Introduction

I. Relevance of the study

            In developing economies, agriculture is argued to have 5 potential contributions to the rest of the economy (John W. & Mellor 1972 p.5, Kuznet 1965 p.244):

a)     supply food and raw materials to other expanding sectors in the economies;

b)     provide an investable surplus of savings and taxes to support investment in another expanding sector;

c)     sell for cash a marketable surplus that will raise the demand of rural population for products of other expanding sectors;

d)     supply labor surplus for other expanding sectors;

e)     relax the foreign exchange constraint by earning foreign exchange through exports or by saving foreign exchange through import substitution.

            Thus, agriculture, and especially agricultural export sector, play the key role in capital accumulation in the first stage of economic development. However, agricultural exports in developing countries have been facing with both internal and external constraints in the sector’s development process. Up to now there have been a great deal of studies on agricultural exports in general [1] while very little focus has been found on a specific commodity. A concrete commodity has its own characteristics, then it possesses various distinct opportunities and challenges. Therefore, by focusing on the coffee industry, this thesis is expected to specify findings of previous agricultural studies.

Vietnam is in the process of economic transformation and industrialization. The demand for foreign exchange is pressing. How and where Vietnam can access to the needed foreign exchange? Recent experiences of developing countries shows that the foreign borrowings and foreign direct investment is not sustainable sources[2] then should, to reasonable extent, rely on domestic sources. In the context of poor industry in Vietnam, the agricultural exports is the crucial one. While rice export is intensively discussing, previous researchers seem to ignore the role of coffee export which is the second largest agricultural contributor in export earnings. In near future it is expected to be the largest one, because increasing population pressure will not allow Vietnam to export rice as much as presently does. 

Moreover, coffee industry also create positive linkages to the economy through the above mentioned channels. First, this supplies input and creates incentives and conditions for developing coffee processing sector. Second, the investable surplus can be attracted from many sources in coffee industry, namely export taxes, fees and household savings. Third, the development of coffee production for export in poor rural areas is building the ‘vent’ for marketable surplus. Under-employed resources such as labor, land can be put in full use, then increasing farmers’ income, pushing up the aggregate demand, etc. Fourth, along with the said development, labor per unit of land will be reduced thanks to technological progress, creating labor surplus that can be utilized by other sectors.

Recognizing of the importance of the coffee industry, this paper intends to examine, under the structuralism’s  point of view, whether Vietnam coffee industry is on the right track of development or not and to defend the argument "institutional constraints prohibit the coffee industry from achieving stronger development". After identifying these constraints it makes some suggestions, by probable ways, to remove them.

II.    Focus and scope of the research :

II.1. Focus: the research will concentrate on

a. the structure of USA coffee market as a proxy of international market.

b. the structure of coffee’s domestic marketing channels for export:

n      Coffee production

n      Coffee processing

n      Coffee export

II.2. Scope

            The thesis just only focus on the supply side of the coffee industry. The demand side will also be referred as it is relevant.

Timeframe of the study  :  The research will concentratedly study the coffee industry in recent years. However, to have a dynamic picture of developing process of coffee industry in Vietnam, period of 1986-1998 is chosen.

III. Research questions :

1.     What is the typical agricultural marketing system in developing countries

2.     What is the structure of the world coffee marketing system and its implication for exporters in developing countries.

3.     What are the main factors generate the growth of the coffee industry in Vietnam in the period of study? And what are the problems the industry is facing with in producing and marketing coffee.?

4.     Can the marketing agents (in coffee industry) be attributed to these problems? If so, by what way?

5.     What are the pros and cons in promoting coffee roasting and developing arabica coffee in Vietnam?

6.     What policy recommendations can be drawn from above analyses to further develop coffee industry?

IV. Limitations of data and information

            The data and information are mostly drawn from Dak Lak province as a proxy for the case of Vietnam’s coffee industry. Then, sometimes these do not match with those in other provinces that also produce coffee. Interviews with persons in charge in some big enterprises dealing with coffee are also used as a source of information in the thesis, thus this information might be personally distorted by interviewees.

V. Structure of the thesis

This thesis is arranged into 6 Chapters excluding Introduction which are:

n      Chapter 1: in addition to theoretically analyzing gains and structural problems in agricultural trade, the Chapter sketches out the typical agricultural marketing systems in developing countries.

n      Chapter 2: presenting the common features in the international market for coffee, and taking Colombia as a case study.

n      Chapter 3: re-assessing the growth/development of Vietnam’s coffee industry in the study period.

n      Chapter 4: analyzing the coffee marketing system in Vietnam with the role of each coffee marketing agent.

n      Chapter 5: considering other aspects related to the development of Vietnam’s coffee industry.

n      Chapter 6: summary and recommendations.

Chapter 1: Theoretical Framework

I. Introduction

This chapter will consider 2 main points: first, the gains from trade under the viewpoint of international trade theories and the structure of the world agricultural market; second, the typical structure of marketing systems in developing countries. 

II.  Gains from trade under the view of traditional trade theories

International trade theories can be categorized into two groups: the traditional and new trade theories . The traditional trade theories presume that trade takes place because countries are different. The differences between countries that drive trade may lie in resources, technologies, or even in tastes. The new ones say that countries may trade because of economies of scale (Krugman 1994). Its means that the larger scale of production the less average cost of production then trade can take profit of these advantages (Todaro 1994, p.429). However, trade based on economies of scale mostly takes place in industries where economies of scale prevails. Therefore, in this section we just mention the traditional trade theories. Although these theories fail to measure the quantitative benefits, they shed a light on the qualitative gains of international trade. 

II.1 Comparative advantage theory  

This is the fundamental theory in international trade, which argues that: ‘Nations should specialize in production of and export the commodities in which its absolute disadvantage is smaller (this is the commodity of its comparative advantage) and import the commodity in which its absolute disadvantage is greater (this is the commodity of its comparative disadvantage)’ (Salvatore 1990, p.25).

D. Ricardo presented this theory firstly in 1817. In 1936 G. Haberler explained the theory of comparative advantage on the opportunity cost theory . According to Haberler, the opportunity cost of a commodity is the amount of a second commodity that must be given up to release just enough resources to produce one additional unit of the first commodity. Then a country has comparative advantage in producing one commodity over the other if it has lower opportunity cost in producing this commodity. Thereby, the real output, income and consumption will be greater for both countries than it could be in the absence of trade.

