity
and ambiguity of the market and the entropy of the structures of opportunities. The creation
and capture of value would mean, therefore, the adoption of “good practices” that would be
translated by the prescription of management rules.
As it seems, these two last approaches presented under a new guise, rescue the perspective of
managerial theory of the 1960s, in which the personal characteristics of the entrepreneur
played a key role in gaining competitive advantages. On the one hand, it is possible to say that
it was high time the entrepreneurs came onto the scene. As Casson (2005, p. 116) posits,
neglecting the entrepreneurial dimension offers a partial explanation for the behavior of the
firm. On the other hand, this look only focused on the entrepreneur is also telling only part of
the story. Such an observation is reinforced by Foss, Klein, Kor and Mahoney (2006, p. 14)
who say:
It is also important to note that managers’ entrepreneurial perceptions and
imagination are not formed in a vacuum, independent of the firm’s resources.
Subjective managerial perceptions and decisions are shaped by the attributes of
resources (e.g., availability, versatility, and specificity of resources) and managers’
experiential knowledge of these attributes.
The idea above suggests a connection between the KTP and the other analytical perspectives
herein presented. Indeed, this revision of the different approaches deliberately intended to drive
the discussion toward integrating, rather than a differentiating the theories.
While aware of the difficulty of integrating approaches based on so different premises, we believe
that, by bringing from each approach arguments about strategies that create and capture value, a
better understanding can be reached of the forces driving the logic of the SCAs. Thus, this is our
intention in Chapter 2.
CHAPTER 2
AN INTEGRATIVE VIEW OF THE STRATEGIC APPROACHES
This chapter will seek to integrate the approaches previously presented but, prior to that, let us
turn our attention to some works that discuss the association among these theoretical building
blocks.
2.1 The integration of the approaches in the economic literature
The attempt to integrate different perspectives on strategies is a recent movement. While it
emerged as recently as the 1990s, several initiatives to that end were already undertaken, among
which those by: Jacobides and Winter (2005); Nickerson (2003); Foss (2005); Bridoux (2004);
Langlois (1992); Nickerson and Zenger (2004); Hsiek (date?); and Nickerson and Zenger (sd).
Williamson (1999, p. 1103), in “Strategy research: governance and competence perspectives”,
recognizes that the TCE and the RBV deal with overlapping, often complementary phenomena.
He admits that the history of the firms and its endowments do matter in the choice of their limits
and recommends that the TCE’s traditional query: “‘What is the best generic mode (market,
hybrid, firm) to organize X?’ be replaced by the question: ‘How should firm A—which has
pre-existing strengths and weakness (core competences and disabilities)—organize X?’”
In Williamson’s “The theory of the firm as governance structure: from choice to contract”, (2002,
p. 189), we find:
Holmstron and Roberts (1998, p .91) contend, and I agree, that ‘theory of the firm
has become too narrowly focused on the hold-up problem and the role of asset
specificity’. […] I would nevertheless concede that the roles of organizational
knowledge and learning mentioned by Holmstron and Roberts (1989, pp. 90-91) are
with which transaction cost economics deals with in only a limited way. This does
not, however, mean that transaction cost economics does not or cannot relate to
these issues.
And the author verifies that the
“…resource-based theory seeks to delineate the set of market frictions that would
lead to firm growth and sustainable rents, while transaction costs theory seeks to
delineate the set of market frictions that explain the existence of the firm. Further, I
conjecture that the set of market frictions that explain sustainable firm-level rents
would be sufficient market frictions to explain the existence of the firm”.
He also posits that market frictions include: indivisibilities, economies of scope and irrecoverable
costs, poorly defined property rights, asymmetric information, externalities and positive
transaction costs. If frictions exist to maintain Ricardian rents, then they would be the reasons for
the existence of the firm.
Montgomery and Porter (1998, p. xviii) suggest an integration between the SPA and the RBV
when admitting that “sustainable competitive advantages (a) reflect some economic regularities;
(b) often result from advantages created, not inherited, and (c) are built around sets of unique
resources that competitors find hard to imitate” (our emphasis).
In order to discuss the relations between the RBV and the TCE, Foss (2005) compares the domain
of application between both theories, i.e., that which the theory aims to explain. The TCE aims at
explaining a firm’s existence, boundaries and internal organization. The RBV was initially
developed to explain SCAs, but over time it started to also encompass issues that include some of
TCE’s traditional considerations, such as: “Why does the firm exist?” and “What determines the
internal organization of the firm?” Therefore, as observed by Williamson (1999), it can be said
that both theories overlap one another.
Hodgson cited by Williamson (1999, p. 1096), argues that the perspective of “competence”
(RBV) can explain as well as the TCE issues related to the existence, structure and limits of the
firm. He posits that the main factor that explains the existence, limits, nature and development of
the firm …is the capacity of such an organization to protect and develop the competencies of
the groups and individuals contained within it, in a changing environment.
Concerning the theoretical language, or explanatory structure of these theories, which includes
terminology as well as explanatory and behavioral variables, Foss (2005) observes that both have
different focuses. The TCE depends on structures derived from the economic mainstream and
emphasizes incentives, information asymmetry, property rights and contracts. The RBV originates
in research on behavior, strategy and organizations and focuses on bounded rationality, routines
and capabilities.
With regard to presuppositions and concepts, Foss (2005) observes that the RBV’s notion of
resource heterogeneity can be also seen from the perspective of the TCE. The specific way in
which each firm organizes its activities is no more than the task of allocating property rights
within the firm, which determines gains in specialization and cooperative production. Given the
high costs of writing contracts, the firm has advantages over the market: it is more efficient both
in enforcing agreements due to its fiat power 21 and in creating norms and conventions that
emerge from the continuous interaction among the workers.
The concept of property rights associates transaction costs and value creation. The theory of
property rights contributes, therefore, to the dimension of analysis of heterogeneity, which
highlights the efficiency inherent in resources and their complementarities. In this sense, resources
belonging to the firm result from the process of economizing on transaction costs, which changes
under the impact of innovation and other technologies. Paraphrasing Williamson (1999), inter-
temporal attributes concur in determining transaction costs, since other governance structures are
predominantly instruments for cooperative or autonomous adaptations.
The problematic of these dynamics is specially dealt with in the article “Transaction cost
economics in real time”, by Langlois (1992, p. 113), in which dynamic transaction cost is defined
as the cost of persuading, negotiating, coordinating, and teaching outside suppliers. This
view suggests a connection between market structure and entrepreneurial strategy. The firms
tend to be vertically integrated if the transaction costs are high when searching for the necessary
capability to carry out its innovation strategies in the market.
From an evolutionary viewpoint, Jacobides and Winter (2005), in “The co-evolution of
capabilities and transaction costs: Explaining the institutional structure of production”, also
discuss how transaction costs and capabilities under a dynamic perspective can be integrated to
determine the structure of vertical integration. For them, it is important to observe endogenous
changes in transaction costs to understand the vertical scope of the firm. In other words, it is
necessary to understand how transactional and capability conditions are determined vis-à-vis
feasible alternatives of the firm at a given moment of time and how they evolve. For this reason,
they posit that transaction costs are not totally exogenous: their magnitude depends on conscious
actions adopted by the firm. Moreover, Jacobides and Winter presuppose that changes in the
governance structure depend upon a feedback process, based on learning.
In addition to that, the concepts of routines and capabilities can be understood as forms emerging
from the interaction, from the learning among the agents, who are limited by transaction
costs/systems of property rights within the firm.
21 fiat=Latin word, referring to an arbitrary decree or pronouncement, which exists inside the firm
It is also possible to understand that, on the one hand, shared knowledge allows reducing agency
problems in so far as information asymmetries are reduced (and vice versa). On the other hand,
the accumulation of new capabilities, often promoted by the diversity of preferences, beliefs and
knowledge, may lead to agency problems. Thus, at least in the short-term period, that means an
exchange between learning (dynamic deficiency) and alignment of incentive (static deficiency).
Williamson (1999, p. 1097) agrees with the proposition that internal mechanisms to protect
knowledge are superior to intra-firm contracts. Nevertheless, since he also verifies that not all
firms are equally competent to mobilize their institutional capabilities and to protect them, he
proposes the following question: Which firms are more and which are less competent in
deploying their institutional capabilities to protect their knowledge? According to him, the
answer to this question would enable the operationalization of the perspective of competence
(or of the RBV).
Another concept from the TCE, which is essential to understand the function of the firm as a locus
of knowledge accumulation, is that of human specificity. However, Foss (2005) highlights that
this concept needs to be refined and related to a wider context, in which the quasi-rent for several
types of productive knowledge be determined. Demsetz (1973), by his turn, argues that the
economic organization has wider aspects than those summarized by the TCE, because, according
to his view, firms would exist even in a world where transaction costs were null. Firms are
organizations that enable the acquisition of knowledge in a more specialized manner than the
market does.
An article that tries to integrate the three approaches (SPA, RBV and TCE) is “Toward a
positioning-economizing theory of strategy”, by Nickerson (2003). In it, the author proposes a
new perspective to understand value-creation, which he calls “positioning-economizing”. It is
worth understanding the effort made to consolidate the essential pillars of its theoretical proposal,
i.e.: (a) the unit of analysis; (b) the set of assumptions; and (c) the common and central decision
variable.
Regarding the unit of analysis, Nickerson suggests the concept of an activity chain. Concerning
behavioral assumptions, the author defends the inclusion of both opportunism and cognitive
limitations (bounded rationality). As for the key-variable, which integrates the three views,
Nickerson suggests the resource profile in the activity chain. This term, in contrast to the
definition used in the literature on the RBV, is more expansive; it includes resources across the
entire activity chain, not just within the firm, so that it is possible to disentangle resources
from their ownership.
The resource profile depends on both the use of resources in each activity of the activity chain and
the degree in which they are specialized (unique and idiosyncratic within an activity) or co-
specialized (unique and idiosyncratic within other activities) and it is a source of sustainable
competitive advantages (SCAs)
This holistic and integrative view of strategy implies that, in order to capture value, entrepreneurs
need to choose a single market positioning, which requires strategic resources able to create value
for clients and economize transaction costs. To reach this result, the author assumes a system A
comprising n activities not necessarily sequentially connected (each one can have several
interconnections). R, the resource profile, is an n x n matrix.
The magnitude of each element Rij of the matrix corresponds to the degree to which the resources
in the activity i are co-specialized regarding activity j, which can be measured through the cost to
use the next best resource (measure of the quasi-rent). In other words, a measure of quasi-rent Rij
is the level of the asset specificity in the transaction among the activities Ai and Aj, where i ≠ j.
Rij > 0 indicates a contractual hazard generated by the asset specificity between these two
activities. This value will inform, according to the TCE approach, the mode of governance that
economizes transaction costs for each activity. The diagonal of the matrix shows the degree to
which resources within an activity are specialized and superior to other substitute resources,
which can be measured as the cost of its next better use. If Rii is negative, that indicates the
existence of a superior substitute resource.
Whereas co-specialization is the focus of the TCE, specialization and the superiority of a
particular resource over a substitute is the focus of the RBV. In this sense, R characterizes the
uniqueness of resources (a) between activities, (b) within an activity and (c) for all activities in the
activity chain. Considering that a range of investments can probably produce a range of levels of
specialized and co-specialized resources, managers can choose a variety of resource profiles for
any particular activity chain.
The choice of resource profile facilitates integrating the three approaches insofar as it
provides the foundation of competitive advantage proposed by each one. The choice of
specialized and co-specialized resources is foundational in the SPA (strategic positioning).
Besides that, specialized resources are also sources of competitive advantages for the RBV,
and co-specialized resources produce cost advantages, when organized so as to economize
transaction costs. In an extreme case, the activity chain can be totally integrated, or, in another
one, efficient governance can have several firms operating within the chain.
In this case, Nickerson’s view assumes that the aim of the manager is to research each resource
profile that is feasible and use it in a profitable manner (preferably, in the way that maximizes the
expected profit). Implicitly, it is assumed that there is no agency cost, since managers seek to
maximize the expected profit. Each profile entails: (a) expected demand, (b) fixed and variable
production costs, and (c) fixed and variable governance costs for each activity. Because of
cognitive limitations, it may not always be favorable or possible to identify the optimal strategy in
terms of competitive advantage. Thus a feasible strategy would be that which produces a non-
negative result for each activity of the chain. The feasibility of any strategy depends upon two
constraints: (a) the nature of the demand and (b) the cost to govern, conjugate and access the
resource profile.
To identify feasible strategies, Nickerson builds an objective function of the manager 22 . One of
the problems arising from the formal representation of this approach is the need to assume that
every manager has the same set of feasible strategies. He also argues that the research of feasible
strategies is not impossible once practical considerations should reduce the possible alternatives,
even though he admits that it is difficult to find a solution due to the cognitive limitations to
solving R and estimating the governance cost.
In order to create value, the activities (Ai, Aj) must be complementary (for instance, the
investment to improve the image of a brand with respect to quality must correspond to the
investment in the quality of the firm’s product or service), i.e., ∂π2 /∂Ai∂Aj > 0 for i ≠ j, where π
is profit. That means that the alternatives will be reduced to a small combination of extant and
accessible resources. In order to deal with cognitive limitations, managers estimate, even though
imperfectly, governance costs based on their personal experience (learning) or that of other firms
22 This function is represented by the equation: {R: Max Σ (q(pfj,R)[pfj – cfj(G(R),R)] - Ffj(G(R),R)] > 0} for f. It represents set of all resource profiles, R, that yield non-negative results, (i.e. a feasible profile) for any firm, f, in the activity chain. Profit is maximized with respect to the price of the final product or service, pfj, and summed over all activities j in the activity chain A. The term q(Pfj, R) is the demand realized from price pfj received from the de products and services generated by the resource profile. The term pif – cfj (G(R), R) is the price cost difference for each activity where the variable cost cj includes a governance-cost component, cfj (G(R,.) and a production-cost component, cfj (.,R). Finally, Fjf(G(R), R) indicates the fixed cost that may be due to a fixed governance cost component, Fjf(G(R), .) and a production cost component, Fjf(., R) (Nickerson, p. 2219-20, 2003).
with related organizational structures or activities. In this sense, the trajectories of the firms also
affect the managers’ decisions, since they, during the process of identifying strategies to be
adopted, will take into consideration the set of activities and the resource profile they have
available, in the case of already established firms. In a new firm, the decision-making process is
more complex since no past experience exists. Anyhow, identifying an optimal strategy is
presumably impossible because of uncertainty or bounded rationality (p. 28).
The formal foundation described by Nickerson (2003) is a great advance in the literature, but
leaves out important arguments. For instance, if managers are assumed to have the same feasible
set of strategies and have (complete) information about them, the theoretical basis of the RBV is
somehow neglected.
A new perspective for integrating the KTP, TCE and RBV is presented by Nickerson, in
partnerships with other authors, in “A knowledge-based theory of the firm: the problem-solving
perspective” (NICKERSON and ZENGER, 2004) and “Opportunity discovery, problem solving
and the entrepreneurial theory of the firm” (HSIEK, NICKERSON and ZENGER, s.d).
Based on Williamson’s approach 23, all of the above authors argue that the discovery of
opportunities by the entrepreneur involves two aspects: (a) identifying problems, which, if solved,
create value, and (b) govern the organization so as to allow the creation of a continuous process of
solution search. The efficient organization depends on the type of solution search required. For the
authors, there are three alternative and polar forms of organizations associated with the problems,
according to their degree of complexity: (a) Problems low in complexity (decomposable): the
entrepreneur would ideally seek its solution through the market; (b) Problems of intermediate
complexity (nearly decomposable): the entrepreneur would ideally govern the search within the
limits of the firm using his or her authority (or fiat); (c) Problems of high complexity (non-
decomposable): he or she would ideally govern a solution search through a consensus-oriented
organization, in which socialization is used to create a common communication code by which
knowledge can be economically aggregated .
Hierarchy-based authority is aligned with the reasons appointed by Langlois (1992, 2002)
previously described in item 1.4 herein. That means that knowledge transfer is costly and there are
losses in using the market, particularly when knowledge is strategic for the firm. 23 Menard’s position (2004), also based on the TCE’s view, explains the hybrid forms of Williamson’s model and seeks to highlight the role of trust relationships, relational networks and formalized governance. However, he does not use the RBV to explain the alternative forms.
These authors point out that the discovery of valuable opportunities usually requires choices
involving multiple knowledge sets about the project and that their commercialization
encompasses different characteristics of the agents. Only in operations of small scope can a single
entrepreneur know precisely which decision and which choices to make about the activities of
planning, manufacture, finance, accounting, marketing, human resources and strategy. When
problems are complex and non-decomposable, the authors argue that the firm will acquire a
specific feature while creating a favorable environment for knowledge sharing. The entrepreneurs
will have to organize the firm so as to create its own culture and identity, thereby favoring
knowledge sharing and a search heuristic. Picture 2 presents the three types of polar problems and
expected solutions.
Picture 2 - Solutions for each type of knowledge search
Problem type concerning its
complexity
Solution
Governance instruments
Features of solution searched
Low: decomposable
Market Market incentive: price. Problems of low integration
Average: almost
decomposable
Hierarchy-based authority
Internal communication channels to share knowledge.
Strategic information that cannot be shared.
High:
non-decomposable
Hierarchy-based
consensus
Incentives to motivate knowledge search.
Knowledge needs to be shared. Needs to engage multiple agents in its transfer. Agents need to develop cognitive maps.
SOURCE: NICKERSON AND ZENGER (2004); HSIEK, NICKERSON AND ZENGER (S.D).
The proposition presented by the authors in Picture 2 provides reflections for the analysis of
supply chains, even though both of the articles mentioned center on strategic solutions regarding
the firm.
Therefore, taking into consideration supply chains, the connection between strategic solutions and
governance structures could be conceived by using the classical notion of interdependence,
originally developed by Thompson (1967), a traditional author in the Theory of Organizations.
This concept was rescued by Lazzarini, Chaddad and Cook (2001) in “Integrating supply chain
and network analyses: the study of netchains”, aimed at introducing the concept of netchains 24.
Thompson identifies three types of interdependence: (a) pooled interdependence, in which each
individual in a group has a well-defined contribution for a given task; (b) sequential
interdependence, in which tasks are sequentially structured, i.e., one activity of a firm or agent
precedes the next; and (c) mutual interdependence, which involves relations among the parts, and
the input from an agent depends on that of another and vice-versa.
For each type of interdependence it is thus possible to associate a solution related to the
complexity of the strategic problem, as seen in Picture 3, “Solutions for each type of a solution
would provide rationality for the firm’s decision, inserted in the supply chain, in the choice of a
specific governance structure (be it horizontal and/or vertical). Thus we have that: (a) joint
interdependence is linked with a problem of low complexity; (b) sequential interdependence with
a problem of average complexity; and (c) mutual interdependence with a problem of high
complexity. As we shall see, this perspective will be further explored in the empirical analysis
carried out in Chapter 4.
The attempts to unify different views on the study of strategy show that a long path is still ahead
of us. Though the above-mentioned authors point to the limits of dealing with the issue of value
creation and capture in an isolated manner, they also highlight the difficulties in formalizing a
unified approach with such different theoretical bases and units of analysis.
2.2 An integration of the strategic views: An analytical proposal
This session re-examines the four views presented—SPA, TCE, RBV and KTP.—. They are
confronted with each other so as to understand their relevant variables, assumptions and units of
analysis prior to integration
The theoretical views discussed have different focuses, though at times complementary, on how
SCAs are obtained. The SPA view asserts that companies must observe the competitive
interactions with their immediate and potential rivals. Such a strategy involves the creation of 24 The concept of netchains can be understood as a set of networks that encompass horizontal ties among firms within the same industry, which are sequentially organized based on vertical ties (LAZZARINI, CHADDAD and COOK, 2001).
entry barriers (economies of scale, economies of scope and differentiation) to old and new
competitors in the consuming countries. This strategy of creating entry barriers reflects a
particular view of how markets work, having as a paradigm the perfect competition model, in
which the only source of profits would be the creation of monopoly rents.
The RBV argues that companies must develop and benefit from internal differentiated resources.
In this case, in order to maintain SCAs, the firm’s strategy consists of identifying, developing and
emphasizing its capabilities, so that its rivals are unable to imitate them. The source of value
comes from Ricardian rents.
Under the TCE’s perspective, firms adopt differentiated governance structures aimed at reducing
transaction costs. Given that value creation takes place through trade, transaction costs can
prevent exchanges from being made or make them more expensive. Thus value is created when
transaction costs are reduced through governance structures that allow better coordination among
the agents, or make it possible to explore, through the redefinition of property rights, previously
unexplored attributes of goods.
Finally, the KTP proposes that competitiveness depends on the entrepreneur’s judgment. This
judgment is characterized by its uniqueness due to a subjective evaluation (made by the
entrepreneur) concerning future gains. The importance of this approach lies in the fact that it
nestles uncertainty within its scope, besides highlighting the role played by the agent who decides
which strategies the firm will use. An interesting implication thereof is that, even in the absence of
information asymmetry, the economic agents (entrepreneurs) will disagree on the best way to
allocate resources, since interpreting reality depends upon their personal judgment about the
future, which reflects on the firms’ heterogeneity. The consolidation of the main features of these
theories is presented in Picture 3.
Picture 3 -Main features of the SPA, RBV, TCE and KTP views
Theoretical views
Unit of analysis
Variables that define firm
competitiveness
Sources of competitive advantages
Pressupositions Bridge between approaches
Critical points
SPA
Value chain
Entry barriers: (a) Economies of scale and scope; (b) Differentiation.
Monopoly Power.
(a) Complete rationality; (b) Agents’ self-interest (implicit in IO).
There must be market failures (transaction costs) for the positioning strategy to be adopted.
Ignores different firm performances within the same industry. Does not explain the
boundaries of the firms.
RBV
Resources 25
Rare resources costly to be transferred and replicable.
Ricardian rents.
(a) Resources are imperfectly imitable / transferable; (b) Agents’ cognitive limitations.
Transaction costs can explain which governance structures will be adopted to exploit the resources.
