Monday, April 5, 2010

Do Middlemen Produce Any Value?

The Ministry of Commerce announced that its "Farmer-Supermarket Linkage" pilot program will be expanded this year. This innovative program, begun last year by the Commerce, Finance, and Agriculture Ministries, arranges for supermarket chains and other agricultural companies to purchase farm produce directly from producers.

The idea is to reduce marketing costs by cutting wholesalers and traders out of the supply chain. The cost savings are distributed to farmers, consumers, and retailers. Farmers get a higher sale price, supermarkets purchase at a lower price and they pass on savings to consumers through a lower retail price. The Commerce Ministry says it supported 205 projects last year, which on average raised farm prices 15% and cut retail prices 15%, bringing benefits to all three parties: farmers, consumers, and enterprises.

The losses sustained by traders and wholesalers--most of whom were probably poor farmers a few years ago--apparently don't matter. The program reflects the Communist Party's dim view of middlemen--they can be cut out of supply chains with no loss to society.

A local Beijing newspaper reports an example. At a Wu-Mart hypermarket outlet in Beijing, consumers are lining up early in the morning to buy sweet red strawberries that had been growing in greenhouses in Changping County just a few hours earlier.

The report says that the traditional supply chain is for farmers' strawberries to be sold to traders at local wholesale markets, then resold to wholesalers at larger markets before entering the supermarket. A 10% mark-up is added at each stage. The direct purchase program reportedly allows farmers to get their harvest to the retailer faster with less waste, while the strawberries are fresher and more flavorful. A farmer told the reporter that they have been selling over 100 kg. of strawberries daily, valued at 4000 yuan, since the direct sales to Wu-Mart began March 1.

At first glance, the linkage program makes a lot of sense. There is a lot of waste in food marketing. Farmers often have a big harvest that goes to waste because there is no purchaser.

However, the unspoken premise of the program is that the middlemen do not perform a valuable function (and therefore do not deserve to be compensated). This fits in with Marxist ideology where value is derived only by creating material objects. In fact, traders and wholesalers do perform a function by tracking down berries in far-flung corners of rural China and getting them to the markets where they are demanded. If you cut them out of the supply chain, someone has to perform this function--who does it?

In the direct linkage program, the matching of suppliers and retailers is subsidized by local officials who organize meetings to do this. In Beijing, the local agricultural and commerce commissions organized a strawberry season launching meeting in January where Wu-Mart signed agreements to purchase directly from two villages in Changping and a grower in Xiaotangshan (probably associated with the extension station there). Interestingly, the Beijing wholesale market management commission was part of the meeting where arrangements were negotiated to cut wholesale markets out of the supply chain.

In ideal circumstances, the program looks good, but central planning looked good when it was on the drawing board in the first half of the 20th century. Small scale traders are "chaotic" and hard to control, but they also provide flexibility needed in a dynamic and unpredictable market. What happens if the growers have more product than the contracted supermarket can take? What if there is a drought or pest infestation in the designated supply region--where will the supermarket get strawberries then? In both cases, the "chaotic" traders and wholesalers will probably step up to balance supply and demand.

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