             The largest contribution of these scholars is that they pointed out, in principle, the orientation of international trade. Accordingly, the export industries should base on the national comparative advantages.

II.2. Heckscher-Ohlin theory :

The essence of Heckscher-Ohlin theory is that different countries are differently endowed resources (land, labor, capital and etc.,), then a country has comparative advantage in the products which are intensively using its abundant resources during production process. Vietnam is lack of capital but abundant of unskilled labor and endowed with the suitable climate for coffee planting, while coffee planting is a labor-intensive industry, thereby Vietnam’s concentration on coffee export is relevantly explained by the Heckscher-Ohlin theory.

II.3. Vent-for-surplus theory of international trade

The "Vent-for-surplus theory of international trade" was elaborated by Burmese economist Hla Myint from ideas of Adam Smith, points out that promotion of export is the efficient way to make use of underutilized resources (Todaro 1994, pp.429-430).

According to this theory, by accessing to the world markets, developing countries can make use of formerly under-employed land and labor resources to produce greater output for export to foreign markets, and commercialize the agricultural production.

Conclusions :

In international economics there are many theories explaining the gains from trade under different perspectives such as Trade Based on Product Differentiation, Trade Based on Different tastes, (Salvatore 1990, Chap.6) Technological Gap Models, etc., (Posner 1961, “International Trade and Technical change”, Oxford Economics Paper, cited in Salvatore 1990, p.167), however just three aboved-mentioned theories are the most relevant in explaining agricultural trade.  They show the great potential benefit from international trade for developing countries. The shortcomings of these traditional trade theories are: they are based on unreal assumptions such as fixed productive resources, fixed and freely available technology for all nations, perfect competition in the market, etc. Consequently, these theories just are of generality not of concrete, they overlook the inherent obsta cles in international trading.

III. The common features of international agricultural market

III.1. An overview of the world market

Theoretically, developed countries (DCs) initially well endowed with the vital resources to economic growth and development such as capital, entrepreneurial ability, scientific capacities, the ability to carry out technological research and development and skilled labor then they can produce high quality, high-priced and more market-adapted products. Developing countries (DgCs) by contrast, endowed abundantly with supplies of unskilled labor, poorly with necessary resources as mentioned above. So DgCs just can produce and export simple, labor-intensive products that are primary products. This sets up unfavorable structure of the world market for DgCs. The DgCs export mostly labor-intensive products with low quality, low price and marketing inflexibility for which the world demand prospects and terms of trade may be very unfavorable[3] , and they often find themselves locked into a stagnant situation that perpetuates their comparative advantages in unskilled, unproductive activities. DgCs unambiguously face sluggish demand for their commodities. The per capita income elasticities of demand for agricultural foodstuff and raw materials are relative low compared with those for fuels, certain minerals and manufactures. This means that only sustained high rate of per capita income in the developed countries can lead to even modest export expansion of these particular commodities from developing countries.

III.2. The structure of the agricultural market

Agricultural commodities are primary products, so they not only confront the common structural problems as a primary product but also face particular obstacles.

             Firstly, agricultural products are being produced much more efficiently in DCs than in DgCs (see Table 1). Thereby, DCs are not the importers but increasingly becoming the main exporters of agricultural products in the world market.

            Secondly, the agricultural products of DgCs are facing high trade barriers when entering into DCs as well as DgCs markets, including tariff and non-tariff barriers (See Table 2). The non-tariff barriers include quotas, licenses, or other types of surveillance, administrative barriers, and health and safety rules. The markets for DgCs’ agricultural products seem contracting. In 1996 DCs exported USD186 billion of agricultural products while DgCs only recorded of USD133 billion (FAO 1998, p.17). The main reason for setting up the barriers is to protect employment and standard of living in rural areas in these countries. 

Fortunately, the structure of beverage crops market (coffee, cocoa, and tea) look more brightly. DgCs are the sole exporters of beverage crops, because the climate in DCs is not suitable for growing these crops..

            To sum up, in agricultural trading fields, there are great potential benefits for both developing countries and developed countries. In general, the agricultural market structure, however, seems to incline to the developed countries and to be unfavorable to the developing countries. Consequently, when taking part in international trade the latter must take the unfavorable market structure as given and adjust their agricultural marketing structure accordingly.

IV. Agricultural Marketing System in Developing Countries

Agriculture marketing  includes all activities that are involved in transforming, storing, transporting, and promoting agricultural products to the domestic consumers or foreign buyers (Elz 1997, p.5). These functions are closely interwoven into the whole national economy and materially contribute to the economic and social development of a country. This section tries to spell out theoretically the role and structure of the systems in the economy. And in this section the agricultural marketing system just means non-food marketing system only.

IV.1. The Agricultural Marketing System and Development  

IV.1.1. Interaction between Agricultural marketing and the economy  

At different stages of development agricultural marketing play different roles in the economy. At the subsistence level, agricultural production is confined in a self-sufficient system, farmers cater basic needs themselves. So the agricultural marketing is not essential for agricultural sector at this stage. When farming aims to produce marketable surplus or called commercial farming , farmers depend on the markets not only to sell their products but also to get the necessary inputs for production. Obviously, agricultural marketing play an indispensable role in this type of farming. It is demonstrated by its following functions:

            - to provide farmers with signals about products and crops in which they specialize;

- to make inputs, technologies, techniques of production, and information available for farmers when needed;

- to provide necessary services such as storage, procession, and transportation, to forward the products to consumers in the most efficient way.

The marketing system makes a significant contribution to the general economy by adding value, by generating employment and by increasing productivity in agricultural production. At the same time the agricultural marketing is also driven by development elsewhere in the economy as showed in table  below.

Table 1: Indicators of improvements needed in agricultural marketing

Indicators	Improvements needed
Strong population growth and urbanization	- Development of infrastructure - Development of communication - Price and institutional adjustment
Insufficient growth of agricultural  production	- Improvement of logistics and production services, that is, supply of inputs credit, research and extension.
At first stage of development	- Increase productivity of production to produce marketable surplus - Development of market
Advanced stage of development	- Processing industries and development of high-value products

IV.1.2. Individual groups involved in marketing systems

Generally speaking, there are four main groups of individuals influence the marketing system: Producers, Traders and Trade planners and decisionmakers and customers.