Ignores firm’s external environment (demand). Has not capacity to predict.
Transaction (Williamson)
Alignment between governance structure and transaction attributes: asset specificity; frequency; uncertainty.
Reduction of transaction
costs.
TCE 26
Property right (Barzel)
Alignment between governance structure and costs of measuring the attributes of the goods
Maximize transaction
value.
(a) Bounded rationality; (b) Agents’ opportunism
Bounded rationality and specific asset (implies Ricardian rents) and may explain firm heterogeneity
Ignores gains resulting from team production. Ignores firm heterogeneity
KTP
Human action
Entrepreneur’s cognitive characteristics / learning.
Entrepreneur’s judgement.
(a) Uncertainty; (b) Market disequilibrium.
Entrepreneur’s vision determines governance structures (transaction costs).
There is no economic logic behind entrepreneurial decision.
Thus it can be noted that all of the theories herein presented provide only a partial view of how
firms can create and capture value. According to Nickerson (2003), both the SPA and RBV fail to
take into consideration the costs of organizing activities internally, which may imply the adoption
of costly strategies to capture value. In addition to that, under the perspective of the RBV,
managers will not capture value if their unique resources are not valuable to consumers.
Concerning the TCE, the main criticism regards the fact that a strategy that economizes
transaction costs may fail to capture or create value due to limited demand or excessive
competition. The KTP fails for not providing the understanding of the rationality of decision-
makers whilst choosing problem solutions to carry out an idealized strategy (NICKERSON;
ZENGER, 2004). Integrating these views could, therefore, minimize the deficiencies found in
each one, thereby providing a theoretical instrument that would allow a better understanding of
the SCAs.
25 The unit of analysis under the RBV is not consensual; it includes other definitions such as: activities, strategies, processes, routines, capabilities and core competences, among others. 26 For a discussion comparing Williamson’s and Barzel’s approaches, please see ZYLBERSZTAJN (2005)
The column labeled “Bridging the views” in Picture 3 above indicated some conditions that
enable making connections among the four views. The bridge between the SPA and the TCE
might be built by taking into consideration that the existence of transaction costs makes the
strategy of creating barriers sustainable. In addition to that, resources internal to the firm (RBV)
can be interpreted as specific assets and, therefore, be analyzed with the instruments of the TCE.
It is worth observing that the TCE understands resources as a set of attributes that determine
property rights. Consequently, the way in which attributes are aggregated in order to constitute a
resource depends upon transaction costs. The value that a resource owner can create will depend
on the set of property rights (specified or not) that s/he owns (FOSS, 2005).
The KTP and the RBV, by their turn, assume the heterogeneity of firms as one of the main
implications of strategies adopted (in the former case, based on the entrepreneur’s vision and, in
the latter, resulting from resource allocation). Thus both for the RBV and the KTP, capturing
value is compatible with null transaction costs.
By the same token, for both theories, if the offer of inputs is not perfectly elastic, rents can be
appropriated and remain sustainable. In this sense, firms can implement strategies based on
resources that are rare, hard to imitate and irreplaceable, even when transaction costs are
nonexistent. However, in this case, the maximum value of a transaction is created instantly in each
period, all rents are protected and the bargaining for the division of the surplus is instantaneous
and costless. In addition, any arrangement tends to be efficient: there is no loss of value in the
process of sharing the surplus. Paradoxically, there is not a “genuine discrimination” (or a genuine
strategic choice), since the problems of hold-up or moral hazard only occur with the introduction
of market failure (FOSS; FOSS, 2004).
However, with the introduction of transaction costs, not only the strategies proposed by the SPA
but also those suggested by the RBV and by the KTP take on new roles, once the choice of the
organizational form will allow a higher (or lower) rent appropriation.
It can thus be inferred that transaction costs, i.e., the costs for protecting and capturing property
rights directly or indirectly, influence value creation. Costs for measuring or bargaining dissipate
value, leading to losses in well-being or the creation of “dead weight”. These considerations imply
that SCAs depend not only on value creation through the use of resources that are scarce and hard
to imitate, but also on the costs to control the property rights of these resources. In the words of
Foss and Foss (2004, p. 16):
Sustainability of competitive advantage depends not only on controlling capture in
the form of competitive imitation and substitution, but also on other kinds of capture
such as moral hazard, adverse selection and hold-up. Estimating sustainability must
take such capture and the costs of controlling it into account.
What can be seen, therefore, is that resources result from a process of economizing transaction
costs. However, it is worth noticing that, in economic terms, the same resource can be
economically differently for firms within the same industry, because they are not equally able to
protect relevant attributes or visualize ways to explore them economically. Or, as Knight would
say, each entrepreneur has a particular perception of the value of a resource.
Foss (2004, 2005) argues that, “in isolation”, neither of the views—the TCE nor the RBV —can
account for the essential elements of the SCAs. The TCE fails for not incorporating bounded
rationality in an adequate manner, which would allow understanding the heterogeneity of firms.
The RBV would have methodological problems to explain the existence (boundary) of economic
organizations 27.
Yet another powerful argument in favor of the integration of these theories, advanced by Foss and
Foss (2004), lies in the little attention given by the RBV to the interaction between value creation
and its capture (distribution). The authors admit that there is a significant difference between the
value of the quasi-rent to be created and the way it will be divided. In the bargaining process
among the several owners of resources, rents can be lost, thereby causing value dissipation and
weak incentives for its creation.
Thus we have two good reasons to incorporate the TCE in the strategic decisions centered on
resources. The first regards its “negative” view. If the strategy focused on resources involves a
relation-specific investment, once the contract is signed and the assets are allocated, one of the
parties may threaten to not comply with the contract. The threat of a hold-up situation could, also,
affect the choice of the investment ex ante. Thus, in the absence of contractual safeguards, the
parties can choose a less specific investment with lower productivity so as not to have ex-post
costs (LANGLOIS; FOSS, 1999). The second reason concerns the “positive” view of the TCE.
The firm shall be organized so as to coordinate the production by efficiently exploring/developing 27 Theorists of the RBV defend that the firm exists because it allows the creation of assets (such as learning
capabilities), which the market cannot create, and have a superior flexibility when compared to market contracting. However, this argument can also apply to the market itself. For instance, industrial districts can foster the creation of learning capabilities, and cooperative production can also be flexible (FOSS, 2005).
its resource, with productivity gains, thus minimizing the transaction costs of internal
organization.
Thus value creation and appropriation must be jointly determined through the development of a
single strategy so that sustainable gains are achieved. The reason for that is that the consistency of
the strategy will depend not only on the characteristics of the sources of value, but also on the
relations among the segments of the supply chain and, therefore, on how the division of the quasi-
rent will happen based on the determinants of this relation.
In this sense, an integrative view allows an understanding of how the firm’s strategy of value
creation (Ricardian/monopolistic rents) aligns with the governance structure in the supply chain
(how property rights are allocated) and how value appropriation will be determined.
That is particularly important to our research problem: there is no use in formatting a value
creation strategy if when the transaction is carried out the value is transferred to the segment
upstream. Or, in other words, residual property rights must be allocated in such a way to allow
agricultural producers to capture value. Thus, the value that the producer will appropriate along
the supply chain does not depend only upon the firm’s ability to exclude non-proprietors and
enforce its rights 28; it also depends on how the bargaining power is established between the
parties.
In the specific case of the rural segment of small-scale producers, we can think of the following
analytical scheme of value creation and appropriation, as illustrated in Figure 7. Initially, the
entrepreneur-producer discovers an opportunity for value creation by its business (Figure 7 - 1).
This opportunity (problem identification) relies on the creation or exploration of new attributes of
productive resources (Figure 7 - 2). In this situation, there will always be two elements of
uncertainty. The first relates to the need to estimate from beginning to end all production
operations. It is impossible to state precisely what the result of a productive activity will be in
physical terms (quantity and/or quality) before the resources effectively enter the production
process.
The second element regards the need to forecast the wish of consumers toward whom a good is
directed. Producers must estimate (a) the future demand they intend to meet and (b) the future
result of their operation aimed at meeting the demand (technology direction and production
28 A franchise chain, for instance, can have its brand depreciated by a drop in quality by the franchisers.
control). Such activities are directly connected with the SPA strategy, and, therefore, are
conditioned by the structure and competition pattern of the industry within which the firm is
inserted (Figure 7 – 3).
In our particular case, as entrepreneurs-producers do not have scale, the adoption of an individual
strategy will have to take into consideration the transaction costs (Figure 7 – 4) of a collective
action. They will have to persuade producers in their neighborhood to adhere to the strategy with
a view to obtaining a scale, which will allow them to fulfill their aim29. The analysis of the
transaction costs of vertical coordination shall be jointly analyzed with the horizontal strategy
(Figures 7 – 5 and 6); i.e., once the profile of the resource necessary to reach the objective is
defined, the horizontal production strategies and the vertical strategies to realize the product must
be integrated.
It should be highlighted that the definition of horizontal and vertical strategies is rather complex:
others do not easily adopt an innovative strategy idealized by an entrepreneur-producer; the
former need to be persuaded to invest in that idea, as previously discussed (item 1.4). Collective
action takes several forms and, therefore, must be aligned with the idealized strategy.
Based on the model of Nickerson; Zenger (2004) on the taxonomy adopted by Lazzarini, Chaddad
and Cook (2001) presented in item 2.1, it is possible to indicate three basic types of coordination
among rural producers for solving value-creation problems, namely: (a) joint interdependence,
which is associated with a low complexity (decomposable) problem, (b) sequential
interdependence, related with an average complexity (nearly decomposable) problem), and (c)
mutual interdependence, which concerns a high complexity (non-decomposable) problem.
Thus, each of these problems requires different solutions, which imply different resource profiles.
Each resource profile defines organizational arrangements, which will generate attributes
consistent with the target positioning.
At the end of the supply chain, consumers will respond to the strategic choice by buying products,
based on the association between their preferences and the utility of the product, i.e., analyzing
costs and benefits of the products offered through the strategies they have available
29 Though an individual strategy could be thought of, it would have a very short reach. For instance, the
production of homemade jam made by a producer from a specific rural holding could probably only be traded in a small retail due to its small scale.
(NICKERSON, 2003). In other words, consumers are those who will ultimately validate value-
creation strategies and determine the value that can be appropriated.
Thus, quasi-rent appropriation (Figure 7 – 8) will depend on demand elasticity (how much
consumers are willing to pay for the product), i.e., the total value created and how property rights
among agents are allocated. The definition of property rights will depend upon the governance
structures formatted (Figure 7 – 7).
Figure 7 - Analytical scheme of value creation and appropriation
The three types of structures consistent with the complexity of the problems, in terms of value-
creation strategies, are as follows:
(a) Joint interdependence (Figure 8). In this case, each producer within a group makes an
autonomous and well-defined contribution to a given task. The relations among the agents are
scarce and social ties are weak. That represents the low complexity, or decomposable, type of
problem. Prices reflect the totality of investments required. Producers’ cooperatives represent, for
instance, a type of solution to deal with problems of this nature. Standardization, which can be
Entrepreneur finds a business opportunity (1)
Definition of
property rights
(7)
QUASI-RENT APPROPRIATION (8)
Strategy depends on creation/exploration
of resource attributes (2)
Analysis of
transaction costs (4)
Conditions of
the product
market (3)
Choice of vertical
organizational
structure (5)
Choice of horizontal
organizational
structure (6)
obtained through certification, is a key instrument to solve problems of information asymmetry.
Though there is a differentiation strategy, producers have little power to influence product prices,
which are defined through the market. As Barzel (2002) would put it, while reducing the costs to
obtain information about the attributes of the goods, standardization brings the worlds of costly
information and that of perfect competition close together. This is why producers make more use
of the externalities of networks (reduced transaction costs) to obtain competitive gains than of
price differentials. The adequate vertical governance structure is the market. Even if producers,
through a cooperative, possessed processing means, their power to appropriate quasi-rents would
be limited. An example of this case would be a value-aggregation strategy based on the sale of a
product with standardized quality.
Figure 8 - Joint Interdependence
(b) Sequential interdependence (Figure 9). This type of interdependence occurs when a
producers’ strategy is directly related to the specific investment of an upstream firm that will
determine the conditions for the organization of production. In this case, the type of solution, with
regard to the complexity of the problem, is average. Hierarchy-based authority is necessary to
prevent the dispersion of strategic information. Residual decision rights are allocated to the
upstream firm, which makes the coordination through planning and adaptation to changes in the
external environment. Since the firm is responsible for the decision of all the network of relations,
the solution is trivial (SAUVÉE, 2002). In marginal terms, the result of this type of governance
structure can be more advantageous for rural producers, as compared with the result obtained
through a joint interdependence, since there is the creation of a value to be negotiated.
It is worth observing that when this type of strategy is started by a rural producer, it is more
feasible when a producer also owns the processing firm upstream, because, on the contrary, the
producer would have to persuade an entrepreneur to invest in the processing of the product. Since
the focus of this work is on small producers, this strategy is more commonly fostered by a
processing firm. A case illustrating this example is a processing firm’s brand strategy regarding a
specific quality of a product.
Figure 9 - Sequential interdependence
(c) Mutual interdependence (Figure 10). In this case, each agent is mutually dependent on the
choices and actions carried out by other agents. Decision rights are distributed among rural
producers, which imply the presence of a complex solution process. Once it is not a trivial
problem, a consensus mechanism is presupposed, as well as a negotiation between the parties and
a mutual adjustment (MENARD, 2004; ZYLBERSZTAJN, 2005). The forms of coordination and
adaptation require learning through feedback rather than through centralized decision-making
planning. Due to its complexity (and, therefore, difficulty to be imitated), the resources created
through this mechanism allow better appropriation of the margin by rural producers. Therefore, if
the firm’s performance depends on the resources it controls, the meaning of its existence derives
from its relative greater ability, in comparison to other governance structures (market and
contracts), to generate and appropriate economic rents (RUMET, 1984; WERNERFELT, 1984).
An example illustrating this case is that of a brand strategy in the rural segment, in general not
related to its origin and regional quality. As it involves several producers, exclusion rules must be
clear and consensual, and there are problems of free-riders.
Figure 10 - Mutual interdependence
Thus, we see that vertical and horizontal organizational strategies are defined based on
opportunities for value creation devised by entrepreneurs. Picture 4 consolidates this discussion.
Picture 4 - Value creation and appropriation Opportunities and strategies
types of problems identified
Governance structures
adequate to profile of resources
Allocation of property rights
Market conditions
Capacity to appropriate quasi-rent
Strategy gains (SCAs)
Low complexity
Joint interdependence
Market Low entry barriers
Null Economies of scale and scope/efficiency
Average complexity
Sequential interdependence
Authority (one of the
segments)
High entry barrier: focus on consumer
loyalty
Total for the agent with authority
Ricardian/monopolistic rents
High complexity
Mutual interdependence
Shared High entry barrier: focus on unique
resources
Shared among agents
Ricardian/monopolistic rents
In the first case, the market is the most expected form to be seen, since there is no way to improve
the distribution of the producers’ quasi-rent through the adoption of hybrid forms or forward
vertical integration (acquisition of a processing firm). In fact, the cooperatives that adopt such
integration strategies start to behave similarly to processing firms, aimed at competing on the
market. The capacity to appropriate quasi-rent is null and gains result from economies of scale
and scope.
In the second case, in which the firm’s brand is an important strategy, hybrid forms are expected
to be more commonly observed, and relational or formal contracts or even hierarchy may occur,
depending on the type of resource that is related with the brand. Gain will result from the use of
differentiated resources and the creation of entry barriers on the product market. The quasi-rent
will tend to stay with the agent that holds the residual decision rights (or the strategy’s
coordinating agent).
In this last case, more complex coordination mechanisms are necessary to deal with problems
resulting from joint actions. More complex coordination mechanisms mean consensual decision-
making and responsibility sharing. As the strategy is shared among the agents, the division of the
quasi-rent will also tend to be so.
The next chapter will analyze the three strategies, based on the examples of four experiences in
the Brazilian coffee system.
PART II
RENT CREATION AND APPROPRIATION IN THE SUPPLY CHAIN: FOUR
EXPERIENCES IN THE COFFEE AIS
CHAPTER 3
THE COFFEE MARKET DYNAMICS
Drawing on the theoretical discussion presented in Part I, this Part II has a twofold objective. The
first will be to present in this Chapter 3 a brief contextualization of the problematic of the global
trend toward decreases in agricultural rents, having as an example the case of coffee. This
scenario creation will serve as the basis for introducing the market trends of this commodity based
on the emergence of the phenomenon of specialty coffees.
Based on the theoretical scheme presented in Chapter 2, the second objective of this part is to
analyze cases of value-creation strategies in the coffee AIS, aimed at verifying which strategies
are able to originate SCAs for the rural segment.
3.1 Agricultural segment: competitive markets and ephemeral profits
The agricultural sector is often mentioned in the economic literature to illustrate the competitive
market. The several offerers, each having such an insignificant portion of the global market,
cannot, individually, affect prices while manipulating their own offer. Producers are price takers,
acting as mere observers of the market forces. “In the economists’ ‘perfectly competitive’
industry, jockeying for position is unbridled and entry to the industry very easy. This kind of
industry structure, of course, offers the worst prospect for long-run profitability” (PORTER, 1979,
p. 1).
Extraordinary gains resulting from innovation are almost immediately transferred to prices and
disappear in the process of imitation by competitors (KONING; CALO; JONGENEEL, 2004).
Once an innovative technology able to translate into a productivity increase is implanted, the
pressure from the competition will disseminate this new competitive pattern. The resulting higher
productivity means higher offers and lower prices and, therefore, higher average return rates than
those observed in the previous pattern. Thus the lower are the entry barriers to the technological
pattern in force, the faster will prices tend to reflect productivity gains.
Theoretically, the dissemination of innovations would oust from the market the producers that do
not adhere to the new technology or that have costs incompatible with prices in force. Thus these
excluding dynamics accelerate the process of finding equilibrium between supply and demand,
whilst eliminating producers that are on the margins of technological incorporation.
The logic of this argument, only consistent with null transaction costs, does not encompass the
sector’s reality, which is far more complex. Or, to put it another way, if there were no market
failures, a new equilibrium would be reached with lower prices and profitability adequate to the
characteristics of the “non-regulated” market of the agricultural segment. Since that is not the
case, se sector may face losses for a long cycle until prices are again adjusted.
Mobilizing production factors in agriculture is very difficult since there are transaction costs
associated with changing from one type of crop (or activity) to another, be it due to the specificity
of the land, or be it for the specificity of production.
Concerning land, the possibilities of profitable crops are limited in some regions, or, sometimes,
there is only one possibility. In this case, producers are expected to remain in an activity even if it
does not provide them with financial returns. In family holdings, producers’ monetary costs tend
to be lower than those of technified holdings, since the low use of inputs and the use of family
labor distort the relative costs of the activity and ensure producers’ permanence in a region for a
long time.
Concerning the specificity of the production, perennial crops imply irrecoverable costs, which
impacts on the time necessary for the offer to respond to negative price signals.
The coffee commodity is a typical case that brings together high transaction costs related to the
immobility of the production factors—particularly land—and the specificities of the production,
since coffee is a perennial crop.
3.1.1 Transaction costs in coffee production: the immobility of the factors With reference to the issue of the specificity of the land, let us have in mind that coffee is
produced by millions of poor producers from over 50 developing countries, most of whom have
no other source of income (DAVIRON; PONTE, 2005).
Table 1 shows the characteristics of coffee producers. According to the production structure,
coffee growers worldwide except in Brazil generally produce in areas smaller than 2 hectares.
Most of what is produced in Colombia, Vietnam, Mexico, Honduras, Costa Rica and Kenya
comes from this type of property. Additionally, in some of those countries, mainly from Africa,
this product represents an important share of export revenues.
Given the transaction costs resulting from the characteristics of the production structure,
innovation dissemination will be slow and marginal producers will be ousted from the market.
However, depending on the moment of the cycle and the rigidity of the agrarian structure, both the
productivity gains in the areas that adhere to new technology and the resulting increase in offer
will increase the loss in profitability throughout the chain. In this situation, the producers that
invest in technology and have high fixed costs will have economic losses, pressed by those whose
costs are lower due to the use of family labor and the limited use of inputs in their production
Table 1 - Coffee producing countries and coffee growers: main features
Countries Total producers
Production structure Area %
Total
production%
Average yield 2000/01-2007/08
thousand 60k bags
Coffee % in total export
revenues 1999
Brazil 300 thousand
<10 ha 10-50 ha
+ 50 ha
27%42%31%
26%40%34%
39,825 4.0%
Colombia 500
thousand
up to 1.5 ha 70 – 80%30-40% 16,663 9.8%
Vietnam - <5 ha
5-10 ha10-190 ha
70%15%15%
- 14,825 4.5%
Ethiopia - - - - 4,088 38.9%
India - <10 ha>10 ha
65%35%
40%60%
4,771 0.7%
Indonesia - 1-2 ha 90% - 4,297 0.6%
Mexico 280 thousand
up to 2 ha 2-10 ha+ 10 ha
72%27%1%
35-40%40-45%
20%
4,230 0.3%
Guatemala 43.7 thousand
1-2 ha 2-500 ha+ 500 ha
90%9%
<1%
15-20%45%35%
3,802 20.5%
Peru - - - - 2,983 3.1%
Honduras 109 thousand
Up to 1.5 ha up to 10 ha+ de 10 ha
95.5%4.2%0.3%
60%22%18%
2,973 13.4%
Uganda 500
thousand
0.5 h. most- 2,701 81.8%
Ivory Coast - - - - 2,467 22.7%
Costa Rica 77 thousand up to 1.5 ha
up to 10 ha + de 10 ha
95.9% 3.4% 0.7%
55.5%19.4%25.1%
2,057 3.5%
El Salvador 20 thousand up to 1.5 haup to 10 ha + de 10 ha
72.8%20.2%
7%
5.8%21.9%72.3%
1,505 11.8%
Nicaragua 30 thousand up to 1.5 haup to 10 ha + de 10 ha
94.6% 4.9%
0.54%
24.4%39.3%36.3%
1,368 7.9%
Kenya 600
thousand
0.3-1 ha
75%
60% 838 6.5%
Tanzania 270 thousand
< 1 ha most 92% 729 5.9%
SOURCE: KASTEELE; ZELDENRUST (2000). ICO (2008). Among coffee producing countries, Brazil is a differentiated supplier, both concerning its
production structure and the organizations that support the productive activity. In Brazil, the so-
called small coffee growers produce in properties equal to or smaller than 50 hectares (Tables 2
and 3)29 whereas competing countries produce in areas equal to or smaller than 1.5 hectares, as
seen in Table 1.