Agricultural producers are generally interested in maximizing their net farm income while reducing the risk of producing and marketing their production. Traders are interested in improving the efficiency of the exchange of goods. Their ultimate end is profit, then they are concerned about lowering the cost of operation and price paid to producers and try to maintain low competition within their domain. Planners and decisionmakers have social political goals, generally related to stabilizing prices, expanding domestic production and export markets. Not only do the individual marketing interest groups face conflicts among each other, but they also face considerable problems in achieving their marketing goals.

Table 2: Potential Problems for Individual Interest Groups in Agricultural Marketing

Producers	Traders	Customers	Trade decisionmakers
Sales    -Lack of customers    -Lack of transport    -Lack of funds    -Lack of storage	Logistics    -Dispersed supply    -Inefficient transport    system    -Insufficient    information system    -Lack of facilities and    services	Supply    -Lack of input for    operation    -Various grades of    commodity quality    -Exporters’ unstable    trade policies	Supply    -Spatial distribution    and transport    -Storage    -Suitable processing    -Qualitative and    quantitative losses
Market position    -Isolated location,    unsatisfactory market    -Dependence on    buyers    -Little market    transparency    -Small quantities of    supply per producers	Working conditions    -Unfavorable  conditions for    competition (storage,    processing, etc.)    -Lack of professional  knowledge    -Unstable trade legislation    -Political discrimination    -Lack of means to access to foreign markets	Demand    -Diversified tastes    -High substitutes    -High demand    elasticity	Prices    -Absolute price level    -Relative price level    -Price transparency    -Exchange rate
Economics    -Subjectively      determined low    producer prices    -Large supply in    market overall    -Lack of liquidity	Economics    -Low price paid by foreigners    -High direct and    indirect cost    -Lack of liquidity    -High transaction  cost	Economics    -Large sunk-cost    requires to position    of brand in retail    market and    processing facilities	Economics    -Productivity    -Credit
Special risks    -Price fluctuations    -Physical sales risk    -Insecure income    -Insecure input supply	Special risks    -Large price fluctuations    -Supply fluctuations    -Insecure legal system    -Large physical losses	Special risks    -Supply fluctuation   -Demand fluctuation [4]	Special risks     -Integration and    concentration    -Minorities    -External trade    -Foreign policy

 

IV.2. Improving agricultural marketing system

The agricultural marketing system evolves along with the development of the economy. So improving agricultural marketing system in developing countries depends very much on the specific situation in each country and to certain extent on the international aspect. Figure 1 provides a conceptual framework for improving agricultural marketing system.

     The figure above just describes the general framework for improving agricultural marketing system in developing countries. The specific activities needed are presented in the table below.

Table 3: Alternative Activities for Improving Agricultural Marketing

Kinds of development	Improvements needed
Infrastructure	Development of large and rural markets, storage, processing industries, foods, communication, and information systems
Market organization	Development of state, parastatal, and private marketing organizations, such as marketing boards, cooperatives, and private trade Support and strengthening of self-help organizations, especially for small-holders
Market information and extension	Regular reporting and projection of agricultural marketing, especially prices and volume Development of marketing extension services for producers and marketing organizations
Agricultural market administration	Standardization and quality control Development of planning capacities Strengthening of professional competence of agricultural marketing administration
Training	Creation of training institutions and programs for people and organizations involved in marketing
Research	Market systems analysis Development of appropriate marketing technologies Demand and supply analysis Projections and market behavior
Credit	Small-holder supply and market credit Investment credit for marketing institutions

Source: Adapted from Elz, D. 1987, p.11

Some of these measures require little financial input to improve efficiency of marketing. Others, particularly, infrastructure and buildings require a great deal. In all cases, however, professional expertise is required to implement and maintain these activities. The marketing training in DgCs should be mostly based on the local research and experience with specific situation in each country at its particular stage of economic development.

IV.3. Alternative Agricultural Marketing Institutions

IV.3.1. Alternative agricultural marketing institutions

In developing countries there usually are 4 broad organizations providing marketing and associated services for farmers:

n      Independent private firms operating within some institutional framework such as assembly and auction markets or exchanges, possibly with some mechanism for cushioning extremes price fluctuations;

n      Transnational companies using processing technologies, economies of scale and established market outlets;

n      Farmers’ associations or cooperatives;

n      Marketing boards or other state agencies.

IV.3.2 Comparison between these institutions

+ Indigenous independent private firms:

These enterprises operate at very low costs. Decision-making is concentrated, allowing them to efficiently take advantage of and exploit unforeseen opportunities, follow up new ideas, start up and go along with very little capital, as well as response quickly to changing situation. So this type of marketing institution is specially suitable in trading products that need special storage and processing and change sharply in prices in response to variable supplies such as coffee business.

The farmers are mainly small and located discretely, then the quantities sold and bought by each customer are small and varying. Thus those sales and purchase require considerable local knowledge, patience, and willingness to work for long hours at many location. With such requirements, private enterprises also demonstrate themselves to be the most suitable.

+ Transnationals:

This kind of enterprise has many advantages in agricultural marketing.

They can bring capital into a country to acquire land, facilities and to provide a working base. They can also bring in equipment, improved seeds, strategic supplies, skilled management and technologies.

The transnationals are also experienced in meeting international quality standards, can help developing countries overcome such barriers to penetrate into foreign markets and enhance value of exports.

The great advantage of transnationals is that their brands have strongly positioned in importing markets and they own an widespreasd outlets and retail network in major importing markets.

Therefore, establishing a close link with a transnational is the best way to maintain market access for exports.

+ Cooperatives:

Cooperatives help farmers benefit from economies of scale in the use of transportation and other services through increasing the volume of commodities handled at one time and raise their bargaining power in sale transaction. It performs especially well in such conditions as specialized producing areas distant from their major markets, concentrated and specialized production, homogenous production, and groups of farmers dependent on one or few crops for their total income (e.g. coffee planters), assembling fairly standard, not-very-perishable products (such as coffee and cotton) for sales in pre-established markets in which the price risk is small or for exporting. Especially in coffee industry in many developing countries, this institution combines efficiently distribution of fertilizer with marketing the crop on which it is used. This constitutes a practicable basis for distributing inputs on credit.