Table 2 - Stratification of coffee holdings
Minas Gerais Parana São Paulo Area % Production % Area % Production % Area % Production %
Below 10 ha 231 32 3.021 28 18 11 212 10 44 21 994 2910-50 ha 293 40 4.334 40 76 47 964 46 72 34 1146 34
Above 50 ha 209 29 3.557 33 67 42 920 44 98 46 1246 37Total 734 100 10.913 100 161 100 2.097 100 214 100 3387 100
SOURCE: CIC, 2008.
Table 3 - Stratification of coffee holdings
29 Data relative to the average of the period in which the Brazilian Enterprise for Research on Farming and Cattle
Raising (Embrapa) was responsible for crop surveys.
Espírito Santo Bahia Subtotal Brazil Area % Production % Area % Production % Area % Production %
Below 10 ha 151 30 1213 29 8 9 74 9 452 27 5513 2610-50 ha 239 47 1721 41 34 39 329 39 714 42 8496 40
Above 50 ha 115 23 1244 30 46 52 442 52 535 31 7410 34Total 506 100 4178 100 88 100 844 100 1701 100 21419 100
SOURCE: CIC, 2008.
By and large, Brazilian coffee growers count on the support of research centers and class
associations which play an important role in supplying collective goods30. Most coffee growers
are affiliated with private cooperatives that disseminate technology and good practices of
agricultural production.
For this reason, Brazil has been the great inducer of innovation in the supply chain. These changes
have been evident since the early 1990s. In the new Brazilian production areas, in which holdings
are bigger than 500 hectares, the intensive use of technology is more clearly evidenced in the use
of ferti-irrigation and mechanization. The scale of production, allied to the configuration of the
flat areas of Brazil’s savannah, has favored mechanized harvest and increased average yields.
As shown in Graph 1, world coffee average yields in the years 1985 to 1995 was 8.8 bags per
hectare, while Brazil’s was 10.6 per hectare. From 1996 to 2005, world yields increased to 10.9
per hectare, whereas Brazil’s increased to 15.8 per hectare. It is clearly seen that Brazil is directly
responsible for the increased land productivity in the world’s coffee AIS.
It is also worthy of note that in the new production areas of Brazil productivity is well above the
country’s average: in some regions of the state of Bahia producers manage to harvest 100 bags per
hectare (SAES; NAKAZONE, 2002 and SAES; NAKAZONE, 2003). That means that these data
on average productivity cannot capture the real process of technological change in place.
Naturally, this process has been one of the main factors for coffee price decreases in the
international market, mainly due to the fact that Brazil participates with 30% (average 2002 to
2006) of the world exports of the product (CIC, 2008).
Graph 1 - World and Brazilian coffee production (bags per hectare) 30 The main research agencies that render services to the sector are: Agronomic Institute of Campinas (IAC),
Enterprise for Research on Farming and Cattle Raising from Minas Gerais (EPAMIG), Paraná State Agronomic Institute (IAPAR) and the Brazilian Enterprise for Research on Farming and Cattle Raising (Embrapa).
SOURCE: FAO (Harvested area) and ICO (production), (CIC), 2008.
Thus the characteristics of the production structure do not allow the negative effects of the prices
to affect the offer, thus preventing the natural adequation to low price stimuli31.This situation
generates a long cycle of low prices and losses for a large number of people who depend directly
and indirectly upon this commodity. The coffee offer increases not due to the demand, but
according to the availability of lands and under-employed labor and the advantages of profitability
that it offers in relation to other activities.
3.1.2 Transaction costs in coffee production: crop specificity
Apart from the question of the immobility of the production factor, the specificity of the crop is
the most studied aspect to explain price behavior in coffee production (DELFIM NETTO, 1973;
SAES, 1997).
Coffee is a perennial crop involving high irrecoverable costs. It takes a coffee tree from three to
four years to reach complete maturity. Such a long cycle determines that producers react too
slowly to market stimuli. A period of high prices fosters production for several years before the
31 Though it is accepted that the supply elasticity for price increments is also near zero in the long run, the same does
not happen in the long run. Long-term supply elasticities for several producing countries (10 years after the price increase) were estimated by Akiyama and Varangis (cited by SAES, 1997), who obtained the following results: Colombia 0, 74, Ivory Coast 0.84, Costa Rica 0.41, Burundi 0.95 and Brazil 0.36.
0
5
10
15
20
25
1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005
Thou
sand
60
kg b
ags
/ hec
tare
World Brazil
offer can have a full reaction. And, as soon as new coffee plantations start to produce, there is a
tendency toward overproduction, since it takes a long period of prices lower than direct costs for
producers to abandon their investments and eradicate the crop. The market operates with low
entry barriers and high exit barriers.
It is not hard to imagine the dilemma of any producer who must choose whether to abandon a crop
after having invested four to five years for the crop to begin producing. Agents also tend to
believe that prices may increase again in the longer term (there may be a drought or a frost in
producing regions of another location or more decapitalized farmers will abandon their crops).
This perception of the business, known as irrational escalation of commitment or commitment
bias (BAZERMAN; NEALE, 1998), results in a long period of adjustment, when considered
with regard to annual crops.
Graph 2 illustrates over a century of evolution of Brazilian coffee production and deflated prices
in the New York Stock Market. Production cycles resulting from a high in prices (damage caused
by frost or drought) can be clearly seen. Despite the fall in prices after a shock of high prices
(drought or frost), production growth keeps being driven by previous investments.
Graph 2 - World production (million 60-kg bags) and Brazilian coffee prices New York Stock Exchange - 1901 to 2004
(US $ per 60-kg bag) Deflactor: IPA-EUA – 1990 = 100
0
20
40
60
80
100
120
140
1901
1907
1913
1919
1925
1931
1937
1943
1949
1955
1961
1967
1973
1979
1985
1991
1997
2003
mill
ion
60 k
g - b
ags
0
100
200
300
400
500
600
US$
per
60
- kg
bags
Production New York
SOURCE: BACHA (1992) from 1901 to 1990 and ICO (2005) from 1990 to 2004. Prices: New York (CIC, 2008
But what contributes to worsen this situation is the relative price-inelasticity of the demand for
coffee in the short term. Production surplus is not easily absorbed by the demand in function of
the stimulus from the decrease in prices. The analysis of these natural characteristics of the coffee
market allowed Delfim Netto (1973, p.125) to conclude, in 1959, that the self-regulation
mechanism of the coffee market of the 19th century tended to cause mid- and long-term extended
and increased oscillations, characterizing a dynamically unstable market, where “depression
periods will be longer that prosperous ones”. For this reason, the author argued that stability
conditions in the coffee market are far more complex than those approached in the models that
analyze economic cycles of agricultural products32, tending to present cycles of growing
amplitude.
In fact, the rationality for the regulation of the international coffee market, with the creation of the
economic clauses of the International Coffee Agreements (ICA) within the International Coffee
32 The classical model to analyze agricultural markets is the Spider Web. Ideally, based on this model, prices can be
expected to change within the limits of a pendular movement with regular characteristics. When buyers acquire goods at a lower price to resell them at a higher price, prices are stabilized in the long run.
SeSeGea
Frost
Frost
Drought
Drought Frost
Frost Frost
Organization (ICO), was based on these promises. For a historic view of this market regulation,
see Box 1.
Box 1 – World International Coffee Market Regulation
The coffee market has a long history of regulation, started in the early 19th century. Holding at this time
three fourths of the world production and relying exclusively upon this product, in terms of foreign exchange receipts, Brazil adopted a unilateral policy to sustain prices. Until the early 1960s, the country made several attempts to implement agreements that would make other producing countries share the cost of its valorization policy. Since these attempts failed, Brazil had to use its own credit to stabilize the market.
In 1962, the first International Coffee Agreement (ICA) was signed within the scope of the International Coffee Organization (ICO), including 42 exporting countries and 25 consumers. Since then, the world market started to be systematically—with interruptions due to hiked prices—the object of a price maintenance policy, which continued until July 1989.
As the leading world producer, Brazil had a central role in the success of the price maintenance policy in the international market because it agreed to reduce its participation, becoming a residual supplier and retaining stocks, while competitors expanded their production. Thus Brazilian exports were defined by the difference between the world demand, at the price level established by IAC’s members, and the production of all other exporters (known as the “umbrella policy instrument”).
As a result, Brazil was losing its share in the global market. Whereas in the beginning of the century it accounted for 80 percent of world exports, in 1950’s that share had dropped to 40 percent and, in the 1980s, to 25 percent.
In the late 1980s Brazil took a different stand in the negotiations of the IAC’s economic clauses: that of no longer accepting reductions in its share of the international market. In 1989, the decision made by Brazil and the US—which under president Bush’ liberal philosophy was against a new export quota agreement—led to the collapse of the IAC with regard to the economic clauses.
The surplus of the world coffee supply in the early 1990s brought about a sharp fall in prices and subsequent crisis, not only for the sector, but also for several countries whose economy significantly depended on the those revenues. This crisis brought along the institutionalization of a new regulation body, the Association of Coffee Producing Countries (ACPC). In 2001, a new crisis in the sector and failed attempts to work out a mechanism of control over coffee prices led the ACPC’s council to announce its self-dissolution, through the elimination of its executive secretariat and administrative costs. The agency started to work in a new format, without a physical structure, keeping only the legal and juridical structures of the association. The ICO’s aim, by its turn, started to be the supply of public goods to its members, by implementing actions for coffee development with regard to fighting pests and diseases, quality improvement, certification and consumption increase.
3.2 Income distribution in the supply chain
In the late 1990’s and early 2000’s, coffee producers were confronted with another cycle of
surplus supply and low prices. In 2001, total world production reached a record of 120 million for
a consumption of 107 million bags.
Supply surplus was mainly triggered by the positive price stimulus of the mid-1990’s caused by
the 1994 frost and the 1997 drought in Brazil’s producing regions. High prices allied to low entry
barriers attracted new and old producers to the sector. There was a significant expansion of the
market in several producing countries, mainly in Vietnam and Brazil, as can be seen in Table 4.
Vietnam, which in the 1980-81 to 1989-90 crop years had produced 377 thousand 60-kg bags,
from crop years 2000-01 through 2007-08 becomes the second largest producer in the world with
a production of 14.8 million 60-kg bags.
Table 4 - Average production of main producers (in thousand 60-kg bags)
Countries 1960-61 - 1969-70
1970-71 - 1979-80
1980-81 - 1989-90
1990-91 - 1999-00
2000-01 -2007-08
% Total 2000-01-2007-08
Brazil 25370 19370 26515 27470 39825 33.7 Vietnam 48 66 377 4661 14825 12.5 Colombia 7815 9476 12514 12797 11663 9.9 Indonesia 2196 3204 5853 7004 6459 5.5 India 1131 1757 2478 3562 4771 4.0 Ethiopia 2675 3653 4651 4843 4297 3.6 Mexico 2218 2700 3125 3631 4230 3.6 Guatemala 1777 2321 2794 3783 3802 3.2 Peru 823 1025 1206 1575 3020 2.6 Honduras 422 841 1439 2328 2973 2.5 Uganda 2688 2712 2732 3247 2701 2.3 Ivory Coast 3431 4337 4144 3643 2668 2.3 Costa Rica 1097 1441 2247 2526 2057 1.7 Others 15527 18934 20757 18359 14880 12.6 Total 67218 71834 90831 99427 118171 100.0 SOURCE: ICO (2008)
The growth in production both in Vietnam and in Brazil has been mainly occurring with the
Robusta species, as seen in Graph 333. In 1990, according to the ICO (2008), the main Robusta
producers, by order of importance were: Indonesia (6.7 million 60-kg bags), Ivory Coast (4.7
million 60-kg bags), Brazil (3.5 million 60-kg bags) and Uganda (2.2 million 60-kg bags). In
2006, Brazil produced 10.7 million 60-kg bags of this species and Vietnam 18.1 million 60-kg
bags.
Graph 3 - World production of Arabica and Robusta coffee (thousand 60-kg bags)
33 There are many coffee species and varieties. The ones with economic importance are Coffea arabica and Coffea
Cannephora (known as Robusta). The former is known by its superior quality and price and grows mainly in South and Central America, Kenya and Tanzania. Large-scale production of the latter mainly occurs in Vietnam, Brazil, Ivory Coast, Angola, Uganda, India and several other countries in Africa, Asia and Oceania. Brazil is the largest world producer of Arabica and the second largest producer of Robusta (SAES; FARINA, 1997).
SOURCE: ICO (2008).
The growth in coffee production, mainly of the Robusta species, tends to further reduce prices,
once these species are complementary goods and Robusta is offered at discount prices below par
value in comparison with the Arabica, as seen in Graph 4 (which shows daily prices of Arabia and
Robusta, deflated, and the respective futures markets, since the early 1990’s in the New York and
London futures markets.
Graph 4 - Arabica and Robusta coffee closing quote - New York Coffee, Sugar and Cocoa
Exchange (CSCE) London International Financial Futures and Options Exchange (LIFFE), 1st contract, in 1982 U.S. dollar values, per 60-kg bag 34
0,000
50,000
100,000
150,000
200,000
250,000
300,000
350,000
01/0
3/19
91
01/0
9/19
91
01/0
3/19
92
01/0
9/19
92
01/0
3/19
93
01/0
9/19
93
01/0
3/19
94
01/0
9/19
94
01/0
3/19
95
01/0
9/19
95
01/0
3/19
96
01/0
9/19
96
01/0
3/19
97
01/0
9/19
97
01/0
3/19
98
01/0
9/19
98
01/0
3/19
99
01/0
9/19
99
01/0
3/20
00
01/0
9/20
00
01/0
3/20
01
01/0
9/20
01
01/0
3/20
02
01/0
9/20
02
01/0
3/20
03
01/0
9/20
03
01/0
3/20
04
01/0
9/20
04
01/0
3/20
05
01/0
9/20
05
01/0
3/20
06
USD
/60
kg
Robusta Arabica SOURCE: CIC (2008).
34 Figures deflated using U.S.A.’s Consumer Price Index (CPI)
0
20.000
40.000
60.000
80.000
100.000
120.000
140.000
1960/61 1965/66 1970/71 1975/76 1980/81 1985/86 1990/91 1995/96 2000/01 2005/06
thou
sand
60
- kg
bag
Robusta Arabica
62%
38%
81%
19%
It is worth observing that, in the 1990’s, as a means to profit from the increased supply of Robusta
coffee, large roasters developed a new technology called vaporization, which allows increasing
the use of Robusta as filler in their blends. This new technique of steam-cleaning uses the same
equipment as decaffeination and, by reducing undesirable off-flavors of this raw material,
neutralizes their impact on the drink (SAES; NAKAZONE, 2002; SAES; NAKAZONE, 2003).
As seen in, the deflated coffee prices of the late 1990’s neared those seen n the worst crisis of the
commodity of 1930, and reflected on producers’ absolute income. From revenues of 12.3 billion
dollars verified in the 1997-98 crop, producers started to receive only 5.1 billion U.S. dollars in
2002-03 (Graph 5). According to Fitter and Kaplinsky (2001), in 2001 almost no rural producer in
the world could cover production costs, even when labor costs were near zero.
Graph 5 - Revenues from world coffee exports in all forms (billion US$)
12,210,1
8,17
5,39 5,12 5,64
02468
101214
1998 1999 2000 2001 2002 2003
billi
on U
S$
SOURCE: ICO (2008).
In contrast to what had happened in previous low-price cycles, the impact of the fall in prices was
this time particularly debated under the perspective of the asymmetric division of the rent
generated in the coffee chain (DAVIRON; PONTE, 2005, GIOVANNUCCI, 2001; FITTER;
KAPLINSKY, 2001).
Graph 6 illustrates the decline of the rural population’s share in the total income generated in the
coffee chain, in the last three decades of the 20th century. Naturally, the participation of producing
countries decreases as the share of consuming countries’ value added grows. In the 1970’s,
producers answered for some 20 percent of the total generated by the supply chain, whereas in the
1990’s they started to account for some 10 percent, due to the increase in the value added to their
products in consuming countries.
Graph 6 - Distribution of gains along the coffee chain
SOURCE: TALBOT (1997).
Studies concerning the problem of the division of the gains in supply chains argue that the speed
of diffusion of price transmission among the upstream and downstream segments is asymmetric.
The variations of price paid to producers of coffee beans are not totally transferred along the
chain, pointing to the fact that the margins of both the retail and the processing companies grow
when there are surplus supply and price decreases of green coffee (DAVIRON; PONTE, 2003).
In his analysis of four agricultural products from 1970-1995, among which is coffee, Morisset
(1997) shows the decrease in the prices of the raw material of these goods in the international
market on the one hand and, on the other hand, the increase in prices paid by consumers, which
indicates an increase in the margins of the segments up and downstream of the agricultural sector.
In addition to that, the author verifies the decrease in agricultural producers’ percentage
participation of in the total generated by the agro-industrial sector which, according to him, is a
consequence of the sector’s market structures: little concentrated in the rural segment and
increasingly monopolized in the retail and processing segments.
In another study, Cankorel (2000) analyzes the coffee market in 14 countries, which represent 77
percent of the world’s coffee imports, between 1977 and 199935. This work proves that there was
an increase in the margins between international and retail prices in the consuming markets of 11
of the countries studied, mainly for Japan, the United Kingdom, the US and Italy. Only for three
countries, Germany, France and Finland, the results of the regressions point to a weak relation 35 The data used, supplied by the International Coffee Organization (ICO) were: the price of roasted coffee in the retail
and the Composite Price Index, to represent the price of green coffee in the international market. This index, calculated by the ICO, is the weighed average of four groups of coffee: Mild Colombian (15 percent), other Mild (30 percent), Natural Brazilian (20 percent) and Robustas (35 percent).
0%
20%
40%
60%
80%
100%
1971-80 1981-88 1989-95
Value added inconsuming countries
Transportation costsand losses
Value added inproducing countries
Price paid to producers
between margin and time. The conclusion is similar to that of Morisset’s, admitting that the result
found reflects the changes in the structures of the markets of the industry, which have suffered a
strong process of concentration at several levels. These dynamics, according to Cankorel, allow
large multinational companies to exercise market power, thereby increasing the difference of their
margins.
In the 1990’s, the coffee roasting industry of developed countries became concentrated, and
started to present important leadership changes. In 1978, the average Herfindahl-Hirshman36
index was 543, whereas in 1999 it was 1299. As a consequence, from being non-concentrated in
the 1970’s it became moderately so by the late 1990’s.
According to Oxfam (2002) data, the profit margins of firms that produce ground and roast coffee
in the world market have increased by 17 percent and those of soluble producing firms by 30
percent. It is important to distinguish between these two types of industry, since they show an
important difference in terms of technology. The soluble coffee industry requires sophisticated
plants and is very capital intensive, thus requiring a very concentrated structure, and makes almost
impossible the presence of small-and medium-sized firms in this sector.
In the case of the roast and ground industry, on the contrary, the sector can accept small roasters
side-by-side with large ones, because the capital required for the business is much smaller. That
explains the difference in the margins of both industries. Despite being concentrated, the roast
industry is in a competitive fringe. In the United States, for instance, it is estimated that there are
1900 small- and medium-sized roasters, holding at least 20 percent of the domestic market
(DAVIRON; PONTE, 2005), whereas the three largest ones hold over 80 percent of the market in
terms of volume: Folgers, with 38 percent, Maxwell House, 33 percent and Sara Lee, 10 percent.
According to Leibtag et al. (2007), the three largest such firms in the U.S. adopt a coordinated
price policy, not following sudden price alterations in the raw material. Thus a 10 percent increase
in the price of green coffee corresponds to an increase of only 3 percent in retail prices.
This behavior can be visualized in Graph 7, which presents the evolution of green Arabica coffee
prices (paid to producers) and retail prices in the United States. From 1997 to 1999, when prices
paid to producers increased due to weather problems in the producing regions, retail prices
36 The Herfindahl-Hirschman index (HHI) is calculated based on the sum of squared squares of the percentages of the
market shares held by the firms in a market. An HHI below 1000 means that the industry is "un-concentrated", between 1000 and 1800 "moderately concentrated", and above 1800 is "highly concentrated”.
increased at a lower proportion. In contrast, when prices decreased, retail margins increased.
Taking into consideration that the growth in coffee production in different regions of the world
allows companies to acquire coffee from different sources, these companies can buy the cheapest
raw material. That is possible because crops mature in different periods.
Graph 7 - Prices paid to Brazilian producers of Arabica coffee beans and prices of roasted coffee
in U.S. retail (U.S. cents per lb)
SOURCE: ICO (2008).
Another interpretation of the crisis is provided by Daviron and Ponte (2005), in their “The coffee
paradox”. The authors argue that coffee growers’ loss in income participation is associated neither
to problems arising from disequilibrium between supply and demand, nor to issues upstream or
downstream of the agricultural sector, as previously discussed.
In their opinion, the crisis is a paradox of the coffee supply chain. On the one hand, this chain is
characterized by the boom in the consumption of specialty coffees, driven by the ascension of a
consumption pattern more and more sophisticated and differentiated. On the other hand is rural
producer’s segregation from this differentiation strategy. The authors defend that the coffee sold
in the international market and the coffee negotiated for the end consumers are becoming
increasingly different. Accounting for that is the fact that roasters and retailers are not selling the
same product as coffee producers. Instead, they are selling a product with an aggregated symbolic
value with attributes of service quality. Rural producers do not control part of this immaterial
production. Thus coffee producers are stuck to a position of commodity producers even though in
developed countries this product no longer has the status of commodity.