+ Parastatals:

These organizations are common vehicles manipulated by the government in applying public capital implementing, government price policies, determining marketing policies, and assigning marketing monopoly. Theoretically, the government just makes up the guidelines for these institutions, in terms of day-to-day operations they are autonomous. Generally, these organizations’ contributions to agricultural development are observed as follows.

n      They moderated supply and price fluctuations in domestic markets by buying into and selling from buffer stocks .

n      Export marketing monopoly can obtain high return for the growers if they control enough the total volume going to a particular market to be able to influence prices.

n      Monopolies in domestic markets are assigned to parastatals to concentrate sales of products through a particular processing plant to justify investment, to facilitate collections from small consumers of credit repayments and other dues, and to implement market separation programs by which higher overall prices can be obtained. Coffee, cocoa, and cotton are typically sold by standard quality specification and are widely handled by parastatals.

IV.3.3 Constraints and support management

Each type of marketing institutions has its own advantages and disadvantages. The government should have appropriate kind and level of support to each type to utilize their advantages and restrain disadvantages.

+ Private enterprises:

The collusion among these enterprise may keep prices down to producers and up to consumers. In DCs, private marketing enterprises have been also considered to be too small and too numerous. They cannot afford storage systems, modern technology, sorting and managing quality of products after purchase because of capital constraints. Consequently, their product quality and responsiveness to market are limited. In these cases, the government should introduce new enterprises and remove all entry barriers, create an equal competitive market for all these enterprises. The most efficient ones will likely to develop to larger scale.

+ Transnationals:

DgCs may become dependent on and thus dominated by transnationals. However, the dependence on transnationals is subject to the  political and economic policies of each country. That situation has become one in which the government of a developing country can access the `benefits of transnational investment or collaboration and can then bargain over the terms.

+ Cooperatives:

Lack of capital, inexperienced decision-making groups, loose commitment of members, etc. all can make the coperatives less responsive to changing marketing opportunities. The decisions made centrally do not always provide inputs or sell output to the right place, at the right time, with the right quality or to the right customers. These constraints could be minimized if cooperatives satisfy such conditions as local leadership and management, a well-educated membership, and members all belonging to one family group with strong kinship ties or integrated by religions.

+ Parastatals:

The interference in parastatals’ operations by the government may cause corruption by government officials and rent-seeking  from parastatals. Subsidies for parastatals to stabilize their supply and prices are often continuing burdens for the governments.

If buyers’ preferences are varied, an exporting marketing parastatal with monopoly power may obstruct price signals from an industry seeking to adjust production to its requirements and producers and consumers will be obliged to use its services and commodities, will bear the burden of its costs. Therefore, a parastatal monopoly should be maintained only if it permits a certain marketing function to be carried out more efficiently than what would be feasible otherwise.

       Chapter 2:  Coffee Industry: External Consideration

I. Introduction

The purpose of this chapter is to spell out the supply and demand in the world coffee market. Colombia is chosen as a case study of operation of the coffee industry in DgCs because: first the natural conditions for producing coffee in Colombia is, to some extent, similar to Vietnam’s (altitudes, climate, rainfall, etc.); second, coffee exported from Colombia is reputed to be the highest quality in the world[5] , then Colombia’s experience may be useful for Vietnam; third, Colombia, like Vietnam, export coffee mostly under form of green coffee beans.

II. The world coffee market    

II.1. Supply

 In the world coffee market Brazil and Colombia are the two biggest providers of green coffee, thus they are of influence on the world coffee market. In addition DCs cannot produce coffee due to lack of suitable natural conditions.

Therefore, the weather condition, the health of the coffee trees and harvesting practices also affect the supply of coffee. Furthermore, a new-planted tree takes 3-4 years to produce first cherries, thus  green coffee response to price change in the world market with a lag of 3-4 years. Historically, the frequent frost in Brazil [6] and the lag in supply response to coffee price changes are the two decisive factors generating the “boom and bust” cycles in coffee market.

II.2 Demand

The demand for green beans is the derivative one by roasters. In periods of normal price variation, the demand for roasted coffee is price inelastic. However, when coffee prices show big increases, consumers tend to reduce their consumption commensurately.

The demand is usually distorted by the buyers (roasters). J. Morissets (1997) found that the spreads between international and domestic commodity prices of coffee in six countries: Canada, France, Germany, Italy, Japan and US increased dramatically over the periods 1975-1994. For example, the price of green coffee declined by 18% on world markets but price of roasted coffee increased by 240% for consumers in the United States between 1975 and 1993 (Ibid., p.28). He proved that the presence of large trading companies in international commodity markets caused this “asymmetric responsive price”. Morissets argued that many of these companies are large enough to have a dominant position on most commodity markets, their strategic position between buyers and sellers allows them to influence the transmission of world prices. These companies generally provide information, define the terms of transactions, manage the payments and record keeping for transactions, and so figure out ways of clearing the market. So when the world price declines their obligopoly power allow them to keep the domestic price up to maximize profit, by contrast, when the world price rises, they mostly transfer the high world price to domestic price. Mc Laurent (1996) when studying the coffee market in USA had put forward similar conclusion.

However, roasters have to import purely green coffee to maintain a minimum amount of input to keep the operation efficient (in large scale) and remain their position in the roasted coffee market. High fluctuation in green coffee supply may causes loss to the roasters. In addition, weather conditions may cause shortage of green coffee supply (e.g. frog in Brazil) then the roasters may suffer loss if there is not a mechanism to encourage coffee exporter to store.  

III. Coffee industry in Colombia

      Colombia is the second largest coffee exporter in the world after Brazil. Coffee is grown by 300 thousand small and medium-sized farmers with an average of 3ha each. The natural condition is favorable for producing coffee, and enough rainfall (1500-2500mm per year) to make irrigation unnecessary.

            Coffee farmers in Colombia practice ‘selective picking’, in which only the ripe coffee cherries are harvested on each pass. As a result, the coffee trees are typically harvested 6-8 times per season. Growers themselves carry out much of the processing, using the ‘wet processing’ method. The green coffee beans are then sold for further cleaning and selection. The processing and export industry is composed of both private companies and coffee cooperatives. Although Colombia does produce soluble coffee, virtually all of its exports are in the form of green (unroasted) beans.

            The Federacion Nacional de Cafeteros Colombianos (the National Federation of Colombian Coffee Growers or FEDECAFE) has played an important role in developing the coffee sector. With revenues generated from a small export tax, FEDECAFE funds coffee research at various centers, an effective extension system, and a coffee inspection service. It also funds projects to improve infrastructure and social services in coffee-growing areas and to diversify income among small farmers. FEDECAFE also sponsors a successful world-wide advertising campaign to maintain Colombia’s reputation as a high-quality producer. The advertising campaign is only successful, however, because it is backed up by efforts to ensure coffee quality. Colombia defines six grades of export-quality Excelso coffee based on seven criteria: humidity, aroma, color, bean size, defects, foreign material, and taste. Coffee that does not meet Excelso standards cannot be exported by law and is marketed domestically.

Chapter 3:  An Overview of Vietnam Coffee Industry in Period of 1986-1998

I. Introduction

            The aim of this chapter is to present some characteristics of coffee industry in Vietnam and to sketch out a dynamic picture of the industry in period of 1986-1998. It puts forward some preliminary assessments on comparative advantages of Vietnam coffee industry, on its competitiveness, on production system and marketing channel in general and their operations in the period.  

I.1. The background of coffee tree

I.1.1. Crop characteristics

Coffee trees, or bushes, grow primarily in subtropical climates. There are two types: arabica and robusta. The Arabica coffee has milder flavor, and fetches higher prices on the world market in comparison with the robusta coffee. Coffee is vulnerable to frost and many diseases, especially the soil-born disease that can destroy the farm massively.

I.1.2. Processing characteristics

The processing can be divided into two stages. Primary processing involves conversion of harvested coffee cherries into green coffee beans[7] and is always done in the producing countries. The secondary processing involves the transformation of green coffee beans into final consumer products such as roasted beans, ground coffee, and soluble (instant) coffee. Secondary processing is almost always carried out in the consuming country. Coffee traded in the world market is mostly in form of green coffee beans, meaning coffee after primary processing. Coffee beans are shipped and warehoused in natural fiber bags, and coffee sales are usually accomplished through the use of inspected samples offered by importers and brokers. So the quality and then price of coffee beans are crucially affected by the primary processing.  

There are two types of primary processing. The dry method is generally used with robusta coffee. It involves harvesting the coffee cherries and drying them to reduce moisture content from 25-60 percent to 10-15 percent (Minot 1998, p.46). The quality of the green beans can be further improved by cleaning, sorting, and grading. The wet primary processing method is generally used for arabica coffee. First the coffee cherries are fed into pulping machine that removes the soft outer layer, leaving the green beans and a sticky covering. The green beans then are put into tanks of water for 6-72 hours. During this time, the sticky covering ferments, allowing it to be removed by repeated washing. Finally, the green beans are dried, cleaned, and sorted as in the dry method.

II. Competitiveness of Vietnam’s coffee industry

II.1. Concepts

n      Competitiveness is a dynamic concept. Economists such as Fafcham, M. and G.H. Peter (eds) (1995), E.Siggel and J.Cockbum (1995) introduced alternative definitions, however there is no universal agreement among them. One of the reasons is that the term is used with reference to both enterprises, industries, countries and even supranational regions. However, it can be inferred from these definitions that determinants of competitiveness of an industry come from comparative advantages and productivity of the industry.

II.2. Comparative advantage of Vietnam’s coffee industry

The table below show that opportunity costs of using land and capital for producing coffee is lowest. It means that coffee has comparative advantages over these commodities.        

Table 4: Profit Rates of Agricultural Commodities                                   Unit: %

Commodity	Rice in Mekong delta	Coffee	Rubber	Ground-nut	Pork	Tea
m/(c+v)	35.45	40.40	18.15	17.89	4.07	-12.41
capital opportunity cost	1.143	1	2.226	2.258	9.926	-
land opportunity cost	5.354	1	4.294	9.484	-	-

Source: MARD 1998, p.20

II.3. Productivity        

            The data from FAO indicate that land productivity of planting coffee in Vietnam is the highest in the world, and 3 times more than the average level of the world. This, to certain extent, presents that Vietnam has an absolute advantage over other countries in producing coffee.   

            Vietnam has great comparative advantages in planting coffee, and this is the crucial factor creating the competitiveness of Vietnam’s coffee in the world market. However, the competitiveness of Vietnam’s coffee industry is based mostly on natural factors such as land productivity, climate, etc. This competitiveness can be enhanced or eroded subject to man-made factors such as processing, exporting systems. It seems that these factors have undermined the natural competitiveness of Vietnam’s coffee industry because despite generous endowments and naturally good quality, Vietnam’s coffee has still been discounted in the international markets. These factors themselves prevent Vietnam’s coffee industry from developing further.

III. Coffee production

III.1. Production system

III.1.1. Geographic pattern

            Coffee production in Vietnam is concentrated mainly in Central highlands (80%) and the Southeast (16%).The North accounts for very modest proportion (3.7%) while Dak Lak province alone produces about 60% of national coffee output. Income from coffee accounts for 94.47% income from agricultural activities and 78.96% of total income of all households in Dak Lak, the figure in Nghe An province (the biggest coffee producing province in the North) are 41.21% and 22.17% respectively (MARD 1998, p.63).

III.1.2. Ownership pattern

            Starting in 1986, the Doi moi process has allocated cooperative land to households, legalized private ownership of productive assets. At the same time, many of state farms began allocating plots to workers, retaining the ownership of the land and the trees, and provide a variety of inputs and services to the farmers: irrigation, fertilizer, credit and so on. In some cases, the households are similar to tenant farmers, paying a proportion of their output to the state farm management for the use of land and trees as well as for fertilizer, water, and services provided by the management. Most farms use a combination of these different organizational forms. Thereby, coffee now is grown under a wide range of production systems, including small farms of less than one hectare and state farms of more than 1,000ha. Around 85-90% of coffee area is cultivated by small farmers (Minot 1998, p.44).

These farm households are independent businesses, own their own land and deal with buyers by contract relationship (e.g. they may receive credit or fertilizer from a buyer according to terms and conditions they signed with the buyer). A survey conducted by MARD reveals that in Central highlands, the average farmer had 1.2ha (Dak Lak: 12478m²) of agricultural land, of which 0.7ha (Dak Lak: 10971m²) was planted with coffee. If these figures can be taken as representative, then there are around 300 000 households growing coffee (ibid. and MARD 1998, p.61). At the other extreme, state farms account for 10-15% of coffee area, the biggest is Vietnam Coffee Corporation (VINACAFE) whose 22000ha of coffee takes up 10% of 1996 planted area.

III.2. Marketing channels

           

            Since Doi moi the marketing channels has become much more complex as shown in the figure below.