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Thus, in reality, the scenario created as of the late 1990’s decreased the participation of the
agricultural segment in the total income generated in the supply chain. The coffee raw material at
the end of the chain—i.e., in the cup—has a substantially smaller participation as compared with
the other cost items. In coffee shops, for instance, coffee represents a mere 6 percent of the total
price of a cappuccino, as seen in Graph 8.
Graph 8 - Percentage of retail price of one cappuccino in a coffee shop
SOURCE: FITTER; KAPLINSKY (2001, p. 7).
Based on what has been described so far, we can see that the market dynamics have been affected
by a number of factors, which include the following: (a) High transaction costs in agricultural
production due to the non-mobility of production factors and the specificity of the agricultural
production; (b) oligopolistic features of the sectors downstream from the rural producers; and (c)
new market strategies of retail and processing firms driven by the growth of the specialty coffee
market.
Considering that this last aspect is recent, it is important to examine these trends to validate the
arguments given by Daviron and Ponte (2005), who assert that the changes occurring in the coffee
market are increasing the concentration of income in the segments of the supply chain beyond the
farm gates.
We suspect that the differentiation process, as symbolic as it may be, as defended by the authors,
will require attributes of the product in the cup, which depend upon incentives to producers.
6%
8%
15%
16,5%
16,5%
17,5%
25%
0% 5% 10% 15% 20% 25% 30%
Coffee
Other Costs
Administrative costs
Other Products
Profit
Taxes
Personnel
Therefore, we admit that, according to the complexity involved in the exploration of the attribute
differentiation—due to the fact that it involves a specific investment, which is hard to measure—
the supply chain will be reorganized and that can become an opportunity for the rural producer.
But before examining this question, let us first see what the specialty coffee market is.
3.3 The specialty coffee industry and the rural segment
According to Kotler (1999), a commodity is a product waiting to be differentiated. It is only
necessary to develop or discover attributes that allow consumers to have the desired perception of
the product. This perception can be based on physical differences, availability of services or an
image associated with the good—like its place of origin—or the exclusive use of a name or brand.
Coffee has a host of possibilities for differentiation, starting with the attributes related to the
variety of the bean (Brazilian Bourbon coffee bean, for instance), including production processes
(organic, shade-grown, family-farmed, Fairtrade38), place of production (origin, estate coffee39),
types of processing (natural coffee, pulped cherry and demucilated40), quality of the drink (which
takes into account aroma, taste, body and acidity), the industrialization process (aromatization,
decaffeination), type of preparation (espresso, cappuccino) and even the place where it is sold
(coffee shop). This wide array of possibilities has been under the denomination of specialty
coffees. One definition that encompasses all these possibilities is presented by Zylbersztajn and
Farina (2001, p. 68-69):
The concept of specialty coffees is closely associated with the pleasure derived from the drink. Such
coffees stand out for some specific attribute linked with the product, the production process or a service
related to it. They differentiate due to characteristics such as superior quality of the drink, aspect of the
beans, type of harvest, type of preparation, history, origin of the crops, rare varieties and limited
quantities, among other aspects. They can also include parameters of differentiation related to the
economic, social and environmental sustainability of the production, so as to promote more equity
among the links of the supply chain. Changes in the industrial process also lead to differentiation, with
the addition of substances like in the case of aromatized coffees, or their subtraction, like the
38 Fairtrade coffee is directly bought by small producers’ cooperatives that guarantee a minimum price, pre-established
in a contract. This market will be discussed in the next item. 39 Coffee originated on a farm. 40 Coffee is processed in the following ways: (a) Natural coffee: After being washed, newly harvested coffee fruits are
taken to sun-dry on a brick patio before going to the dryer; (b) Hulled cherry: Coffee beans are washed, green and dry beans are separated from ripe ones, and then they are hulled. Next, they go to a drying terrace where the mucilage adheres to the beans bringing unique characteristics like body, acidity and sweetness; (c) Pulped, also known as demucilated, are processed similarly to the hulled cherry coffee; beans are also hulled, but this process includes a fermentation process that requires from 24 to 36 hours to remove the mucilage. That allows a uniform type of coffee, mild and more acidic. It is recommended for regions with an excess of rain (ZYLBERSZTAJN; FARINA, 2001).
decaffeinated. Traceability and service incorporation are also factors of differentiation and, therefore, of
value-aggregation.
This definition aggregates several concepts. Some concern easily observable or testable aspects,
and others regard aspects that are hard to identify, such as the conditions under which the beans
were produced. Thus differentiation attributes can be associated with tangible characteristics, like
the physical and sensorial features, and intangible ones, like those present in the goods of belief 41,
whose features are not readily identifiable. When it is hard to identify attributes, mechanisms are
necessary to reduce the consumers’ uncertainty, which can be represented by certification or
brand tools. In other words, the differentiation strategy adopted will require new arrangements in
the supply chain so as to make it effective. The type of arrangement can vary, including a
certifying organization, the adoption of differentiated contract forms or even vertical/horizontal
coordination in the supply chain.
And though differentiation through origin is well known nowadays—the most famous such brand
is Café de Colombia—before the 1980’s the chain as a whole showed few differentiation
attributes. Even on the shelf, brands varied little, and were highly elastic, with a limited
monopolistic power 42.
In contrast with the consumption of soft drinks, the world demand for coffee grew slowly in the
1990’s, at a rate of only 1.1 percent a year. In the American and European markets there was a
decreasing trend in per capita consumption. Research has showed that consumer’s behavior was
associated with the difficulty of conveying to young people the image of a favorable product,
apart from the association made by older people of coffee being harmful to the health. In the
United States, the largest world consumer of the drink, consumption dropped from 2.0 to 1.7 cups
a day per capita between 1980 and 2000, with the highest fall being registered among young
people. In 1962, 81 percent of the population aged 20 to 29 drank coffee, whereas in 1990, this
share had dropped to 31.2 percent. Among people aged 30 to 59, coffee consumption decreased
from 90.8 percent to 65.7 percent in the same period (THE ECONOMIST, 1996, p. 96).
41 Douglas (1992) classifies good and services as research, experience and belief. This classification is based on the
difficulty and cost consumers face when evaluating the quality of a product at the moment of the purchase. Information costs for consumers increase from researching the good, experience and belief, due to the difficulty of evaluating attributes.
42 A study conducted by Nevin (cf PINDYCK; RUBINFELD, 2002, p. 426–427) of the Hills Brothers, Maxwell House and Chase & Sanborn brands, verified that the price elasticity of the demands were 7.1, -8.9 and -5.6, respectively.
In the late 1990’s, this scenario started to change with the arrival of specialty coffees. This market
inflection point began with the appearance of coffee shops and cafés with sophisticated drinks and
differentiated drinks that attracted the young public.
A remarkable example is that of Starbucks Coffee Company. Founded in Seattle, Washington,
United States, after some fifteen years of existence it had almost 15 thousand sales points and its
billings reached 7.8 billion dollars in 2006. That growth led to the entry of companies like Second
Cup, which has a strong presence in the American market and is the second largest network of this
segment in the Canadian market. Other networks, like McDonald’s, were also stimulated to
introduce espresso coffee in their shops, in several countries. The growth of the sales of specialty
coffees reflected in the market of roast and ground coffee of the large multinational companies,
which introduced segments of specialty coffees.
According to the Specialty Coffee Association of America (SCA), the specialty coffee market
grew from 3 billion in 2006 (CIC, 2008). In the United States, also according to estimates
from the SCA43, the daily consumption of coffee among young people aged 18 to 24 grew in the
2000’s. In 2007, 37 percent of young people interviewed reported that they drank the product
daily, in contrast with 16 percent in 2004. The number of adults consuming this product daily
increased from 49 percent to 57 percent in the same period. For this reason, the U.S. Department
of Agriculture started to follow the consumption of gourmet coffee since 199944, which started to
be reflected in the growth of the global U.S. market, after almost four decades of retraction, as
seen in Graph 9.
Graph 9 – U.S. domestic coffee consumption – Regular and Gourmet
43 Based on an annual national survey at the national level conducted over the telephone. 44 The term gourmet coffee is used in the specialty market as an indicator of coffees with superior quality. It is related
to the intrinsic features of the green bean that are involved in the end-quality of the drink, like aroma, taste, acidity and residual flavor. By and large, it refers to prepared coffees, type 3 or better (number of failures in a 300 gram sample), with a very good uniform aspect, with soft/strictly soft drinkability (the highest punctuation that a coffee can receive in the classification of the drink.
0,00
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1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1996 1999 2002 2005
xíca
ras
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apita
Regular Gourmet SOURCE: CIC (2008).
In parallel with the boom of coffee shops and cafés and the increased billings of coffee roasters,
three other movements that began in the developed countries have brought a new connotation to
specialty coffees. Nevertheless, their appeals are different. One movement is concerned with the
impoverishment of coffee producers, another seeks to preserve the environment, and the third
defends the consumption of healthy foods. They all ended up aggregated in the so-called
sustainable coffee market. The advance of these movements, which are coming closer together
through life-style and philosophy, has been reflected in the global market, imposing the need for
special attention from retailers and processing firms in terms of marketing strategies.
A typical example of this type of action was what happened in 1999, in Seattle, during the
negotiations of the World Trade Organization (WTO). A large manifestation of common people
and NGOs accused companies of growing at the expenses of the impoverishment of
underdeveloped countries. Starbucks was one of their targets. According to the people present,
Starbucks exploited third world coffee producers. In answer to that, this network signed a contract
to launch a line of coffee with the Fairtrade certification (HORNBLOWER cited by SAES;
NAKAZONE, 2002). In 2005, Starbucks acquired 10 percent of the global supply of Fairtrade-
certified coffee, which corresponded to 11.5 million pounds45.
Despite the upward market trend, the sustainable coffee market is still small. In 2000 it answered
for less than one percent of the world’s total in terms of volume (0.29 percent) and a little over
one percent in terms of value (Table 5). From 1999-2004 the specialty coffee segment grew at a
rate of some 10% per year in several countries of Europe and in Japan (GIOVANNUCCI;
45 http://www.starbucks.com/aboutus/StarbucksAndFairTrade.pdf
KOEKOEK, 2003). Exclusively with regard to Fairtrade-certified coffee, 52 thousand tons were
negotiated in 2006 against 11.9 thousand tons in 1999, according to the Fairtrade Labeling
Organizations International (FLO)46.
Table 5 - Distribution of gains along the coffee chain
Volume Retail value Thousand 0 kg bags
% of total cofffee market
US$ million % of total coffee market
Total of market coffee 111,545,5 100 49,257.00 100 Total of sustainable coffee 318.2 0.29 565.00 1.15 Certified soluble 272.7 0.24 490.00 0.99 Total of organic coffee 160.6 0.14 286.00 0.58 Certified organic coffee 125.0 0.11 223.00 0.45 Certified Fairtrade 220.5 0.20 393.00 0.80 Total shade-grown 17.4 0.02 30.50 0.06 Certified shade-grown 9.1 0.0 16.20 0.0 SOURCE: PONTE, 2004, p. 42.
3.3.1 Categories of specialty coffees
For the purpose of analysis, specialty coffees are divided into five categories: Exceptional quality,
origin, organic, shade-grown and Fairtrade. Nevertheless, these are not static markets; they
overlap each other more and more (Picture 5). Consumers’ demand for Fairtrade coffee, for
instance, has been preferably associated with its organic quality. The attribute drink quality is an
increasingly important requirement for sustainable coffees. Besides that, environmental and social
sustainability is becoming a requirement for high quality coffees.
Each type of differentiation presents differentiation attributes required for producers to enter the
market, attributes that determine consumers’ perception of the differentiation strategy,
conditioners of profitability for producers, and, finally, the necessary requirements for producers
to adopt the strategy.
Picture 5 - Categories of specialty coffee
Type of Differentiation
Attributes Required for the producers
Attribute most important in the chain according to
consumer perception
Profitability drivers for producers
Requirements for producers to adhere to strategy
a) Exceptional b) quality
To produce with quality
Brand (company’s). Low entry barriers. To produce quality. can be induced by price
46 http://www.fairtrade.net/.
premium c) Origin (Estate
Coffee) To be located in a region that has a specificity.
Certificação de café de Origin in the region, brand of farm
High entry barriers (must be limited )
To be in the region and produce according to certification requirements
d) Organic To use method that preserves soil and absence of pesticides and highly soluble fertilizers
Organic coffee certification.
Low entry barriers. Producers have certification. Price must compensate investment / in poor countries there is no need for investment.
e) Shade-grown (eco-friendly)
To produce in the forest shade.
Eco-friendly coffee certification.
A high entry barrier, a large part of the world’s production is sun grown.
Producers must be producing in areas of forest and must be certified
f) Fairtrade To be a small producer and be associated to cooperative
Fairtrade coffee certification
High entry barriers (FLO defines the growth of associates’ number according to demand).
Producers must adhere to Fairtrade rules
SOURCE: Based on GIOVANNUCCI (2001)
(a) Exceptional quality coffees
The quality of the coffee drink is related to the intrinsic characteristics of the green bean, which is
involved in the composition like: aroma, taste, body, acidity and residual flavor. In general, every
ripe fruit (cherry) of Arabica coffee in the tree has the potential for a high quality drink47. The
depreciation of the bean takes place after it is picked, i.e., in its processing, storage and
transportation. If adequate methods are not adopted in the post-harvest stages, the natural sugar
contained in the bean will favor fermentation, making the drink astringent.
For processors whose brand strategy is high quality, the acquisition of coffees with the required
characteristics can be via the market, since the internationally adopted coffee standardization and
classification systems are efficient. Prices above and below par in the futures markets reflect not
only the scarcity and lack of the product, but also the differences among the coffee qualities.
Thus, once the analysis of the samples to be acquired takes place, processors know exactly the
quality of the product they will receive.
One of the problems verified in these markets that can lead to difficulty in finding a better quality
product is the fact that, in general, the commercialization system does not give producers adequate 47 The classification according to the quality of the beverage (coffee taste and aroma) is carried out by cuppers
who, in sessions called Cup Tests, determine the quality through the use of the senses of the taste, smell and touch (mouth-feel). This type of analysis admits seven scales for the quality of he beverage: strictly soft, Soft (pleasant taste and mild) Hard (acid or sharp taste), Softish; Riada; Rio (very hard type preferred in Rio de Janeiro).; Rio Zona.
incentives. This is quite common in the case of coffee, due to its commercialization process
because, particularly in African and Central American markets, intermediaries create irrelevant
information (noise) whilst making use of privileged information
Information asymmetry and divergent interests enable companies to make profits in the
intermediation process, inadequately prizing high quality coffees. This practise, in which the
person holding privileged information can impose losses on another party, leads to adverse
selection, and consequent lack of stimulus to high quality coffee production, since the market does
not usually value it.
If the market does not function properly, since there are transaction costs, companies whose
strategy is differentiation through high quality need to coordinate the supply chain aimed at
obtaining gains of efficiency. That explains why, in order to implement their strategy, companies
like Illycafè were obliged to buy green coffee directly from Brazilian producers, creating a unique
incentive system in their production of high quality coffee, as we shall see in chapter 4.
In addition to that, the growth of the socio-environmental demand has triggered actions directly
connected with raw material suppliers in companies’ agendas. They started to include in the field
a “Manual of good agricultural and social practices”, as a function of agricultural extension
technicians. To that end, they cannot evade the imperative of the fundamental transformation of
the relations between producers and processing companies, with the latter playing the role of
coordinator of the supply chain, a role previously played by price mechanisms.
(b) Origin, Estate Coffee
With the arrival of the specialty coffees, the quality of the drink has incorporated a series of
concepts which have brought coffee and the wine market very close together. At the global level,
issues like location, altitude and soil quality have also been added by coffee tasters—or cuppers—
to the definition of gourmet coffee. For instance, it has been observed that beans produced in
regions over 800 meters high and those grown in volcanic soils present peculiar characteristics.
These are sold at a premium price, as is the case for such brands as Blue Mountain from Jamaica,
Kona Fancy from Hawaii, Bleu from Haiti, Sagri A. from Papua New Guinea, Yirgacheffe from
Ethiopia, and A.A. from Kenya.
In Brazil, the first strategy to promote the product as coffee of origin in the specialty markets was
implemented in 1992, when producers the savannah (cerrado) region of the state of Minas Gerais
founded the Council of the Savannah Coffee Growers - Caccer (SAES; JAYO, 1997). In 2005,
the first coffee brand with a geographic indication of origin (GIO) was officially recognized at the
world level, according to the norms of the World Organization of Intellectual Property (WOIP).
The characteristics of the place of origin—savannah—include a high plateau region, about 1000
meters high, and a continental climate with well-defined seasons having a hot and rainy summer
and dry winter.
Theoretically, this strategy related to the origin is the one offering the highest possibility of
capturing value. A limited area, with high barriers to entry by regulation can ensure the earning of
Ricardian rents. For this reason, this is a type of strategy hard to be implemented; it requires
norms and negotiation among the interested players and can give rise to conflicts or the actions of
free-riders among the excluded.
Further, this strategy needs to be accepted by buyers upstream from growers, who will have to
invest in a brand through the identification of origin and start to depend upon a single and
exclusive raw material supplier. This situation can lead to contractual problems ex-post and
transaction costs48. According to a representative of a European roasting company interviewed by
Daviron and Ponte (2005, p. 150): “Roasters have no interest in disseminating the culture or
origin because they want to defend their own brands. They do not want consumers to identify
coffee as coming from Kenya, but as Lavazza49”.
In the case of producers of large quantities of coffee, the concept of Estate Coffee is a more
efficient strategy, since the company itself can have a partnership with a small roaster/cafeteria
(ZYLBERSZTAJN; FARINA, 2001). Alternatively, the producer can industrialize the product for
a specific niche of a commercialization channel. Nevertheless, these strategies are limited to
market niches with agreements with small roasters and/or cafeterias
Small producers, on the other hand, feel that the biggest difficulty in this type of strategy is to find
a partner who is willing to share. Given the high asset specificity (place) and, therefore, a high
48 To some extent, this verification is what also happens in the wine market, as of the 1990’s, with the entry of companies that do not have tradition and do not want to depend upon the origin to grow in high quality wine market. In a marketing strategy they started to introduce the concept of grape varieties, thus decreasing the importance of the origin in determining the quality of the drink. On this issue, see Saes (2006).
bilateral dependence, the probability of hold-up can shun investors, mainly the large processing
companies.
(c) Organic
The organic practice among coffee producers is adopted in a large number of countries, since
many do not use pesticides and soluble fertilizers. To be labeled as organic, both production and
processing must be monitored by accredited certifiers. In countries that export organic foodstuffs,
certification can be carried out by local bodies, partnerships between local and international
agencies or by branches of international inspection bodies.
The main exporters of certified organic coffee are: Ethiopia; Colombia, Mexico, Nicaragua and
Honduras, as seen in Graph 10. The countries do not have a specific strategy for the production of
the organic product. Instead, they benefit from the fact that they have small areas, use family labor
and adopt traditional cultivation practices, given the scarcity of financial resources to acquire
inputs. Thus, despite their low productivity, their production costs are relatively low compared to
those of conventional production.
Graph 10 - Exports of certified organic coffee per origin
October 2005 to June 2006
SOURCE: ICO (2008).
In Brazil, the organic system was introduced in the 1990’s, but it was only in the early 2000’s that
this production started to have a significant increase, being mostly exported. Compared to other
world producers of organic coffee, Brazilians have their production costs higher than that of
traditional production, mainly due to labor.
The strategy to invest in the organic market makes producers face two types of problems due to:
(a) the cost of certification50 and the requirement of different certifications for different markets.
Because it is a “belief good”, consumer’s guarantee that the product has the desired attribute
depends on a certifier with a good reputation and each market trusts a specific certifier. Thus,
producers often need more than one certification to place their products in different markets,
which increases costs; and, (b) low entry barriers to the market, which determines that prices
behave in a similar manner to those of conventional coffee. The excess in the offer of the product
can make producers negotiate the organic coffee the price of the conventional coffee, despite their
low productivity and higher costs (in the case of Brazil). Thus the sustainability of the prices of
50 There are several certifying bodies, which are under the umbrella organization IFOAM (International
Federation of Organic Agriculture Movements). IFOAM congregates and coordinates the network of organic movements at the global level, and its main responsibility is to establish the exchange of information among its associates. It has an international program that accredits certifiers, operated by the IOAS - International Organic Accreditation Service. Until 2001, the IOAS had accredited seventeen certification bodies. In this same year there were also ten agencies in the process of being certified, from countries like New Zealand, Germany, Japan, the U.K., the U.S., the Czech Republic, Thailand and China (FARINA, 2002).
6.874
67.066
12.531
100.164
21.788
41.11729.553 34.445
0
20.000
40.000
60.000
80.000
100.000
120.000
Brazil Colombia El Salvador Ethiopia Honduras Mexico Nicaragua Others
60 –
kg
bag
s
this market depends on a demand that suffers the same price oscillations as the conventional
coffee.
d) Shade-grown coffee
Coffee grown under a canopy of wild trees supplies a habitat for birds, insects and animals; hence
its denomination eco-friendly. Shade-grown coffees were born from society’s demand for
products that respect the environment. The valorization of this market niche would allow the
maintenance of producers of these types of coffee in the market, since they cannot compete with
large-scale production due to the low yield of these plants, much inferior to that of conventional
coffee. In some regions, like El Salvador, Mexico and Colombia, this production is associated
with eco-tourism activities, which generates other forms of rents.
This is a very specific and not very representative market, since price premiums are lower that
those of organic coffee, as seen in Table 6. Considering that forest coffee has a much lower
productivity that the conventional, this market is limited to regions where coffee is already
planted.
Table 6 - Average premium: Organic, Fairtrade and shade-grown in the U.S., 2000 (US$/lb)
Organic Fairtrade Shade-grown Importers 0.36 0.74 0.35 Distributors 0.47 0.48 0.44 Wholesaler 0.50 0.58 0.49 Roasters 0.46 0.51 0.41 Retailers 0.64 0.65 0.60 Industry Average 0.59 0.62 0.53 Average among categories 0.49 0.59 0.46
SOURCE: DAVIRON; PONTE (2005, P. 166).