Figure 2:  Flow of coffee

Vietnam produces coffee mostly for international markets, domestic market consumes only 8% of coffee production. So this paper only concerns about channels serving for export.

            Independent farmers may sell the dried cherries to a private trader or an agent of a processing plant, or directly to a processing plant, however, this is not is not widely used. An increasingly common channel of coffee flow is the farmers to pay a small fee for coffee processors to hull their dried cherries, retaining the ownership of the green coffee beans. These small processors are privately-owned locally-made hullers with capacity of less than 1000 tons per year. Many of them are mobile, allowing them to be moved from one production area to another during the harvest seasons. In addition, some of the households are also self-equipped with these simple hulling machines. As a result, the beans (unlike the dried cherries) can be stored for up to 2 years, giving the farmers the option of holding the coffee in expectation of a higher price. Furthermore, after processing the weight of coffee is decreased by 40-44%, reducing the cost of transporting the coffee to assemblers and then to larger processing factories. One researcher estimated that about one half of all coffee was processed in that way (ibid., p.47). However, because the processing units are simply equipped and lack of technical skills, so green coffee beans are unsorted and not very clean, then need to be re-processed for export.

            The green coffee beans are therewith sold to assemblers who will distribute them to processing factories. The processing factories are mostly state-owned ones including both state farms and specialized processors-exporters who are allowed to export directly. Until September 1998, private processing factories, even large ones, did not have the right to export directly.

            Finally, re-processed green coffee beans are forced to export through those state-owned processing or specialized exporting companies.

            In recent years, some joint-venture companies have participated in coffee processing sector, but the volume is insignificant. The largest JV processing plant - DakMan, a joint-venture between DALIMEXCO (a Dak Lak state enterprise) and E.D&F Mann (a British company), has the capacity of 15-20 thousand tons but it exported only 8182 tons in 1996 (ibid., p.68).

            To sum up, in the marketing channels, private enterprises, transnationals, and parastatals are all presented. However, the role of private enterprises and transnationals is minimized to the corner. The parastatals or exactly being SOEs are interfered deeply and protected by the State. Consequently, these SOEs play a dominant role in export while cooperatives have been fully dissolved, playing no role in this field.

III.3. Production and export trends

III.3.1. Production trend

            Since 1986 it has been observed a quick development in coffee industry in Vietnam, not only planted area but also yield have grown so quickly. Over the period 1986-1998, the average annual growth rate of coffee yield and production area were 3.6% and 13.36% respectively. In period 1986-1996 the figures were 6% and 21% respectively. As a result, coffee production has expanded more than 15 fold. These figures are more impressive if compared with those of Indonesia.

III.3.2. Export trend

            Coffee production could not expand so impressively as it did if export was still stagnant. The rapid growth of coffee production generates the motivation for expanding export and vice versa.

            Coffee export has grown rapidly not only in quantity but also in value. Over the period of 1987-1998 coffee production increased 10.22 times while coffee export value increased more than 11 times. As a result, coffee export have accounted for 6-12% of the total value of Vietnam’s exports and ranked the second place in agricultural exports after rice. On the world market, Vietnam became the fifth (1995) and the third (1997) largest coffee exporter and in 1997, Vietnam was the largest robusta exporter. In the conference held by International Coffee Organization (ICO) in September 1998, ICO stated that from 1 October, 1998 the world price of robusta coffee would be determined by prices of coffee export from Vietnam and Indonesia instead of those of Madagascar and Central Africa ( Thoi bao Kinh te Viet Nam No. 90, 11 Nov., 1998).

            In terms of market, from 1986 to 1990 Vietnam’s coffee was mostly exported to former Soviet Union and Eastern European countries according to protocols signed between governments. Now, Vietnam’s coffee is present in 52 nations and territories all over the world.

           

III. Motivating Factors Generated Growth of Vietnam’s Coffee Industry 

III.1. Push factors

            Before Doi moi farmers all were workers of state farms, working for work-points. The work-points were based on days of working, not on the individuals’ efficiencies and contributions. After the harvests, foods and residual incomes were distributed to members of households on the basis of need (number of people) and work-points. Such a working and distributing system weakened the connections between individuals’ efforts and rewards, therefore undermining the incentives to work, while coffee industry required continual patience and hard-working (like providing care, inspecting for diseases, manuring, watering, etc.).

It can be said thatDoi moi process started firstly in agricultural sector by allocating cooperative land to farm households, legalizing private ownership and productive assets, deregulating agricultural marketing and prices. These reforms resulted in better farm-gate prices for agricultural commodities, especially for coffee. It stimulated private farmers to expand coffee cultivation. At the same time, the ‘product contact’ policy[8] has really created great incentives for farmers to invest their maximum capital and labor in their land. In coffee industry, farmers who used to be members of a state farm are now converted to tenants or renters who are responsible for the production of given parcels of land.[9]

            These two trends have reduced the proportion of coffee area under the state farm management from over 75% to around 10-15% today. The impressive increase in coffee yield and production as in Table 16 is clear evidence of ‘ownership incentive’ which generates a great breakthrough in coffee industry.

III.2. Pull factors

            After Doi moi, Vietnam gradually gets access to large international markets which used to be shut down by political ideology. The Doi moi has cleared the ‘vent’ of obstruction for Vietnam’s coffee surplus. The special flavor, high natural quality and low price have made Vietnam’s coffee attractive in international markets. In addition, unlike other commodities, Vietnam’s coffee is the one not discriminated when entering the US market, despite the fact that Vietnam is still not benefited from Most Favorable Nations status (MFN). This is  the decisive factor for Vietnam’s coffee penetrating and expanding to the largest coffee market in the world. The rising demand from foreign markets is one of the biggest motivations pushing Vietnam’s coffee industry forward.

            The collapse of ICA in 1989 created opportunities for new comers, like Vietnam, entering the international market without any obstructing action from ICA. Importing countries that are now free of any binding agreement tend to buy from ICA non-members because these countries usually offer more competitive prices.

            Finally, the soil in the Middle Highlands is a ‘heaven-gift’ for Vietnam. It is the decisive factor producing the highest coffee yield in the world. Thereby, although coffee price is discounted, farm-gate price pressed, the highest yield still brings about high profit for farmers.