(d) Fairtrade
The certified Fairtrade label first appeared in the late 1990’s in Germany under the umbrella of the
Fairtrade Labeling Organizations International - FLO network. Aimed at contributing to the
sustainable social and economic development, FLO seeks more equity in the international trade by
focusing on the guaranty of the rights of producers and marginalized workers from
underdeveloped countries.
The main guidelines of this movement include the payment of fair wages to workers, cooperative
work, consumer education, environmental sustainability, technical/financial support and respect
for cultural identity (DICUM; LUTTINGER, 1999).
Thus it aims to improve the standard of living for coffee producing families in developing
countries, through a system that allows growers to sell their product directly to roasters and
retailers, thereby eliminating intermediaries.
The Fairtrade movement acts by guaranteeing minimum floor prices to certified producers, in
opposition to the price volatility of the commodity in the international markets. Another
distributive mechanism used is the obligation that the premium obtained by the producers’ sales
be invested in actions designed to benefit the community as a whole.
The minimum price can be sustained through a control of the offer of the product according to the
demand, thereby creating a scenario significantly different from the coffee world market.
(DICUM; LUTITINGER, 1999; DAVIRON; PONTE, 2005). Graph 11 shows price variations in
the New York Stock Exchange vis-à-vis Fairtrade market prices. The Fairtrade price over 1998-
2006 was established at 121 cents of dollar per pound of coffee. When the New York Stock
Exchange price was above the Fairtrade price, producers received the premium of 10 cents of
dollar per pound. On June 1st, 2007, the premium increased 5 cents of dollar per pound.
Graph 11 - Arabica coffee market: New York Stock Exchange and Fairtrade - 1998-2006
0,00
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300,00
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03/0
1/19
89
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90
03/0
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91
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92
03/0
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93
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94
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95
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96
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97
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98
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00
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01
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03
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04
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05
03/0
1/20
06
US
cent
s lb
Nova Iorque Fairtrade SOURCE: CIC (2008).
The Fairtrade market also has high entry barriers, since it needs to maintain a limited offer so that
the prices established by the FLO can be maintained. Thus only a small parcel of the population of
coffee growers has conditions to participate is in this market. Prices would not be maintained
otherwise. With the logic of cartel, the Fairtrade market may find a limit to its operation if other
certifiers enter this market and cause prices to fall.
These are, therefore, the main characteristics’ of the dynamics of the coffee market, which shall
serve as a backdrop for the empirical analysis and theory application to be presented in the
following chapter.
CHAPTER 4
VALUE CREATION AND APPROPRIATION: DIFFERENTIATED COFFEES
4. 1 Introduction
4. 1 Introduction
This chapter aims to discuss experiences that allow the theoretical platform presented in Part I of
this work to be illustrated. Drawing on the analysis offered in Chapter 2, these experiences have
been grouped into three categories: (a) Joint interdependence, designed to examine the strategic
focus on the value creation of the Cooxupé Coffee Growers Regional Cooperative. (Cooxupé). As
idealized by its founder, Cooxupé’s strategy consisted in investing in the direct export of premium
coffee, with gains of scale in terms of commercialization; (b) Sequential interdependence,
approaching the coffee brand of exceptional quality created by the illycaffè roaster’s owner. Such
strategy required an action targeting the coordination of the supply chain in Brazil; (c) Mutual
interdependence, in which two cases are presented: the experience of coffee growers from
localities named Baturité and from Poço Fundo. Both communities have registered actions from
growers aiming to add value to their coffee based on the market of sustainable brands; in Baturité,
the key focus is on the Brazilian consumer, whereas in Poço Fundo, the emphasis is more on the
foreign side, of the market. Taking the contemporaneity of these two cases into consideration, the
results obtained in terms of the sort-run rent appropriation remain unclear, although they do
provide some interesting reflections with regard to theories and public and private policies.
4.2 Joint interdependence: Cooxupé making progress in the path of SOCIAL network
economics
The experience that will act as the cornerstone of this item depicts a long history of growth
established by Cooxupé, a cooperative situated in the state of Minas Gerais. Cooxupé is the
largest member-owned corporation of coffee growers in the world. It trades in some 3 million 60
kg bags of coffee a year, accounting for 11 percent of Brazil’s production. It comprises some 11.2
thousand members, 80 percent of whom are small producers harvesting below 500 60 kg coffee
bags annually. Its revenue of R$ 1.2 billion (approx. U$ 500 million) in 2005 places it among the
300 largest Brazilian companies (CHADDAD, 2007).
Cooxupé was organized in 1957, when engineer Isaac Ribeiro Ferreira Leite (known as Dr.
Isaac) had the idea, along with 24 other coffee growers, for the transformation of an inoperative
credit cooperative located in the hinterland of the southern part of Minas Gerais state into a
production cooperative. This strategy was mainly aimed at strengthening growers’ power in
negotiations with local buyers. With no interruption or break in the continuity of his
administration, Dr. Isaac served as president of Cooxupé from 1957 to 200314.
Besides his work in the cooperative, Dr. Isaac was intensely involved in secondary economic
activities. His bachelor degree in Civil, Mechanical and Electrical Engineering from São Paulo
University Polytechnic School (POLI-USP) led him to hold positions in large companies, chief
among which was Brazil’s General Motors. While gaining a broad knowledge in the urban sector
he was also actively participating in associations of the agricultural sector15.
4.2.1 Incorporating the advantages of scale
Having stepped into the role of Cooxupé’s C.E.O. at the age of 46, Dr. Isaac was driven by the
objective of finding possibilities to add value to coffee, whereby local growers’ remuneration
could be enhanced (SAES, 1995). To that end, the entrepreneurial vision he conveyed to others
conferred a quite peculiar and innovating aspect to this strategy. Dr. Isaac had brought to Cooxupé
his observations of the dynamics of large firms, which included, for instance, gains in economies
of scale and scope in textile manufacturing, as well as a professional work ethic in the workplace
and in negotiations with clients. This happened at a time when Brazilian cooperatives placed
almost no emphasis on professional management, and, even less, on internationalization
strategies.
Furthermore, it is necessary to bear in mind that Brazilian agricultural cooperatives are quite
disseminated economic structures, often seen as tools for the development of rural areas. The
main argument in defense of cooperativism is precisely what led to the creation of Cooxupé,
namely, the competitive nature of the primary sector that interacts up and downstream of highly
oligopolized markets. To balance these forces, the union of rural producers enables a decrease
14 Dr. Isaac passed away in 2006, at the age of 94. Since 2004, Carlos Alberto Paulino da Costa has been the president
of the cooperative. Interviews were conducted both Sr. Carlos Alberto Paulino da Costa and with cooperative members in January 2008. The authoress of the present work undertook a case study of Cooxupé in 1995.
15 He was the technical director of the Federation of the Rural Associations of Minas Gerais; founding president of Guaxupé’s Regional Society for Soil Conservation; an officer of Minas Gerais State Government at the IBC’s Administrative Board; a member of the Council of the Executive Group of Rationalization of Coffee Production and director of the Mogiana Central Cooperative, which gathers over 24 regional coffee growers’ cooperatives, representing 10 thousand coffee growers in São Paulo and southern Minas Gerais (BRASIL, 2003).
in business risks and the adding of value to their products, which would be—individually—
unattainable (BIALOSKORSKI NETO, 1994).
In the 1960’s and 1970’s, the incorporation of rural development and income generation strategies
led Brazil’s agricultural cooperatives to play an important role as a tool for the dissemination of
farming technology in agricultural communities. The central government’s agricultural policy
aimed at fostering the growth of cooperatives supplied subsidized resources that provided them
with capabilities, such as infrastructure and extension services to their members.
In the specific case of coffee, a compromised stock and the damage of crops by weather in the late
1960’s led to a new governmental plan, the Coffee Renovation and
Reinvigoration Program of 1969, through the Brazilian Coffee Institute (IBC). This program
provided significant resources to coffee growers who—particularly in the southern part of Minas
Gerais—greatly enjoyed this opportunity. In 1957, Brazil produced 21.6 million 60-kg bags of
coffee, with Minas Gerais accounting for only 3.7 million 60-kg bags. The National Supply
Agency (Conab) estimated the Brazilian 2007/08 crop at 42.7 million 60-kg bags, while the
production of Minas Gerais totaled 21.4 million 60-kg bags of coffee (CIC, 2008).
Cooxupé also profited from both Brazil’s economic boom and the incentives of the agricultural
policy during the so-called “economic miracle” period. It expanded its infrastructure and the
number of members, while advancing to other Brazilian regions16. It acquired storage facilities,
coffee processing equipment, warehouses and regional offices, creating better conditions to
benefit from the externalities of the network, both in the purchase of inputs and in the negotiation
of the green coffee.
One of the first actions of the cooperative in this period was in March 1965, when it acquired a
warehouse with a capacity for 200 thousand bags of coffee, financed by the IBC (CHADDAD,
2007). Able to stock coffee, producers could choose the best moment to sell it, thereby increasing
their negotiation power with buyers. In 2008, Cooxupé had 18 warehouses and a storage capacity
of 1.9 million 60-kg bags with a capacity to receive over 3 million bags per year. Another
16 The cooperative operates in over 100 municipalities in the Alto Paraíva River and Southern Minas regions (Minas’ Cerrado) and in the Pardo River Valley (state of São Paulo). It has 16 regional centers located in the following municipalities: Guaxupé – headquarter and center (MG), Monte Santo de Minas (MG), Cabo Verde (MG), Caconde (SP); Guaranésia (MG); Nova Resende (MG); São Pedro da União (MG); Alfenas (MG); Carmo do Rio Claro (MG), São José do Rio Pardo (SP), Monte Carmelo (MG); Alpinópolis (MG); Campestre (MG); Coromandel (MG); Paranaíba River (MG); Serra do Salitre (MG); 5 advanced units: Botelhos (MG); Campos Gerais (MG); Campos Gerais (MG); Monte Belo (MG); Muzambinho (MG) and an exporting office in the city of Santos (see Cooperative’s website: www.cooxupé.com.br).
advantage of the storage system regards input acquisition. By acquiring inputs at large volumes
and being able to stock them in the periods between crop seasons, the cooperative could resell
them to its members at a lower price than the market price17.
To this end, Cooxupé initiated a program called “Coffee with Profit” (CCL) in 199718, aimed at
financing agricultural pesticides and fertilizers for its members by passing on resources from the
national credit system at a faster pace, since the knowledge it has about its members allows this to
happen without bureaucratic impediments. This program also ensures a stronger loyalty to the
cooperative. In 2007, over 70 percent of its members were serviced, which corresponded to 6,855
associates and totaled R$151, 61 million (app. US$80 million) in credits granted.
This storage system includes warehouses for corn and the cooperative also produces animal feed.
Both activities aim to address the deficiency of the region, insofar as a large part of the coop’s
members are engaged in other agricultural pursuits, in particular pig and fowl raising. At one
point in its development history, in the late 1980’s, the cooperative faced the dilemma of whether
to diversify, but opted for exploring its core focus with quality19.
Therefore, what distinguishes Cooxupé from other coffee coops is Dr. Isaac’s strategic proposal
concerning the means to commercialize the product. Cooperatives used to export coffee only with
the support of third parties. Though the practice of exporting indirectly was not generally
contested, Dr. Isaac did not approve of it. That is, if discovering opportunities means identifying
problems, he certainly had one: Why did Brazilian cooperative have to rely on exporters? Why
not export directly? Why not standardize coffee quality to add value to it instead of leaving this
task to buyers?
Anticipating the world market trend of segmentation by quality, Cooxupé built tools and
processes aimed at classifying the coffee being traded in the 1950’s, and hence brought 17 Cooperative website : www.cooxupé.com.br 18 The “Coffee with Profit” program offers: (a) the payment of bonuses proportional to the movement of previous
years. Used as part of the payment, it reduces the real cost of inputs offers; (b) the higher the credit limit, the longer the term to pay back the credit; (c) hire purchase; and (d) producers can pay with their products so escape market risks.
19 In the 1980’s, the volatility of coffee prices led to formalization of the idea of diversification, due to producers excessive dependence on coffee revenues. This policy started to be implemented in the beginning of this period through incentives for the production of grains, fowl, pigs and vegetables. Concerning grains, the topography of the south of Minas is not ideal for their production. However, the greatest problem is that, just like the fact that when coffee prices are low, producers stop investing in the product, and the same happens with regard to other agricultural activities when coffee prices are high: producers quit marginal activities to dedicate exclusively to coffee. In other words, the activities that were implemented still play a very marginal role in the income of rural households. Besides that, it was verified that the cooperative would have a more effective action for producers if it focused on quality coffees.
consistency to the standardization of its product. This system was adopted at a time when the
priority of the governmental policy was the volume of the coffee exports, detrimentally affecting
the quality of the product (see Box 2, about the Brazilian institutional scenario). This pioneering
initiative allowed Cooxupé to develop unique resources to trade coffee directly with international
buyers in the 1980s.
There are two basic steps in the standardization and classification coffee system at Cooxupé: (a)
on entering the warehouses, the coffee is analyzed, classified and piled according to the result of
the standardization process; (b) coffee undergoes a preparation, which comprises the phases of
remilling, ventilation, electronic picking and blending, which will result in the several qualities
the product assumes, as per buyers’ specifications. Since the standardization process adds value,
the average coffee price naturally increases.
Thus product standardization was the first step toward changing the rules of the game that
established how the coop’s coffee was exported. It was important because, over time, buyers
adapted to this system even when purchasing the product through third parties. Dr. Isaac believed
that the success in direct exports would be achieved through the creation of a long-term
relationship based on trust and reputation and, of course, the quality of the product20.
In 1984, the cooperative opened an office in the city of Santos, the world’s main coffee exporting
port. In 1990, export director Joaquim Libânio took over with the responsibility of developing that
relationship, a task facilitated by his previous experience as the IBC’s Brazilian representative at
the ICO. In the same year, Cooxupé made direct exports of 200 thousand bags of coffee. In 2005,
the largest part of the 3 million bags traded by Cooxupé, i.e., 1.4 million bags, was directly
exported (to 30 counties and 150 clients); 988 thousand bags were indirectly commercialized and
630 thousand bags were traded in the domestic market21. Cooxupé’s share in Brazilian coffee
exports over 1991-2001 can be seen in Table 7.
20 In 1992, the Cooperative joined the specialty coffee market by becoming a member of the Specialty Coffee
Association of America (SCAA). 21 See Cooperative’s website
Table 7 -Coffee exports by Brazilian exporting
COMPANIES 1991 1996 1997 1998 1999 2000 2001Tristao Cia. Com. Exterior 730,4 430,3 338,1 454,6 453,2 863,4 1.964,4 Unicafe Cia. Com. Exterior 1.640,1 1.157,5 1.475,1 1.321,9 1.613,6 1.099,4 1.772,8 Esteve S/A 962,0 697,5 750,9 555,1 725,7 826,1 1.391,7 Stockler Coml. Exp.Cafe S/A 1.217,1 453,5 802,0 1.007,3 1.261,5 793,4 1.292,3 Com.Ind.Brasil. - Coinbra S/A 259,5 221,8 157,3 313,6 373,2 864,6 1.131,4 Coop.Reg.Cafeic. Guaxupe 295,7 565,2 640,0 701,4 1.050,7 1.007,4 1.011,2 Cia.Import. e Exp. - COIMEX 225,4 98,6 341,7 589,2 1.013,6 570,7 974,0 Exportad. de Cafe Guaxupe 587,2 682,0 759,7 687,9 793,0 611,8 859,8 Volcafe Ltda 421,1 418,1 606,5 441,0 649,2 464,4 743,3 Casas Sendas Com. Industria 37,4 300,0 503,3 620,9 1.018,1 736,2 634,8 Rio Doce Café S/A Imp. e Exp 1.123,4 749,8 547,1 426,6 268,0 255,4 628,2 Mitsui Alimentos Ltda 113,8 160,0 317,0 256,3 426,3 355,2 543,8 Custodio Forzza Com. Exp. 299,3 230,0 203,9 241,1 351,6 263,2 502,2 Irmaos Ribeiro Exp. Imp. Ltda 322,3 426,9 406,6 411,4 577,2 493,7 487,8 Cargill Agrícola S/A22 717,8 312,4 372,8 297,6 494,7 429,0 -Exprinsul Com. Exterior 662,9 175,0 448,5 573,7 597,0 350,3 485,9 Subtotal 8.897,5 6.766,2 8.297,6 8.602,0 11.172,0 9.555,1 14.423,4 Others 10.562,5 6.006,0 6.140,4 7.961,5 9.888,8 6.467,9 6.508,8 OVERALL TOTAL 19.460,0 12.772,2 14.438,0 16.563,5 21.060,9 16.023,0 20.932,2
SOURCE: CECFÈ (apud SAES; NAKAZONE, 2002).
Allied to the “conscious and responsible consumption” movement, the increased demand for
specialty coffees of the early 200’s offered the opportunity to trade high-quality coffees produced
in a sustainable manner, with price premiums in comparison with the commodity market. In
parallel to that, several quality contests appeared in Brazil as a means to foster the production of
quality coffees23.
In 2002, Cooxupé created the Department of Specialty Coffees. The majority of its members were
small-scale producers who did not have the knowledge required to participate in this market. This
department offered the Cooxupé Excellence Journey Program that, besides being instrumental in
getting producers to improve the quality of their production—through new techniques to handle
and prepare beans—manages to standardize the lots. When their samples fit within the
classification of gourmet coffee, producers are informed and their lots are directed to quality
contests. As the cooperative’s cuppers generally have solid professional expertise, the coffees
forwarded to the contests achieve good classifications and are sold at premium prices. This
22 Cargill Inc. sold its world coffee division to the international group Ecom Agroindustrial Corp. in 2000. As a
result, Esteve S/A, Ecom’s subsidiary in Brazil, took over all the operations of Cargill Agrícola S/A. 23 A number of quality contests were implemented in Brazil in the 1990’s: the first was sponsored by illycaffè, the next
promoted by BSCA (Brazilian Specialty Coffee Association)—Cup of Excellence—and several other state contests followed in São Paulo, Minas Gerais and Espírito Santo, among others.
program allows small producers, who only sell “bica corrida”24, to enter a market in which they
would not otherwise have access.
Another program conducted by the Specialty Coffee Department involves its partnership with
Nestlé, as of 2004. Nestlé has developed a project aimed at making Cooxupé an AAA supplier of
the Brazilian cerrado, for one of its lines of high-quality espresso, the Nespresso brand. This
project runs through several countries, besides Brazil. A conduct code guides suppliers in the
adoption of practices respecting social and environmental sustainability, while observing the good
practices for bean quality. Producers are audited by the Imaflora company25. A total of 390
cooperative associates participate in this program, supplying 176.8 thousand 60-kg bags in the
2006-07 crop year. Of these, 67.4 percent are small producers (below 500 60-kg bags). In the
2006-07 crop year Nespresso paid a premium of R$15,00 (US$7.80) per bag of bica corrida,
which means an additional R$40,00 (US$21.00)—or 16%—per bag of coffee compared to the
coffee sold at the local market26.
4.2.2 Vertical integration
The main driver of vertical integration strategies in Brazilian cooperatives is the value added to
the commodity they produce. The type of negotiations conducted between the rural segment—
characterized by its competitive condition—and the processing sector—largely oligopolized—
justifies this rationality, which was the main motto of the cooperatives in the 1970’s.
This is, nevertheless, a fallacious argument. If a cooperative starts to process a product which is
inserted in a highly competitive environment, its members should acquire raw material in the most
efficient manner, i.e., buying at the best price will be a market imposition (best price-quality
relation). That is true if the cooperative wants to survive in the long run. And this is the case of the
coffee industry in Brazil: margins are small and companies compete for prices (SAES;
NAKAZONE, 2002).
Cooxupé adopted two concrete actions toward making advances in the coffee supply chain. The
first was in 1984, with its roasting factory. On the contrary of what can be imagined, its strongest 24 Only with the initial milling at the farm, in which stones and foreign objects are removed and the coffee is hulled—
the running spout. [Unclear. Please clarify “the running spout”.] 25 This is the same company that audits the Rainforest Alliance certification program. Imaflora, the Institute for Forest
and Agricultural Management Certification and Handling, is a Brazilian NGO founded in 1995 that aims at promoting the conservation and the sustainable use of natural resources and generate social benefits in the agricultural and forest sectors.
26 Small producers sell their coffee in the stage called “bica corrida”, in which only the first processing takes place.
motivation to build this roasting facility was not the issue of rent appropriation, but the coffee
classification strategy. Or, in other words, the advent of the standardization and classification
system caused the coffee not meeting the foreign market’s requirements to lose its value. Roasting
then became a way to add value to the product, in a period when Brazil’s coffee market was
basically focused on low price strategies (SAES; FARINA, 1999).
In line with the overall trends of the specialty market growth of the 1990’s, the roasting factory
launched different brands directed toward quality niches. In 2006, Cooxupé’s roasting unit was
the 42nd Brazilian roaster in production, operating within a regional scope, mainly in the state of
São Paulo and its capital, Minas Gerais, and Rio de Janeiro. It also developed a partnership
program for the production of coffee with brands. The choice for a quality nice is strategic: it
implies not fighting its main competitors—the large roasters—to improve presence on the
supermarket shelves. In other words, Coxupé’s roasting unit did not have great aspirations in
terms of market position or share in the total revenues generated by the cooperative business.
The second action aimed at Cooxupé’s vertical integration consisted of opening two cafés named
CafeChocolat in China, in association with two partners—the Belgian Guy Becker for chocolate
and the Chinese Liu Jun. Again, in this case, the integration did not aim at raising producers’
income, being rather a marketing strategy to increase the sale of coffee beans. It was an
encompassing strategy insofar as it aims to foster coffee consumption in a market to be explored,
the result of which is positive externalities for coffee producers in general, not exclusively for
cooperative associates27.
4.2.3 Gains in horizontal cooperation
Cooxupé’s initial strategy, i.e., eliminating intermediaries in the commercialization process and
negotiating with a stronger bargaining power, enabled it to obtain gains that resulted in higher
incomes for producers. As defined in Chapter 2 of this work, this strategy is called joint
interdependence (Figure 11). Each producer within a group gives an autonomous and well-
defined contribution, and the relations among producers are scarce, generally without the need for
strong social ties. That represents a type of low-complexity problem concerning the organizational
structure, since it is decomposable. Prices reflect the totality of incentives required. Once the
coffee is classified by the cooperative, its price is determined by the market. The standardization
27 At first, the project obtained resources from APEX (Brazilian Trade and Investment Promotion Agency), since it
was an action aimed at the opening of China’s market for Brazilian producers.
adopted by Cooxupé was highly instrumental in solving problems of information asymmetry.
Producers’ largest gains are related to the scale and scope in coffee commercialization, the joint
purchase of inputs and the creation of knowledge and management resources that, through the
cooperative, enabled them to build partnerships with other companies that buy quality product.
Figure 11 – Joint interdependence: Cooxupé
4.3 Sequential interdependence: illycaffè high quality brand
The case to be here portrayed concerns the strategy devised by engineer Dr. Ernesto Illy28, owner
of a traditional Italian family-owned company—illycaffé—well-known for its high quality
espresso coffee.29 The high-quality brand strategy was idealized in the industrial segment, but as
will be seen, its full effectuation required a coordination of the supply chain, i.e., producers would
have to be engaged in this strategy, thereby creating a mutual interdependence (SAES;
ISHIKAWA, 2006). It is important to highlight that the supply chain does not discriminate against
a producer’s size, which means that a large variety of sizes can be found among illycaffè’s
suppliers.
There were two key drivers in Dr. Illy’s choice of strategy: his experience in the company and his
academic background. Francesco Illy, Ernesto Illy’s father, founded illycaffé in 1933 in Trieste.
Before taking over as co-owner and C.E.O. of the company in 195630, Dr. Illy had worked in
several economic sectors, but it was through his experience with clients that he realized the extent
to which consumers valued the consistency, the aroma and the flavor of the beverage. In addition
to that, his education in chemical engineering fostered in him a high regard for laboratory analyses
of the drivers of the quality in the coffee beverage, which had been previously carried out based
28 Interview conducted in March 2006. 29 The spelling espresso comes from the Italian word esprimere, which means squeezed or pressed out. 30 Dr. Ernesto remained in the position until 2000, when his son Andrea Illy took over as illycaffè’s C.E.O.
BUYERS COOXUPÉ
on the subjectivity of specialists. The alliance of these two types of knowledge enabled Dr. Illy to
visualize the potential of the high-quality coffee business.
In 2006, illycaffé had some 40 thousand sales points around the globe, where over 5 million cups
of espresso were served daily, with its unique and always constant blend of nine origins of
Arabica (SAES; ISHIKAWA, 2006).
4.3.1 Supply coordination
Illycaffè supplies 12 countries, benefiting from differences found in climate and altitude
conditions, among other aspects. From June to October it purchases coffee from Brazil and from
January to May from Central American countries, India and Ethiopia (NEVES; SAES;
REZENDE, 2003). The company acquired some 200 thousand coffee bags from Brazil in the
2006-2007 crop year. Though this is a large quantity in terms of high quality coffee, it represents
little if compared to the country’s overall production of approximately 35 million bags on average
(CIC, 2008). In any case, the small quantity bought by illycaffé in Brazil marked a change of
history for Brazil’s coffee production, as we shall see ahead.
Brazil is a strategic supplier of illycaffè. Besides being the world’s largest coffee world producer,
from 65 to 70 percent of illycaffè’s raw material come from Brazil because this is one of the few
countries that uses the dry-process in coffee processing. This is an essential method in the
composition of the espresso, since sun-dried coffee has a higher content of sugar caused by the
migration of the sugars from the drying fruit to the coffee beans, which gives more aroma and
body to the blend (ZYLBERSZTAJN; NEVES, 1997).
However, although illycaffè has bought Brazilian coffee since 1933, it was only in the early
1990’s that the company could have a strong participation in the acquisition of green beans. That
was justified because, before this period, the Brazilian market regulation ruled by the IBC
determined that the product could only be exported by accredited exporters (see Box 2 about the
Brazilian institutional environment).
Allied to that fact, the way Brazilian coffee was commercialized—mixing coffee from different
qualities and regions—made it hard for illycaffè to obtain its desired standard. From the ten or
twelve coffee samples that reached Trieste only one would be approved for purchase by illycaffè.
Finally, because this practice of commercialization carried out in Brazil did not value the product
that had a higher quality, producers ceased to invest in quality and the quality product was usually
expelled from the market.
The early 1990’s fall in international coffee prices mirrored a loss of quality, since decapitalized
producers invested minimally in post-harvest practices. In 1989 illycaffè had serious supply
shortages: out of the 36 samples examined by Brazilian exporters, not a single one was approved
by the company.
Having identified the problem, Dr. Ernesto would now have to discover the opportunities that may
arise from it. Worried about the supply issue, he decided to come to Brazil to know the coffee
producing regions and understand how the production and commercialization of raw material
were organized.
Contrary to his expectations, he was surprised by the high quality of the coffee fruit in the tree.
Nevertheless, he was frustrated with the harvest (derriça)31 and processing methods, which
resulted in a mixture of beans in different stages of maturity in the same batch. Dr. Illy saw that
the main problem was the coordination of activities of harvesting, drying, processing and trading.
Problems occurred because the agents involved were not receiving adequate incentives to produce
the quality he needed.
What, thus, should be the best strategy to coordinate the supply chain? How to induce traders to
change the way they acquired beans? How to persuade producers to invest in high quality when
the market did not signal a favorable trend?
The solution would not lie in acquiring properties, and hence vertically integrate the production:
the coffee quality is influenced by the weather conditions, which causes large variations in its
quality from region to region in a given crop.
The idea to solve the problem came when Dr. Illy observed the strategy of the Italian fashion
designer Ermenegildo Zegna. Faced with difficulties in buying quality cashmere, this company
had created a quality contest offering financial incentives to communities that supplied the best
fabric (SAES; ISHIKAWA, 2006).
31 In this method, ripe and unripe beans picked off the tree (manually or mechanically) are mixed with leaves and
twigs.
Replicating this strategy, in 1991 illycafè started to promote an annual contest, Brazil Coffee
Quality Prize for Espresso, aimed at identifying the superior quality coffee produced in a given
year. The company awards a prize premium that is 20 to 30 percent above international prices of
good quality coffee beans, and purchases the coffee beans that are thus classified.
The incentive structure enabled by the contest allows illycaffè to identify the parties present in the
transaction, a relevant aspect in the product’s final result. In this case, since the spot market
became inadequate to coordinate the transactions, the hierarchy structure could be replaced
through an innovative solution (ZYLBERSZTAJN, 1997).
The illycaffè quality contest brought a change in the pattern of competition in the coffee market.
Producers realized that the Brazilian coffee that was considered as having an average quality in
the international market could have a price premium, as long as better harvest practices and new
commercialization means were adapted.
The number of candidates to supply coffee to illycaffè increases every year. Through a
multiplying effect, similar contests were adopted and regions that traditionally produced low
quality beans have sought new technologies to improve their production processes (Annex 1).
That happened, for instance, in the Zona da Mata (in Portuguese, "forest zone"), whose coffee
beans had been given a low score in the classification (Rio Zona)32. After implementing a new
technology for processing the beans, local producers started to be classified in quality contests33
(SAES; BOLBRINI JUNIOR; REZENDE, 2003).
In order to coordinate the supply chain, illycaffè has built a network of agents (Figure 12). The
contest coordination begins with the forwarding of samples to the office in the Port of Santos34,
which hides the names of producers and sends the samples to Assicafé. Assicafé is a private
company certified by illycaffè with exclusive power to conduct the analysis of the quality of the
drink. Approved samples are purchased by the Port of Santos office and sent to Trieste. To foster
adequate crop handling and subsequent permanent supply of raw material, illycaffè invests in
capacity building through the Illy Coffee University (Unilly) and the Illy Coffee Club.
32 Coffee classification, according to the drink, in decreasing order of quality is the following: Strictly soft, Soft,
Softish, Riada, Rio and Rio Zona. The classification per type admits seven categories (types 2 through 8, with decreasing quality), according to the number of defects verified in a 300-gram sample.
33 The technology used is called hulled cherry. Through a huller, green and dry beans (floats) are separated from ripe beans (cherries) and washed. After the skin is removed the beans go to the patio. In the drying process, the mucilage adheres to the beans providing unique characteristics like body, acidity and sweetness.
34 Belonging to the Carvalhaes family, traditional coffee brokers, Porto de Santos was created in the early 1990’s to service exclusively illycaffé. In 2007, illycaffè started to take stock control of the company.
Figure 12 - illycaffè supply network in Brazil
SOURCE: NEVES; SAES; REZENDE (2003, p. 5)
Producers have an additional advantage in supplying coffee to illycaffè: the positive externality of
possessing an implicit quality certification. Even if only a small parcel of a coffee grower’s
production is negotiated with illycaffè, the status of having been a supplier allows better
negotiation conditions with other suppliers.
This fact was observed in a survey conducted with producers who supply to illycaffè, in which 83
percent (of 46 interviewees) declared that being illycaffè’s suppliers results in gains in
negotiations with other buyers, besides being a general valorization of the coffee from a given
place—if the region has been awarded prizes (SAES; BOLBRINI JUNIOR; REZENDE, 2003).
This type of relation can, however, generate a problem when the prices of the commodity coffee
go up in the international market. As seen in Chapter 3 (Graph 7), roasters tend to maintain more
stable prices in relation to variations in the quotes of the raw material and, therefore, their margins
decrease in these periods. Under those circumstances, the price premium paid to producers also
decreases, as show in Graph 12. For producers, this situation can lead to a decision of making
decreasing investments in specific handlings that generate a better quality product. Producers may
prefer to sell at the price paid for the commodity coffee, thus causing difficulties for the
processing firm to fulfill its demand within the required quality standards.
Coffee Producers
Port of Santos
Assicafé
illycaffè Italy
Unilly and Illy Coffee
Club
This fact occurred in the 2002-03 crop year, when a large number of coffee samples were turned
down by illycaffè. According to the laboratory technician in charge of the analyses of the samples,
besides weather problems that led to a fast maturation of the beans, the decrease in quality
resulted from the following factors: accelerated drying; inadequate handling in the drying on the
patio; probable lack of water and inadequate use of fertilizers (GIORDANO, 2003). That all
points to the conclusion that producers preferred to sell quantity at a commodity price rather than
incurring higher costs necessary to meet illycaffè’s quality requirements.
Graph 12 - Comparative analysis of the cases
50
100
150
200
250
300
350
1994/95 1996/97 1998/99 2000/01 2002/03 2004/05
$ R
eais
por
sac
a
illy CEPEA
SOURCE: CEPEA AND ILLYCAFFÉ (information from producers who supply illy).
But even considering the temporary extra costs paid to find the desired raw material, the relation
of mutual interdependence formatted by the company is the one that best adapts to the type of
strategy devised by Dr. Illy. Besides the fact that the present flow of revenues from the
governance structure makes up for the temporary losses (or the difficulty in finding the product),
the company realizes gains by having an elastic supply of high quality coffees (except in peak
price periods).
4.3.2 Gains with vertical coordination
Consumers identify the illycaffè brand with the quality of their espresso coffee. The brand
reputation ensures the attributes that consumers desire; they know that the company has selected
the best suppliers, no matter who they are. For this reason, the company does not need to format
contracts or establish a formal relation with producers. The relation will only exist if there is good
quality, which is easily perceived before the purchase through the analyses conducted by
Assicafé. The incentive to produce quality is dictated by the market signals that a price premium
exists in comparison with the commodity price.
Therefore, the relation established between illycaffè and producers is characterized by sequential
interdependence (Figure 13). Both the structure of the contest and the premium have led to the
creation of an elastic supply of quality product, thereby bringing about an extremely efficient
situation for the supply chain. The competition in the market of factors produces the participants’
maximum effort (those who do not strive are expelled from the market). In addition to the price
premium signaled by the market, information systems were created, thus providing producers with
technology to enable them to increase the supply of high quality beans.
Figure 13 - Sequential interdependence: illycaffè
4.4 Mutual interdependence: sustainable coffee from Baturité and Poço Fundo
The two experiences that will be presented next share the same focus on the market of sustainable
coffees. Both cases started before the 1990’s coffee crisis, but have, nevertheless, followed
different paths. Baturité, after a bad experience in the international market, decided to turn its
focus toward the domestic market through a more encompassing strategy and, consequently, a
long-term strategy. Poço Fundo concentrated on the fairtrade market, having been Brazil’s first
coffee organization to export under this seal, in a period particularly sensitive for producers: the
product’s low price cycle.
ILLY
4.4.1 Baturité’s sustainable coffee
The first case portrays the experience of the organization of family growers that grow organic
coffee in Baturité, and counts on the important participation of Adalberto Alencar35. Paramount in
the execution of the strategy of adding value to their community was Adalberto’s experience in
Sweden, due to his father exile during Brazil’s military period. Adalberto is from the state of
Ceará and, during the years he lived in Stockholm, the contrast between his native Brazilian
northeastern upbringing and the European realities motivated him to work toward the organization
of a civil society aimed at finding solutions to increase the population’s income. After his return
to Brazil in 1978, during the period of political opening that began in 1974, he started a college
program in Education in 1985 in the city of Sobral, in Ceará state. He reported that the discussions
about the works of Brazilian educationalist Paulo Freire with his agriculturist colleagues played a
pivotal role in his education and professional choice.
In 1989 he created the Center for Popular Education in Defense of the Environment—Cepema—
in Sobral, Ceará, with the support of the Swedish NGO Framtidsjorden (Land of the Future),
headquartered in Stockholm. Two years later, in January 1990, Cepema become the Cultural
Foundation for Popular Education in Defense of the Environment, operating in areas related to
food security and education in organic agriculture practices. Its core mission is to bring awareness
to rural populations concerning the importance of environmental and sustainable development
issues36.
In the early 1990’s Adalberto was invited by representatives of Ceará State Environment
Secretariat—Semace—to examine the situation of deforestation in the Baturité Mountains. A
sensitive issue had to be approached in this region due to the conflict between rural producers in
the Baturité Mountains, who lived off the land, and the participants of environmental movements
interested in preserving that part of the Atlantic Forest, who, despite their best intentions, offered
no alternatives for the survival of the local population.
The problem was identified and the opportunity arose when Adalberto verified that, concomitantly
with the deforestation caused by both the real estate development industry and the presence of
35 Interview conducted in January 2008. 36 The Cepema gathers 60 NGOs in 14 Latin American, Asian, African and European countries. Its most important
activities include capacity-building and professional qualification in ecological agriculture. Its target public consists of ecological agriculturists, producers in the family economy and people settled by the Agrarian Reform. To meet its objectives, it builds partnerships with national and international NGOs, government agencies, small growers’ associations and civil society entities.
crops unsuitable to the region, there had also been a centenary tradition of growing coffee in the
forest, a fact he initially had ignored.
Having witnessed from the outset the growth of the sustainable coffee market in Europe, and
armed with valuable contacts with Swedish NGOs, Adalberto started to envision a strategy for the
region.
Initially, his strategy would include persuading local producers and organizations to support the
productive activities linked to the economic exploration of this crop. The Arabica coffee was
practically abandoned as a productive crop, being sold to intermediaries at prices lower than those
of the Robusta (whose quality is far inferior to that of Arabica beans), at a price 30 percent below
its real value (SAES, SOUZA, OTANI, 2001). The strategy also encompassed negotiating with
the environmental groups with a view toward creating a joint action plan to preserve the forest in
the presence of economic activities.
The advances and the several backward steps in the search for negotiable solutions among the
participants finally originated a mutual interdependence strategy. The path to integrate
producers with the market without having their income dissipated along the way has been
difficult: some attempts had to be abandoned and others reformulated, as shall be seen next.
4.4.1.1 Producers’ location
Traditionally, the production of shade-grown coffee in Baturité is based on producers’ experience
with the edaphoclimatic conditions of the region. Ceará was one of the first states to plant coffee
in Brazil37. The first trees date from 1747 and were located on the Santa Úrsula farm, in the
municipality of Meruoca. Within a few decades the product started to be grown in other regions,
reaching the Baturité mountain range38, in the region of Guaramiranga, in 1822 (SAES; SOUZA;
OTANI, 2001).
The shade-grown production system was widely used in the mountain range due the failure of the
sun-grown process. The coffee crops developed in consortium with native leguminous plants, like
37 The introduction of the coffee crop into Brazil dates from 1727 (SAES, 1997). 38 The Baturité mountain range is located approximately 90 km from the capital city of Ceará, Fortaleza. It constitutes
an atypical region of the state, in terms of topography, climate, soil and vegetation. It presents forest formations remnant of the Atlantic Forest, with average temperatures of 22oC, average rainfall of 1.500—1.555 mm—per year, a regional declivity range from 21 to 42 percent and an altitude of 690 to 820 meters (SEVERINO; OLIVEIRA, 1999).
the ingá (Inga sp.) and the camunzé (Pithecolobium polycephalum Benth) and other crops, like
manioc and fruit trees, have had a better adaptation to the region, whereas sun-grown coffee did
not resist the intensity of the summer heat. In addition to the damage brought by the strong
sunlight, the mountain rains eroded and impoverished the soil, making producers abandon the
crop39.
According to Severino and Oliveira (1999), a large part of the coffee production from the state of
Ceará was destroyed in the mid-1990’s as a consequence of a large-scale coffee eradication
program conducted by the federal government aimed a reducing production.
In 1975, after the frost in the south of Brazil, a new governmental plan, the Coffee Renovation
and Reinvigoration Program, brought a new incentive to replanting coffee trees in Brazil,
including in Ceará. However, this crop has never reached its previous levels of productivity due to
the inadequacy of the sun-grown plantation model suggested by the program, which was
unsuitable to the regional characteristics40. Other obstacles related to its insufficient local
infrastructure also hindered Ceará’s production growth: precarious roads and the absence of good
ports.
In the 1980’s, environmental movements aiming to preserve the Atlantic Forest grew bigger and
stronger. The degradation of the mountain range had intensified due to both real-estate speculation
for vacation home developments and the dissemination of agricultural practices aggressive to the
ecosystem. The disorderly occupation of the region over the years led to concerns regarding not
only the survival of rural producers, but also to the lower flow of rivers, which pay a strategic role
in supplying water to the communities of the mountain range and also to Fortaleza, the capital of
the state of Ceará.
What might at first sight be seen as an impediment to the development of the strategy—the
presence of the environmentalists—eventually came to be a great opportunity that enabled the
strategy of value creation idealized by Adalberto. In 1990, when the Baturité mountain range was
declared an environmental protection area (EPA) by Decree number 20.956/90 of Semace,
39 According to Lima (1946, p. 187), planting these species under a canopy of trees “was a true resurrection. The crop
... planted in 1849, was surrounded by ingá trees. In 1904, when it started to fade, it relived. The failures were replanted. It still presents currently [1945] around sixty percent of old coffee trees, ninety six years old, vigorous and productive”.
40 Financing for production was only granted if producers adopted the recommendations of the technicians from the Brazilian Coffee Institute (IBC), which included more productive varieties and the full-sun system (SAES, SOUZA, OTANI, 2001).
organized producers started to explore the coffee production of ecological grown in the forests of
this area.
EPAs are Conservation Units (CUs) aimed at conciliating human activity with wildlife
preservation, natural resource protection and life quality improvement for the populations. Local
dwellers are provided with adequate soil handling methods and techniques that minimize
interference with the ecosystem, thus raising the conservational and ecological awareness of the
population.
Seen under this aspect, the revitalization of shade-grown coffee incorporated the principles of
environmental preservation and enabled a source of income for the producers within the CUs.
Shade-grown coffee avoids deforestation and burning, which are the causes of decreased sources
of water, obstructed riverbeds and eroded areas. Nonetheless, what was lacking was an economic
project to boost the feasibility of shade-grown coffee.
The first action toward that end would be to organize the community. Thus, within the scope of
the Cepema Foundation presided over by Adalberto in 1995, the Baturité Mountain Ecological
Coffee project41 was created.
Based on the work aimed at involving the community, the Cepema Foundation fostered producers
to found the Baturite Mountain Producers’ Association—Apemb—in 1996. In 2001, this
association counted on 158 members, most with areas smaller than 50 hectares, 30 percent of
which were smaller than 1 hectare. According to the 1995-96 census conducted by the Brazilian
Institute of Geography And Statistics (IBGE), the region had 1,071 coffee producers, most of
whom were in areas less than 50 hectares (SAES, SOUZA, OTANI, 2001). According to
information from local traders, their production was approximately 8 to 12 thousand bags of
coffee per year (SCIPIÃO, XIMIENES, FARIAS, 2005).
The Apemb also made efforts to show the need for community actions. Providing jobs for 60
women from the community, a center for coffee selection was established, which started to be an
important factor of integration. In parallel to that, a program was developed that aimed at
improving the quality and productivity of the coffee. Part of the coffee plantations were over 100
41 The objective of the “Ecological Coffee” program is to foster an ecologically-sustainable development, obtaining
agricultural production whilst preserving natural resources, improving producers’ income and reducing rural exodus, favoring the expansion of labor employed in ecological coffee production, and generating jobs and income for thousands of workers from the region (FUNDAÇÃO CEPEMA, 2000).
years old and in great need of renovation to reach higher degrees of productivity. The region’s
average yield of 5 bags per hectare is considered to be very low, even for shade-grown coffee. In
the past, the region had reached 10 bags per hectare (SCIPIÃO, XIMIENES, FARIAS, 2005).