Chapter 4: The role of economic agents in Vietnam’s coffee industry

I. Introduction

            This Chapter concentrates on analyzing the role of the farmers, traders and a little of trade-planners in the development of coffee industry. The traders in Vietnam, excluding a small number of merchants dealing with domestic consumers, consist of assemblers, processors and exporters. All of these agents will also be considered here. The purpose of this Chapter is to find out why Vietnam’s coffee is always complained to be of low quality, why it is always discounted in the international markets, and with existing structure who will be beneficial: farmers, traders, or the society as a whole.

II. Economic Agents in Vietnam’s Coffee Industry

II.1. Farmers

II.1.1. Characteristics

Vietnamese coffee farmers as mentioned in Chapter 3 are concentrated in the Middle Highlands. Almost the farmers are small and poor ones with coffee planted areas around 1-2ha, and lack of capital to invest, e.g. in Dak Lak the average investment per ha is VND25,349,370 and in Nghe An VND7,491,990 (MARD 1998, p.66). As a result, the farmers’ production depends heavily on a variety of finance, bank credit.

Vietnamese farmers use mostly the dry method for processing after harvest, the cherries are dried outside by spreading them out on the ground. Many of state farms use brick drying yards and some farmers have invested in concrete yards or plastic sheeting, but the overall capacity is limited. Vietnam now has just 0.8 hectares of suitable drying ground per 100 hectares of producing coffee, compared to the optimal level of 3 hectares per 100 hectares (VET 1998, p.36 - cited in Minot 1998, p.57). Consequently, coffee is dried too thickly per yard. According to Thoi Bao Kinh Te Viet Nam No. 39, September 29^th 1994, the thickness of  coffee drying on yard is more than 40cm, while the standard level is below 20cm. As a result, the coffee in the bottom are not dry, absorbing moisture, then  discolored. The remainders of coffee is dried on the ground or even in roads. This method is inexpensive but results in low quality of coffee, because it introduces stones, dirt, and other foreign materials and extraneous flavor. Some of these foreign materials can be removed in processing, but at a cost. Off-color beans can also be removed in processing but it requires laborious hand selection or expensive color sorting machinery. The effects of drying on flavor cannot be corrected in processing.    

II.1.2. Why farmers are stagnant in improving coffee quality at farm

            Low quality of coffee after harvest have been warned for a long time ago, however the problem up to now remains. This phenomenon can be explained as follows:

a. Heaven-gifted soil quality allows Vietnamese coffee farmers to get very high yield per ha of cultivation. With the same producer cost per ha, Vietnamese farmers can obtain 3 times higher coffee quantity per ha than that in Brazil and Colombia. This means that the opportunity cost of using land for processing coffee instead of planting coffee is too high. As a result, Vietnamese farmers focus on planting coffee other than processing. And the problem of lacking land for enhancing coffee quality after harvest remains.

b. Farm-gate price is imposed by export monopoly through assemblers, and the price mechanism lacks incentives to buy, then to encourage farmers to produce high-quality coffee.

      c.The small farmers who are mostly in lack of capital can only get medium-term bank credits (for 6 months in most of the cases) in order to finance their cultivating and harvesting. That is why after harvest, they must find ways to sell their output as soon as possible to repay the due loans. Their capital is always petty, thus being unable to allow them to invest in large-scale storage, drying yards, processing facilities, etc. According to Mr. Le Trong An, Vice-director of VINACAFE, 1 hectares of drying yard needs at least VND600-700 million (at 1994 price) (Thoi Bao Kinh Te Viet Nam No.39, 29 Sep., 1994). In this case, cooperatives can function well (as mentioned in Chapter 1) in mobilizing capital among small farmers for common target, e.g. processing yards. However, the Doi moi process has fully abolished the system of agricultural cooperatives. This might be part of the reason why the improving of coffee quality is impeded.[10]

II.2. Assemblers

            In Vietnam, the assemblers are designated by state-owned exporters, then the competition is eliminated among them. The buying price is introduced to assemblers everyday by export enterprises. The assemblers rely on that price to notice purchasing price for coffee beans which satisfy standards (moisture level: 13-14%). Farmers will be awarded premium if the moisture is less than standard and discounted if the moisture level is higher. However, the premium is not large enough to encourage farmers to lessen coffee moisture because the less moisture in their coffee bean, the lighter its weight is. Almost farmers sell their coffee beans whose moisture is equal or higher than the standard level. In terms of foreign materials, there is no standard level, the coffee beans being discounted or not will depend on the assemblers’ intuition.

            Theoretically, the private enterprises are effectively operating in assembling field and have advantages and constraints as mentioned in Chapter 1. In Vietnam assemblers conduct monopoly power by vertical collusion with monopoly exporters. These assemblers are designated by SOEs who have the right to export (or have the monopoly power over the ‘vent-for-coffee-surplus’). In this situation, it is understandable that the farm-gate price is kept down. But the prices to buyers (the SOEs) are also kept up. According to a survey conducted by MARD, the farm-gate price in 1996 in Dak Lak was VND10322.6/kg while the price paid by export enterprises was VND14562/kg. The difference of VND4239.4 belonged to the assemblers including assembling costs.

            Coffee farmers are mostly self-trucking their beans to assembling spots. So the largest portion of the assembling cost is transportation cost from assembling spots to export enterprises. According to a survey conducted by UNDP, this cost is only VND60/kg, meaning that assemblers earn extremely super profit up to more than VND4000/kg from their business. [11]

The striking feature of the story is that the designators (export enterprises) earn very modest profit only (less than 0.9% in 1997) from the export of coffee. These enterprises in 1995 earned only VND750/kg of profit or 2.87% of export prices. The figure in 1996 was VND699/kg and 4.4% respectively (MARD 1998, p.76). The monopoly seems not squeezed farmers?

            A possible explanation for this paradox may be:

n      Principal-agent problem: the problem occurs as the principal that is the owner (individuals, groups of individuals, or the government) hires an agent to act on their behalf, but the agent may have objectives different from those of the owner. The management tends to have interest to maximize their utility at the expense of the owner’s wealth (Hay & Morris 1991). In this case, the managers (who have the right to dominate the assemblers) of coffee export enterprises maximize their own profit by giving assemblers monopoly power and in turn, the assemblers must share the super-profit for these managers. This is possible because in the transition period, the economy is characterized by the weak financial system whose salient feature is the lack of transparency and accountability, and financial discipline.

n      Probably, the figures reported by the exporters were distorted to disguise their nature of squeezing coffee growers.