Thanks to Adalberto’s contacts, who had negotiated an agreement between the Cepema, the
Apemb and Ceará State’s government in 1997, producers made their first export using the
production of the 110 coffee growers who were members of Apemb, to a Swedish roaster, Classic
Kaffe. Their certification had been awarded by the most important Swedish certifying body
(KRAV) and the Biodynamic Institute for Rural Development (IBD) from the Brazilian city of
Botucatu.
For three years the product was bought at the price of US$160.00 per sack, whereas market prices
ranged from US$100.00 to US$110.00. In 2000, Classic Kaffe decided to no longer keep this
price and Baturité’s producers ceased supplying it.
The main reason why negotiations stopped was the surplus supply of organic in the international
market and subsequent fall in prices. Classic Kaffe understood that negotiations should be based
on new prices, since price quotes had been reduced in the international market. Due to producers’
costs, those new conditions would make the payment of certification and export costs unfeasible.
This buyer was interested in purchasing organic raw material regardless of is origin. The brand of
the Classic Kaffe Company did not identify the origin of the beans, so what mattered was the
organic attribute, not the one related to the region where the raw material originated.
In this case, when there is a surplus supply of organic coffee, certification reduces the transaction
costs for the roaster, which endangers the livelihoods of vulnerable producers who invest in a
specific production without a guarantee of purchase. Producers pay the costs of certification and
may be obliged to sell their product at the price of conventional coffee.
The result of these negotiations brought reflections on which collective strategies should be
adopted by the community. Up to that moment, the format of the organizational structure had
been more similar to a joint interdependence: the association worked with coffee quality
standardization and organic certification. Market prices, in this case, ended up coordinating
producers’ actions.
One way to deal with the difficulties of commercialization came through the creation of the
Baturité Mountain Mixed Coffee Cooperative—Comcafé—in 2000, with 32 organic producers. In
2006, it already had 46 members and was trying to qualify to enter the international fair-trade
market. According to Adalberto, reaching the international market with the production of shade-
grown and organic coffees, at the prices verified in the early 2000’s, would only be feasible with
the Fair Trade certification, due to the low productivity of the shade-grown coffee. The product
exported with the Fair Trade seal allows producers to have a much superior remuneration than
that realized though market prices when the latter is at a low price cycle, as seen in Chapter 3
(Graph 11).
Nevertheless, the major strategic change came, in fact, through the perception that the formatted
governance structure did not meet the objectives of better income distribution for the population
of the mountain. Thus the Cepema Foundation started to see the issue of regional development in
a holistic manner: coffee would start being part of a set of products originating from the
ecological agriculture of the Baturité Mountain Range.
Thus the focus of this new strategy would not be family-grown organic coffee: it would need to
encompass other forest products (banana, papaya, guava, acerolla), and their origin be identified
by the brand “Pico Alto” (which means Highest Peak, in reference to the highest point of the
mountain, 1,114 meters high, located in Guaramiranga). Additionally, the target market now
would be mainly the domestic one, starting with the local market (street fairs) until reaching the
national level42.
Because they involve a whole process of learning, these changes require efforts to train the
population and are time consuming. Ongoing courses teach how to produce sweets from forest
fruits to be sold at local street fairs and in the supermarkets of the capital city, Fortaleza.
Since 2003, the Brazilian Service of Support for Micro and Small Enterprises—Sebrae—from the
state of Ceará has been assisting in the commercialization of the Pico Alto Ecological Coffee in
35 shops in Ceará and 4 shops in São Paulo owned by the Pão de Açúcar Group43. The coffee is
manufactured by Comcafé, which produces an average of 350 kg per month of roast and ground44
42 The Pico Alto brand was launched in 2003 (SOUZA, 2006). 43 The Pão de Açúcar Group trades the Pico Alto coffee in São Paulo through a program called Brazil’s Faces [Caras
do Brasil]. It was developed for producers whose work is based on the idea of cultural and environmental preservation, and the environmental and social management of the local community (SOUZA, 2006).
44 Before the Comcafé roaster started operations, the cooperative hired a third-party for roasting, grinding and packaging.
and 1,250 bags per year of green beans. The Pico Alto ecological coffee, ground and roast, was
sold to consumers at R$6,00 (or US$1.95) for 500 grams, whereas the traditional coffee in the
same period reached R$4,20 (or US$1.37) on average in the same supermarket (SCIPIÃO,
XIMIENES, FARIAS, 2005). But, to further increase sales, according to Adalberto, the quality of
the drink had to be improved.
In 2005, producers commercialized coffee beans through traders who passed the product on to
local roasters, like the Santa Clara and Serra Grande, and received the value of R$180,00 to
R$200,00 (US$75.50 to US$83.89) per 60-kg bag, whereas the value of green coffee beans with
the international organic certification (BCS Öko-Garantie45) was from R$260,00 to R$350,00
(US$109.67 to US$146.82) per 60-kg bag.
A mini-industrial plant to roast coffee with a capacity for 20 tons of coffee per month is planned
to start operations in June 200846. It aims to sell coffee with the brand name Café da Floresta
(Forest Coffee) to the domestic market, this time packed and with the Fair Trade seal. Following
the coffee supply chain, there is a plan to adopt the same strategy for the fruit, biodiesel and
cotton chains, among others.
Besides the complexity of the strategy, which relies on the cohesion of the community, the great
challenge, according to Adalberto, is to deal with the new reality of the field, since producers’
children do not wish to remain on the property taking care of the crops. For Adalberto, technology
allows bringing together caring for the property and engaging in urban activities. In Sweden, rural
producers have other activities: they are teachers or company workers who take care of their
properties on weekends. When producers are allowed to engage in other activities, family incomes
no longer rely exclusively on agricultural production. For him, agriculture must be seen in a
holistic manner, inserted within the urban space, hence the logic of creating industrial products
originated in the community and resulting from the interaction between producers and their
families.
4.4.2 The experience of Poço Fundo’s producers
45 BCS Öko-Garantie is an organization accredited by the authorities of the European Union, USA and Japan, aimed at
verifying the compliance of organic regulations. The organic certifications awarded by BCS are also officially recognized in Switzerland and Canada.
46 This project is a partnership among the municipality’s secretariats, the Bank of the Northeast, the Emater from Ceará, the Bank of Brazil and the Sebrae-CE.
The next experience is about a successful case of small family producers’ strategies providing for
the aggregation of income. The quite well-known case of Poço Fundo’s producers is seen as a
source of inspiration for the other communities that have tried to follow in their footsteps. The
municipality of Poço Fundo is located in the south of the state of Minas Gerais. This location
mainly comprises small family farmers, with coffee representing 85 percent of the population’s
income (SOUZA, 2006; SAES; MIRANDA, 2006).
Just as observed in the previously presented experiences, the 1990’s crisis in the coffee market
served as motivation for the 20 small coffee farmers led by Luís Adauto de Oliveira47, a
technician in agriculture extension, to decide to create in 1991 the Cooperative of Small Producers
from Poço Fundo and Region. The motto for the idealization of an innovating strategy was,
therefore, the same that has been driving the cooperativist movement worldwide: joining forces to
improve the commercial relationships of the municipality’s growers.
Luís Adauto’s facility to organize collective actions resulted from his accumulated experience
from the practice of shared work in coffee crops with his neighbors—mainly in communal tasks
of harvesting—called mutirão. Like most producers from the region, Luís Adauto is a small
family farmer. With the sole help of his wife, he works his 6 hectare-holding, producing some 180
bags of coffee a year. At harvest time, families gather to harvest their crops. Luís Adauto’s
participation in the human rights organization Pastoral Land Commission (CPT) has also been an
important source of learning for improving his natural leadership skills and his communication
abilities with his peers.
However, the resources required to implement the strategy involving the specialty coffee market
did not belong in the knowledgebase of the region’s producers, and much less considering the Fair
Trade market. In this case, a paramount role was played by agronomic engineer Sérgio Pedini,
from the Federal Agro Technical School of Machado, who, interested in seeking solutions aimed
at the region’s development, envisioned the strategy of investing in the Fair Trade market, since
the region’s producers had the necessary requirements for that (small-scale family farmers
associated to a cooperative).
It can be seen that the association, initially, and then the Poço Fundo Family Farmers Cooperative
(Coopfam) founded in 1993, had no great intentions. The cooperative’s aim was to enhance the
negotiation power of its members and raise their income through gains of scale in the purchase of
47 Interview conducted with Luís Adauto de Oliveira and Sérgio Pedini in December 2005.
inputs and joint trade of coffee. However, the joint strategies rising from the gains of the
association only resulted in a small increase in the income of these farmers. Right at the beginning
8 producers gave up participating in the association. The low coffee prices of the period
contributed to their lack of interest. Luís Adauto had identified a problem: the cooperative
solution was shown not to be reaching the aims of its creation. Thus the question was: were there
any opportunities to be extracted from this conclusion?
4.4.2.1 Partnerships and commercialization hindrances
The partnership with the local technical school started in the mid-1990’s has ultimately proven to
be essential in positioning the producers’ coffee commercialization in more profitable markets.
At the time, researchers with the Federal Agrotechnical School (EAF) from the city of Machado
were implementing local development projects. One such project was the work of raising the
population’s awareness of the significance of creating a market under fair conditions of solidarity
for their coffee.
In 1996, the cooperative associates started to show interest in the principles of organic agriculture,
driven by the successful experience of neighboring producers, particularly from the Jacarandá
farm, which introduced organic growing practices into Brazil (SOUZA; SAES, DONOKOFF,
2005).
In 1997, the partnership with the EAF included two priority actions. First, the EAF promoted a
seminar on rural development whilst concomitantly using resources from the Workers’ Support
Fund (FAT)48 to provide capacity-building related activities to groups of farmers to empower
them to effectively participate in the fair trade market.
In the same year these farmers earned the Fair Trade certification49. Yet, even despite this
achievement, the cooperative did not manage to trade its coffee on the international market. Luiz
Adauto attributes that fact to the existence of prejudice from international buyers, who saw
Brazilian producers as large land owners (see Chapter 3). In the case of the 196 associates of
48 The Workers’ Support Fund—FAT—is a special fund linked to Brazil’s Labor and Employment Ministry aimed at
financing its Unemployment Insurance and Salary Bonus Programs and economic development programs. 49 In 1998, 12 members of the cooperative were awarded the certification from the Organic Agriculture Association
(AAO). This certification, however, was not recognized in the international market, which led to a partnership with the Association of Organic Coffee Production (ACOB).
Coopfam, they have areas no greater than 12 hectares of total area, which average 5 hectares per
rural plot.
The first negotiation for coffee exports occurred in 2000, when the International Conference on
Organic Coffee and Fair Trade was held in Machado, sponsored by the FAE. This event allowed
making the region known to the external market, since it hosted some 400 interested participants
and representatives from several buying countries like Australia, China, Japan and Colombia.
It was also observed that if producers were to reach the international market, they were expected
to have quality certifications that supported their organization system in their target markets. The
Ecological Certification from the German BCS Öko Garantie label was their next achievement. In
2001, the 75 families who had obtained this certification made the first sale of 287 bags of coffee
to the US-based Royal Coffee.
The result of this venture motivated other producers, thereby raising the number of Coopfam’s
associates. In 2006 the association counted on 196 members, who were exporting through
Brazilian exporters (Sancoffee from Santo Antonio do Amparo and Exprinsul) to the Royal
Coffee and Braser Wolthers importers, who distribute the coffee in the United States, Italy and
England. Poço Fundo’s coffee can be found in the WalMart stores of the international market. The
cooperative’s annual export volume of 5 to 6 thousand bags, however, does not allow it to export
directly (SAES; MIRANDA, 2006).
As foreseen by the certification scheme (explained in Chapter 3), part of the resources’ proceeds
from coffee sales corresponding to US$0.05/lb (price per pound of coffee) has to be applied in the
community. As a consequence thereof, the following social projects have been carried out in Poço
Fundo: a school of informatics has been built for producers, their children and needy children,
orthodontic and orthopedic treatment for producers’ children and needy children is being
provided, along with dental assistance to all cooperative members, the implementation of an
agroforest organic production system, and a shelter for the elderly. The cooperative also assists
the community with the distribution of staple foods and school material. With these resources,
Coopfam was also able to have its own headquarters, with a warehouse for processing and storing
coffee.
The successful and innovative experience of these producers has helped attract the attention of
other partners and collaborating centers, which maintains the continuity of the resources, thereby
creating a virtuous circle of investments50.
4.4.3 Gains from horizontal and vertical coordination
The cases of the producers from Baturité and Poço Fundo show similar experiences concerning
their initial formation and value-creation strategies. Producers started to have a mutual
interdependence, once they have a brand to uphold. Both in Poço Fundo and Baturité, coffee is
jointly traded, which requires shared knowledge and actions. This is a more complex strategy
since it requires engaging multiple agents in the transfer of knowledge and in developing a
cognitive map. As a consequence, the governance structure has to be aligned to this need for
knowledge transfer and responsibility among the agents. The structure is still being formed,
insofar as the experiences are recent and characterized by vertical and horizontal interdependence.
Figure 14 presents a scheme of the governance structure among the region’s producers.
Figure 14 - Mutual interdependence: Producers from Baturité and Poço Fundo
50 In 2001, the Vitae Foundation invested R$240 thousand (US$123,000) to buy equipment and train personnel. The
Bank of Brazil Foundation offered R$150 thousand (US$76,900) for coffee processing installations (SAES; MIRANDA, 2006).
RETAIL
Box 1 – Institutional Environment of the Brazilian Coffee System51 The regulation of the Brazilian coffee system started in 1906 within the scope of commercialization, aimed at increasing export revenues. Over time, the policy designed for the sector encompassed other segments, leading to the coordination of all coffee production: rural production, processing industry and distribution/consumption. Since the outset of the coffee policy, several agencies were created, but it was under the aegis of the Brazilian Coffee Institute (IBC), established in December 1952, that the coordination of the segments not only determined the particular dynamic of each link involved, but also influenced the performance and competitiveness of Brazilian coffee. In the rural segment, one of the factors that may have prevented new commercialization strategies was the lack of stimulus to good production and processing as a result of the price policy adopted by the IBC. The guarantee prices determined by this autarchy reflect more the concern of regulators with the expansion and control of the coffee production than with its quality. In some instances, no difference was registered among the guarantee prices for different qualities of green coffee. This fact led to the deterioration of the global quality of the Brazilian coffee, ultimately leading to negative implications on the image of the coffee exported. The passage from the punctual nature of the intervention—started in the area of commercialization—to the coordination of the sector by the State, could not be avoided. The results of public policies aimed at valorizing the coffee ultimately established complex networks of actions and reactions in the other segments involved. In particular, an adverse reaction existed against the adoption of policies that restrained the commercialization to maintain prices: the stimulus to increase production (in the rural segment) compromised the efficacy of the results. This is the reason that explains why, as of the 1960’s, when the IBC was faced with a crop surplus and stocks twice as big as the world demands for the produce, it decided to create the "Campaign to increase the domestic consumption of coffee " and implement the soluble industry. Such measure aimed at minimizing the costs to transport stocks, while keeping the policy of valorizing the product in the international market. During the above-mentioned campaign, the roasters received green coffee from the IBC at a subsidized price and the delivery of the subsidy to consumers was controlled through a price control system for roast and ground coffee. This measure led to a dramatic increase in coffee consumption levels in the Brazilian market. From 1960 to 1969, domestic consumption increased by 153 percent and the country became the second-largest coffee consumer worldwide. Since the IBC’s coffee quota assigned to each company was limited to its processing capacity, the industry, by its turn, showed a significant growth in its production capacity. The stimulus to increase production capacity, provided in the early 1960’s, still echoed in the sector, which maintained high levels of idle capacity in the 1990’s. Another action of the State affecting the sector was the control of coffee prices in the retail sector, aimed at keeping the inflation rate at targeted levels. The price control policy did not distinguish among the qualities of the coffees, thus all retailers obeyed the same price. This practice was the main cause of the image conveyed to consumers of coffee as a homogenous product. Two measures carried out by the IBC, resulting from the ones previously adopted, ultimately conditioned the performance of the roasters. The first was the control of the opening of new companies, only revoked in the early 1990’s. The second concerned the prohibition to entry to foreign companies in the international market. The IBC’s authorization to allow multinational companies operations in the market only came in 1978. Concerning the industry of soluble coffee, in 1960 the IBC passed its Resolution 161, in which the first norms for the incentive of its implementation were established. The governmental authority committed to the transfer from its stocks an annual quota, according to the installed capacity of each company, during the first four years of this operation. During the first two years, these companies would be able to pay for the green coffee with the manufactured product. Aimed at acquiring subsidized coffee from the IBC’s stocks, the companies enhanced their production capacity far above that which the market could absorb. Thus, ever since its implementation, the industry has lived with its own oversizedness, in the same way as the roasting industry.
4.5 Strategic choices, governance structure and value adding
Drawing on information gathered from interviews with small-scale producers, the main objective
of this item is to discuss the comparative results of the value-creation strategies devised in the
experiences previously presented. Following that, it will consolidate the empirical analysis based
on the theoretical framework developed in Chapter 2.
51 Based on SAES (1997).
4.5.1 Producers’ performance: an empirical comparative analysis
The case studies herein presented showed the strategies of four organizations and their main
results. This section makes some considerations about the interviews conducted with 78 rural
producers with up to 50 hectares of land, 41 of which are Cooxupé’s associates, 10 illycaffè’s
suppliers, 9 Coopfam’s associates and 8 Comcafé’s associates.
The interviews were primarily conducted over the telephone and the sample was taken from a list
supplied by the organizations52. Although it is not a probabilistic sample, it provides some
indications that may supplement the analysis of the cases, under the point of view of the rural
producers53.
The first column in Table 9 lists the average size of the producers’ lands. As can be seen, those
associated with Coopfam have quite inferior areas. The same table indicates the level of the
technology employed by associated producers.
Concerning the average crop age (column 2), no significant differences are found between
illycaffè’s suppliers and cooperatives’ members, being about 10 years in all cases. However, the
crops from Comcafé’s associates, as expected, are on average much older, and show a high
standard deviation (SD), due to the presence of new crops fostered by the policy of the producers’
association, in contrast with centenary coffee plants.
Coffee yields (column 3) are higher for producers who supply illycaffè. In contrast, the crop yield
from Coopfam’s producers is much lower, which can be explained by the fact that five out of its
nine producers produce organic coffee, whose yield is lower that that of the conventional product.
In the case of Comcafé’s associates, their yield is the lowest registered—5 bags per hectare—a
fact justified by the shade-grown production type.
52 The interviews are part of a survey on the Profile of Coffee Production in Brazil, conducted by the illycaffè
University, between the months of October 2007 and January 2008. The project was coordinated by this authoress. 53 It is worth observing that the 41 producers from Cooxupé who were interviewed represent 0.4 percent of the
population of 8.9 thousand small producers-members of the cooperative. In the sample from Coopfam, although it counts on only 9 members, they represent 4 percent of the total, while the 8 members from Comcafé account for 17 percent of the total. Concerning illycaffè, we do not have information about what percentage its 10 producers represent in relation to the total of small producers negotiating with illycaffè, though it is known that large- and medium-sized producers are more representative due to the very conditions of negotiation with the firm. As noticed, the small producer negotiated the “bica corrida” coffee, without classifying it according to type and sieve.
With respect to mechanization (column 4), two factors contribute to the scarce use of this
technology: the size of the property and the location of the production. Mechanization is not
suitable for mountainous regions. And the non-use of irrigation (column 5) is due to two factors:
the high costs of this technology, in general used by larger-sized producers, and (b) regions with
rainfall rates adequate to produce coffee.
All producers from Coopfam and Comcafé reported having invested in the production of specialty
coffees (column 5). The main investment both organizations made is in the form of certification:
five associates from Comcafé have organic certification and one associate has the BCS Öko
Garantie, whereas six members of Coopfam have the fairtrade seal and two members have the
BCS Öko Garantie. Regarding the suppliers of illycaffè, 90 percent reported investments in the
production of specialty coffees, mainly in hulling equipment to produce hulled “cherry coffee”.
Two investments were registered in certification: one origin certificate and one from Utz Kaphe54.
As for Cooxupé, only 12 percent of its associates reported investments in the production of
specialty coffees. Concerning certification, one producer associated with Cooxupé reported
having the Cerrado coffee origin seal from the Caccer, and three growers from the same
organization belong in the 4 C Program55.
54 Utz Kapeh is a coffee certification program. Created in 1997 by coffee producers from Guatemala and by the Ahold
Coffee Company roaster, it aims to provide bonuses to roasters and brands to ensure responsibility in the production. The certification is designed to promote agricultural practices adequate for coffee production and workers’ well-being.
55 The Common Code for the Coffee Community (4C) is a program that originated in the German Coffee Association (DKV) and the German Ministry for Economic Development and Cooperation (BMZ) supported by the European Coffee Federation (EFC), Germany’ Technical Cooperation (GTZ) and, later, the State Secretariat for Economic Affairs (SECO) from Switzerland. The main requirements of the code are: absence of child slave labor and the preservation of the environment. Since joining the program in October 2007, Cooxupé has exported 250 thousand bags in the 4C pattern.
Table 9 - Technology Indicators: average crop age (years), average yield (2006-07 and 2007-08),
percentage (%) of mechanized and irrigated crops and number and % of producers who invested in the production of specialty coffees
Crop age (2)
Average Yield (3)
Mechanization (4)
Irrigation (4)
Total average area (ha)
(1) Years Sd* bags/ha Sd* (%) (%)
Investments -Number and
% of producers (5)
Cooxupé 23.9 11.0 3.8 30.3 15.3 17.3 9.8 5 (12%) illycaffè 31.0 10.4 4.1 39.3 13.1 3.0 10.0 9 (90%) Comcafé 13.3 56.5 32.3 4.1 2.1 0 0 9 (100%) Coopfam 3.5 9.0 3.9 23.1 3.7 5.6 0 8 (100%)
SOURCE: FIELD SURVEY (2007-08).*standard deviation
Table 10 shows commercialization data. Excluding those who sell to illycaffè, producers
associated with the four entities negotiated the largest part of their production in the 2006-07 crop
year to a single supplier (column 1). This is an expected result, since illycaffé only acquires beans
with a superior qualification56.
Suppliers who trade with illycaffé sell on average 70 percent of their production to the exporter
(in the case, illycaffè, the Port de Santos Company)57 and 30 percent to the cooperative with
which they are associated. Interviewees who were members of Cooxupé and Coopfam negotiated
some 90 percent of their sales with their cooperatives. This result shows the loyalty of the
members to their associations and can be interpreted as an indication of their degree of
satisfaction, mainly taking into account that there is no monopoly of purchase in the region where
both organizations operate. The same can be said about the 16 years of relationship between
producers and the Cooxupé cooperative.
As for Comcafé’s producers, 78 percent sold their production to brokers, and one producer
(representing 6.7 percent) negotiated with another agriculturist. According to the members,
negotiation is one of the key problems in the region’s coffee production. The price of the coffee
that is not bought by Comcafé loses a large percentage of its value, being acquired at the price of
the Robusta, as already observed.
56 In the sample there was only one producer associated with Cooxupé who had negotiated with illycaffè. This
producer remained in the illycaffé’s sample to prevent double counting. 57 For the definition of the sample, producers were asked if they had supplied at least once to illycaffè, i.e., they may
have supplied only one crop.
Table 10 - Commercialization features: number of buyers of the production (2006-07); percentage (%)
sold to cooperative, to exporters and to others (20006/07); years of relationship with main buyer
Buyers to whom coffee was sold (1)
Sales to the cooperative
Sales to exporters
Sales to others
Relationship with main buyer
Number (%) (%) (%) Years Cooxupé 1.3 89.3 3.1 7.6 16.3 illycaffè 1.9 26.7 69.2 4.1 12.2 Comcafé 1.6 16.3 0 83.7* 9.5 Coopfam 1.2 90.9 7.2 1.9 4.0
Note: *78 percent sold to brokers and 6.7 percent sold to another producer.
SOURCE: FIELD SURVEY (2007/08).
In observing the information about the means of processing coffee (Table 11), it is verified that
most producers sell the coffee in its natural form, i.e., dried on patios, which is the most
traditional way of processing the product in Brazil. Growers who trade with illycaffè produce 55.4
percent of semi-washed and 11.4 percent of pulped. Both methods improve the taste of the end
beverage and, in illycaffè’s quality contests most beans underwent this type of processing.
Table 11 - Coffee traded: natural, de-hulled and semi-washed, and pulped (2006/07 and 2007/08 crops)
Quantity of bags sold
Natural (%)
De-hulled (%)
Pulped (%)
Cooxupé 355,75 83,6 16,4 0 Illycaffè 741,00 33,2 55,4 11,4 Comcafé 75,89 100 0 0 Coopfam 33,38 100 0 0
Source: FIELD SURVEY (2007-08)
The gains and the costs with specialty coffees are presented in Table 12. Coopfam’s producers
trade nearly all of their production as specialty coffee and Comcafé trades 65 percent. Only 5
percent of Cooxupé’s members sell specialty coffees, trading only 5.4 percent of the coffee they
produce as special.
Among specialty coffee producers, the ones associated with Coopfam reported having the highest
cost differential between the specialty and traditional coffee. Accounting for this is the fact that
small-scale organic production uses less industrial inputs and only family labor, which results in
lower production costs. Thus, with the need for certification, the relative costs rise significantly58.
58 According to Souza (2006), each producer’s individual contribution to obtain the Fair Trade certification is US$60
per year. Organic coffee producers have to pay an additional amount for the costs of this certification.
Nevertheless, they are the producers who obtain the highest price differential by virtue of the fair-
trade certification.
Table 12 - Production of specialty coffee: cost and price differences (2006/07 crops)
Average of coffee traded as a specialty
Number of producers % of total
Cost difference between special and
traditional coffee (%)
Price difference between special and traditional
coffee (%)
Cooxupé 5 (5%) 5.4 7.0 5.9 illycaffè 9 (100%) 48.2 9.4 19.0 Coopfam 9 (100%) 95.6 22.2 38.3 Comcafé 8 (100%) 64.7 14.2 23.0
SOURCE: FIELD SURVEY (2007-08)
With regard to the source of resources for short-term production credit, producers by and large use
their own. Concerning Coopfam, a significant parcel of resources (30 percent) comes from the
National Program to Strengthen Family Farming (Pronaf), whereas Cooxupé provides on average
12 percent of these resources for its members. Banks have a stronger participation in the total
resources used for illycaffè’s producers.
Table 13 - Sources of resources for crop financing (2005/06 - 2006/07)
% of resources for crop financing Own CPR Banks Cooperativa Pronaf Others Cooxupé 67.9 3.7 8.1 11.7 3.5 5.1illycaffè 63.5 4.5 14.0 5.5 0.5 12.0Comcafé 88.5 0 6.3 0 5.3 0Coopfam 64.4 0 0 6.1 29,5 0
SOURCE: FIELD SURVEY (2007-08)
4.5.2 Conditions of rent appropriation
The question permeating this thesis was whether strategies leading to the creation of
differentiation attributes in the rural segment could ensure appropriate rents to small-scale
producers. To that end, an analysis model was built based on the strategic view of the Economic
Theory of Organizations, having the SCAs of the firms as the focus of the analysis. Later, four
cases were presented aimed at showing how the model could explain producers’ performance in
terms of rent appropriation.
As illustrated in Picture 6, entrepreneurs (TKL) in each of the cases presented have made different
judgments on the business opportunities (Column 1). The solution for the problem proposed by
each experience was related to the life histories of each entrepreneur, as well as their learning
from their own business (Column 2). Depending upon the type of problem to be solved (Column
3), new attributes of the resources had to be explored (Column 4). Therefore, according to the
complexity of the problem, different resource profiles (RVB) were necessary, and different
governance structures (TCE) required. With the chosen governance structure aligned with the
resource profile, both value creation (APE) and its appropriation (TCE) were simultaneously
defined.
128
Picture 6 - Comparative analysis of the cases Cases Business
opportunity (1)
Entrepreneur’s history and learning (2)
Problem type concerning knowledge transfer to
producer (3)
Resources created / explored (4)
Governance structure:
horizontal / vertical (5)
Conditions of product market
(6)
Conditions for value-adding
producers
Cooxupé Good quality coffee of international market standards for better trade possibilities.
• Background and vision of business management in the secondary sector; • Learning to focus on the business, not diversifying.
Low complexity: • Create standardization (reputation and transparency); • Motivate region’s producers to become partners.
• Standardization recognized at international market level; • Knowledge of international market; • Capacity to explore economies of scale and scope.
• Joint Interdependence • Coordinating agent: market.
Competitive market; large traders and exporters and low margins.
Null: Gains from efficient relations, economies of scale/scope and reduction of transaction costs.
illycaffè Market niche of espresso coffee of excellent quality.
• Degree in Chemical Engineering; • Learning by understanding consumer’s demand.
Average Complexity: • Foster the production of quality coffee aimed at decreasing transaction costs.
• Coffee brand of excellent quality.
• Sequential interdependence. • Coordinating agent: authority (firm).
High income elasticity and low demand elasticity
Average: Depends on negotiation conditions. Great possibility of quasi-rent creation (brand).
Baturité Forest-based sustainable products.
• Experience in international non-governmental organizations and degree in Education ; • Learning to observe the foreign market.
High complexity: Joint production, i.e., producers need to be engaged in the production of sustainable coffee and watch over brand and quality (there may be free riders).
Coffee brand Pico Alto. Resources shared among all agents.
• Mutual interdependence.
Coordinating agent: producers (shared)
Possibility to create consumer loyalty.
High possibility, if consumers identify the brand. If the brand belongs to producers, quasi-rent may be shared among them (possibility of capture).
Poço Fundo
Fair Trade coffee for the external market.
• Experience in organizing producers and the capacity to absorb teaching from the University; • Learning from producing/negotiating organic coffee.
High complexity: • Joint-production, i.e, producers must be engaged in producing Fair Trade coffee (free riders may exist).
Resources shared among all agents.
• Mutual interdependence. • Coordinating agent: certifier
Regulated Market: Entry barriers.
High: While market is regulated (cartel).
In the case of Cooxupé’s strategy, good quality, consistency and transparency in the
relationships with buyers in the international market were the attributes conquered through
an innovating system of standardization which, allied to the strategy of increasing the
number of associates allowed the cooperative to have volume and provide regular supplies.
Formatting its business in the international market was made possible through the
development of human resources, enabled in the period of tenure of entrepreneur Dr. Isaac,
who played a pivotal role in the creation of unique competences in his organization.
Due to the low complexity of the initial strategic solution—standardization and sales of
good quality coffee in the international market—in which each one of its integrating parts
(rural producers) provides a discrete contribution to the whole, we have a joint
interdependence. We have also seen that the conditions of quasi-rent expropriation are null,
since coffee is sold at the price set by the Liffe and CSCE da Bolsa Internacional. Gains,
therefore, arise from two factors: (a) the minimization of transaction costs, resulting from
efficiency gains in negotiations, and (b) economies of scale and scope in the
commercialization. In this case, the firm will have SCAs, because it will be more efficient
than its current or potential rivals in the creation of value of the joint production of
standardized good quality coffee (Figure 15). http://fletcher.tufts.edu/research/2005/Fend.pdf
Figure 15 - Value creation and appropriation: producers from Cooxupé
Concerning illycaffè, the attribute Dr. Illy explored was quality excellence, which required
the coordination of the supply chain. To achieve excellent quality coffee, investments were
required in crop handling but, because the market did not pay for them, they were not being
done. Here we have an average complexity problem, because the decision centralized by the
Lower cost Economies of scale and
scope
currency units C Cooxupé P = C Competition
Price at the Brazil Mercantile and Futures
Exchange (BM&F) = Commodity price
firm (it holds residual decision rights) in the coordination solves the problem by signaling
with adequate incentives
As for producers’ capacity to appropriate the quasi-rent generated in the relationship, it is
observed that in the case of coffee there are two types of investments for the production of
specialty products: Fixed Costs (FC = cement drying terrace / suspended drying terrace,
greenhouse, dryers, huller, tanks and labor training, among others) and Variable Costs (VC
= crop handling and processing). Regarding fixed investments, once they have been made,
the processing firm has its negotiation space increased, as illustrated in Figure 16.
Figure 16 - Value creation and appropriation: illycaffè’s suppliers
As the illycaffè brand is the differentiation instrument, it is up to the company to determine
the distribution of the quasi-rent, which is dependent upon the supply of specialty coffees,
the competition with other firms in this market niche and the desire to keep a reputation
with its suppliers. The latter is, in fact, the greatest differential in this relational contract. It
is not only about a buyer purchasing coffee; it is illycaffè, which is investing in the
producing regions, which knows producers and which wants to be recognized by consumers
as a responsible company (socially and environmentally). It is for this reason that in this
case there is a higher possibility to transfer quasi-rent than in the previous one, where prices
are market driven. The company is interested in keeping a long-term relationship and
paying a price premium above (FC+ VC).
With regard to Baturité, we can see that the strategic problem producers face is complex,
since it requires the engagement of all of them in the production of sustainable specialty
coffees. Although the sustainability resource was available in the region, it was not
explored; that only happened when Adalberto became aware of it. In addition to that, the
lack of stimulus due to the traditional form of commercialization reflected in loss of product
Negotiation zone
Currency units
CF +Cv Pcommodity P + Premium +’
New negotiation zone
Cv
quality. That created a cycle of low investment and loss of quality, which ultimately
expelled the product with better quality and resulted in the typical market described by
Akerlof (1970).
To revert this situation not only price signaling is important but also the engagement of
producers in the strategy, inasmuch as when a coffee brand is created in the region all
producers belong to the strategy and each depends on the action of the other for it to
become effective. In other words, cooperation is required so as to protect the brand. If, on
the one hand, this strategy is the most difficult to be adopted, on the other hand, it is the one
providing the best appropriation of the quasi-rent. Since the quasi-rent depends on the value
created for consumers and because, in this case, producers themselves are the agents of
differentiation (Pico Alto brand) they will appropriate the rent themselves. Nevertheless,
there is a huge difficulty in formatting such a strategy: for one reason, the mutual
interdependence relies on constant negotiation among the participants of the community to
choose, develop and adapt internal solutions and, for another, there is a need to adopt
strategies aimed at building the loyalty of consumers, which implies negotiation with the
retail channels.
Figure 17 - Value creation and appropriation: producers from Baturité
With regard to Poço Fundo’s producers, they were the ones who obtained the biggest
success in adopting value-appropriation strategies based on a relationship of mutual
interdependence. Two reasons account for this: they were the pioneers in Brazil, taking the
opportunity when the Fair Trade market was still in formation, and they adopted a strategy
with a well-defined focus in a buying market that was already prepared. That was possible
due not only due to entrepreneur Adauto’s capacity to mobilize producers, but also to the
proximity to the university, which allowed the transfer of knowledge about the development
Cost of joint-production (economies of scope)
Currency units C Baturité P
Price determined by the value created for consumers
Cost of joint production (Economies of scope)
Currency unitsC Copfam P
Price determined by FLO
of a cognitive map by the several agents sharing the same strategy (investment in the
production of organic coffee).
Figure 18 – Value creation and appropriation: Poço Fundo’s producers
4.5.3 Considerations about the results
We can think of the results obtained in terms of practical and theoretical implications. In
practical terms, we could reaffirm that, on the one hand, cooperation gains are important in
the rural environment, but a union is not a guarantee of a better negotiation power. On the
other hand, the strategy of brand creation in this segment is very complex and results have
not yet been consolidated in the case presented. The relationship between the rural segment
and the segment upstream is occurring under new parameters, both respecting the quality of
the drink and sustainability issues, which may mean a stronger participation of rural
producers in the total income generated.
One interesting piece of information is the verification of how the firms’ strategies to
incentivize product quality have reflected in producers’ actions. That could be perceived
through the growth in the participation of better quality coffees in the total produced in the
main Brazilian producing region (Graph 13).
Graph 13 - Participation of each type of coffee in Minas Gerais’ total production
SOURCE: CNC (2007)
Concerning the theoretical questions, it was evident that SCAs are obtained through
strategies that unite gains arising from investments made to explore or create new attributes
of the resources. According to the strategic focus (strategic problem to be solved), SCAs
can be achieved by placing more emphasis on the creation of barriers in the product market
(illycaffè’s case) through gains resulting from consumers’ loyalty or may be related to
barriers in the factor market, as in the case of a single product identified with a specific
region (Pico Alto coffee). In both cases, however, monopoly and Ricardian rents are
present. There is no strategy linked to the factor market without a buyer and there will not
be a brand strategy without the creation of unique competences.
Finally, we have also seen that another way of acquiring SCAs is by the strategy of
minimizing costs, through reduced transaction costs and/or economies of scale and scope.
This result has an interesting implication, since for some RBV theorists it would only be
possible to obtain SCAs through a unique strategy.
39%
51% 51% 53%50%
58% 57% 59%
53%58%
60%
39% 39% 39%43%
35%39% 38%
41%
36% 36%
10% 8%10%
8% 7% 5% 6%3% 2%
5% 6%3%
41%
46%48%
0,0%
10,0%
20,0%
30,0%
40,0%
50,0%
60,0%
70,0%
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Type 6 and better
Type 7 and worse
Residues
Rio and Riados
CONCLUSION
The driving force of this work is the problem of the decreasing trend of the agricultural rent
in the share of the total generated by the supply chains. The impoverishment and exclusion
of rural field workers in poor countries, and the enormous subsidies to producers from rich
countries are dual aspects of the same phenomenon faced by the 21st century economy.
Arising from the social impacts of this situation and allied with growing concerns about the
environment and food security-safety, diverse movements led by NGOs and representatives
of rich countries are willing to fashion a new economic logic. The concern with food quality
and social and environmental sustainability is translated into several possible ways of
differentiating rural production. The de-commoditization with the creation of attributes of
differentiation has been seen as a way to avoid the price competition, thereby allowing part
of the quasi-rent created in the supply chain to remain in the rural segment.
This work, therefore, aimed to discuss whether the strategies leading to the creation of
differentiation attributes in the rural sector could allow the rent to be appropriated by small-
scale rural producers, thus ensuring SCAs for this segment. The main question guiding this
work was whether there were feasible and sustainable strategies which would allow
reverting the fall in the agricultural rent of small-scale producers.
To that end, the first part of this thesis approached the literature that discussed how
entrepreneurs choose value creating and capturing strategies aimed at presenting a model to
analyze differentiation in the rural segment. Four distinct theoretical lines of research have
been put forward, pertinent to the Economics of Organizations: Strategic Positioning
Analysis (SPA), Resource-Based View (RBV), Transaction Costs Economics (TCE), and
Knight’s Theory of Profit (KTP).
It was argued that value creation and appropriation had to be jointly determined because the
consistency of the strategy does not depend only upon the characteristics of the sources of
value, but also on the relations among the segments of the supply chains. Therefore, the
way the division of the quasi-rent takes place is based on the determinants of this relation,
i.e., how property rights are allocated. Thus the integrative perspective of the views posited
in this work determined that the value creation strategy (Ricardian/monopolistic rents) must
be aligned with the governance structure so that the value created can be appropriated.
The analysis model proposed was initially built drawing on Knight’s approach, i.e., based
on the profit expectations about the discovery of opportunities that trigger entrepreneurial
judgment. If a subjective logic is embedded within the entrepreneur’s judgment—and it
could not be different—it was, however, by bringing the logic of the transaction costs
economics that it became possible to bring rationality to decision-making. The resource
profiles that will be used to respond to the entrepreneurial logic will depend on the
complexity of the problem to be solved and will require different governance structures.
Given that the object of this study was the small-scale producer, the adoption of an
individual strategy took into consideration the transaction costs of a collective action. In
doing so, since the governance structure must be chosen according to the resource profiles,
both value creation and value appropriation will be defined concomitantly.
The empirical analysis approached the coffee market, discussing four cases of very distinct
differentiation strategies. As verified, each presented the discoveries of different
opportunities and required differentiated resource profiles, which, by their turn, determined
different vertical and horizontal governance structures. With regard to the conditions of rent
appropriation, our results were very interesting, proposing reflections on private and public
strategies.
The observed strategy that obtained the best result in terms of representation (number of
producers) was the one focused on scale and scope in the commercialization of
differentiated coffees. Horizontal cooperation allowed gains to also be obtained through the
management of resources for financing the production. Being a product traded in the futures
market, the market determines prices and gains arise, therefore, from the reduction of
transaction costs. In terms of public policies, this result validates the importance of the role
of producers’ associations/cooperatives as a factor of development in the rural sector.
The relationship between producers and processing firms, with the strategy of a high-quality
brand, led to the formatting of a sequential interdependence, in which the firm holds the
residual decision right. To motivate the production of high-quality coffee, the firm has to
motivate producers through price premiums that at least compensate for the costs to produce
this type of coffee. The part of the quasi-rent created by specific investments in the
production that producers will appropriate will depend on both the supply of specialty
coffees and the demand from the other firms entering the market that are investing in the
specialty coffee niche. In addition to that, the strong identification of producers as suppliers
of a company produces an idiosyncratic relationship, in which the parties tend to preserve
the relation and facilitate cooperation. On the producers’ side, there are positive
externalities, besides the price premium, in being identified as suppliers of high quality. On
the firm’s side, the growing presence of the social and environmental sustainability
movement and the participation of NGOs in the defense of producers oblige companies to
preserve their images with consumers, thus they act as disseminators of norms of good
social and environmental practices. In other words, the moment a firm invests in producers
from a specific region, providing collective goods, there is no interest in losing this
investment/relationship.
When producers are engaged in a production aimed at commercializing it in the Fair Trade
market, the residual decision rights are with the certifying body, which gathers elements
that represent the whole supply chain. The market is regulated and there are strong entry
barriers. Though this strategy has been the one in which producers had the highest gains, it
is limited to those who have the certification, and therefore it excludes those that, even
having conditions to participate, cannot because they do not have the capacity to mobilize
fast enough. New certifications are only awarded according to the growth in demand.
Nevertheless, it is important to bear in mind that, if this market sustainability depends on an
artificial restriction, nothing prevents other certifying bodies from taking the opportunity of
the growth in the consumer market and creating their own fair trade commercialization seals
thereby decreasing the price premium.
Regarding the strategy of mutual interdependence, which led to the creation of the coffee
brand of a region, the possibility of quasi-rent appropriation is the one that would bring
more results, theoretically. In this case, the brand itself enables the creation of value to the
consumer, as well as his or her loyalty. This strategy requires a complex governance
structure in which the resources shared among all agents impose the engagement of
producers. Since the product is sold jointly, if one producer does not follow the necessary
requirements and the consumer perceives a failure, all the producers will be harmed. There
may be problems with free riders—or producers who take advantage of the cooperation by
acting opportunistically—for instance, by not guaranteeing the proper handling of a crop.
Additionally, the success of the strategy depends upon actions that go beyond the
community and that are aimed at placing their product in the market: producers have to deal
with the competition on the supermarket shelves. The experience portrayed is still in its
infancy and has many challenges to face. Therefore, full results have not yet been observed.
In the cases presented, on the one hand, some concern was verified from the sectors
downstream from the supply chain about producers’ social and environmental
sustainability, even when the focus of the differentiation was the high quality of coffee.
On the other hand, strategies centered in sustainability concern the quality of the raw
material. It can be seen, therefore, that the market for specialty coffees tends to converge
around two basic questions: quality and sustainability. Of the cases verified in Brazil, there
did not seem to be a difference between the strategies of processing firms and retailers and
those of producers. It is not likely, therefore, that specialty coffees sold at retail are adding
symbolic values totally dissociated from rural production and that, for that reason, coffee
growers have no other possibility but to be commodity producers. On the contrary, the
examples herein presented show that processing firms are interested in building partnerships
with producers and pricing product for quality and for their efforts in the adoption of good
production practices.
It is worth noticing, however, that these actions represent very little of the total produced
and that the coffee sold in supermarkets still competes for price. The question is to know
whether the experiences observed will remain just among narrow market niches or whether
they will be able to modify the wider exchange relations in the supply chain.