            In short, the vertical collusion between assemblers and exporters, in all cases, in Vietnam coffee industry not only eliminates the inherent advantages of private enterprises as mentioned in Chapter 1 (rapid response to market change, minimizing costs of operations, etc.) but also worsens its constraints.

II.3. Processors

II.3.1. Introduction 

The functions of processing is to add value-added to coffee commodity, then enhancing its value in the market. However, the ratio of value added to gross output tends to slowdown over 6 years (1991-1997), from 5.4% to 5%. Hence, processing sector seemed not to develop, but even be worsened. In this section, we try to find out what does prevent the processing sector from improvement.

II.3.2. Structure of coffee processing

In this section Dak Lak province is taken as a proxy, because it represents about 60% of national production.

            In Vietnam, the number of smallest processors is the largest. These processors conduct first-stage processing with an average capacity of less than 1000 tons per year and may process half of the output, but the resulting beans cannot be exported without further processing.

Besides, in Dak Lak there are about 10-15 private processors[12] in the range of 1000-2000 tons per year and 3 private companies that have the capacity of 5000 tons or more. These plants have not exported directly, partly because private enterprises were not allowed to.

State farms are suppliers of almost state-owned processing plants. There are about 14 processing plants associated with state farms in Dak Lak. These plants are usually medium in size with capacity of 3000 tons per year. VINACAFE has 7 processing plants in Dak Lak which are supplied by the 7 state farms that are part of Viet Duc Coffee Company. In addition, there are processing plants on provincially-managed state farms such as Thang Loi, Phuoc An and Thang Muoi Coffee farms in Dak Lak.

            The large processing plants (those with capacity of at least 5000 tons) tend to be owned by companies that specialize in processing and exporting. Most of these plants are owned by state enterprises. The largest processor-exporter is INEXIM, a provincially-managed state company, which has 3 plants with capacity of 5000, 7000 and 10000 tons per year each. Among the large processors, there is only one but the largest single processing plant, the Dak-Man, which is a joint-venture between DALIMEXCO (a Dak Lak state enterprise) and E.D.&F.Mann (a British company). This plant has capacity of 15-20000 tons per year.

            It can be said that in coffee industry, processing and exporting sector are dominated by ‘SOE-cartel’. This leads to the fact that the processors/exporters are in lack of incentives to improve the quality of the export as presented in the next section.

II.3.3. Performance of processors

            In processing sector, the first-stage processing is conducted by numerous small private processors. This process does not much affect the coffee beans’ quality. Thus, in this section, we just focus on the reprocessing for export.

            The main tasks of reprocessing are cleaning, sorting, and grading.

            In regard to grading, Table 22 shows that coffee grading system in Vietnam is too simple. There are 3 grades based on only 4 criteria while Colombia defines 6 grades of export-quality Excelo coffee based on 7 criteria: humidity, aroma, color, bean size, defects, foreign materials and taste (see Chapter 2).

Table 5:  Vietnam’s coffee quality standards

Criterion	Standards for each grade
	Grade 1	Grade 2	Grade 3
Humidity	12%	12%	13-15%
Foreign materials	0.5%	0.5%	1.0%
Broken beans	2-3%	2-3%	4-5%
Bean size	7mm	6-7mm	5mm

Source: Interviews with Vice-Director of SIMEXCO, Dak Lak - cited in Minot 1998, p.70

            Insufficiency of criteria in classifying grades of coffee (especially color criterion) leads to the fact that nationally accepted coffee beans are not internationally accepted, consequently the reputation (if any) of Vietnam’s coffee industry and coffee price, in the world market are undermined and suspected.

The standards of grading coffee in Vietnam are rarely compatible with international ones. This leads to the situation that the coffee is exported according to importers’ requirements specified in each contract without any formal standard. Thus Vietnamese processors/exporters become dependent on foreign buyers and lose their initiatives in operation. In such a situation, processing high quality products must be highly risky, because it requires large initial capital, but the processors are still unsure whether their products are accordingly priced or not. So the prudent policy is to process medium-low quality products which, on the one hand, are not bound with strict criteria and can operate at low costs. On the other hand, it is easily accepted by importers if prices are discounted. In fact, reprocessing in Vietnam is just inspecting for foreign materials, humidity (moisture) according to importers’ requirements. By doing so, the processors bear the cost of only VND200-300 per kg (MARD 1998, p.74-75), while processing first grade coffee need at least VND1-2 billion for a modern processing line and raise processing costs up to around VND700-1000/kg (ibid.).

            Generally, reprocessing is a simple process except sorting the color. The color sorters are the most expensive and sophisticated elements of coffee processors. They cost as much as the rest of the machinery combined and calibrating the color sorters is complex and skilled task. Therefore, there is little doubt that lack of capital to operate and equip modern technology are obstacles which prevent processing sector from applying international standards of coffee export to develop further. [13] However, company directors and plants managers tend to attribute all problems to inadequate machinery and capital. Perhaps they expect that by voicing so they may get approvals of loans for capital investment. They rarely  think that poor and old technologies are general circumstances. The question is how to overcome these circumstances economically, not technically. This partly reflects the problems of Vietnamese financial market in which investment decisions are largely determined by the government using political criteria rather than by banks using financial criteria. It also reflects the engineering approach which dominated in the pre-reform years in which production was seen as a technical rather than economic problem.

            In this case the problem of insufficient investment in improving processing machinery can be explained economically as follows:

1. Exporters/processors are in lack of incentives to produce high quality green coffee beans

2. It is not profitable to carry out processing of high quality coffee beans. The reasons are: firstly inapplicable standard system has resulted in the dependence on buyers as mentioned above; secondly, coffee beans were lowered quality by first-stage processing at farm level. As a result, the proportion of grade 1 coffee beans after cleaning, sorting and grading is very small. This means that only that small proportion of coffee beans is priced higher while the left large part is still ranked and priced as the low quality coffee as those simply processed. So, the value added generated by a modern line of coffee processing is insignificantly more than that generated by an old one. The demand for high-quality processed coffee is low, therewith. Thirdly, the low demand raises the coffee processing cost per kilogram because a small number of coffee beans passing through the processing line forces 1kg of processed coffee to bear a much higher depreciation cost. This will further reduce the demand for modern processing.

II.4. Exporters

II.4.1. Legal framework

            Since Doimoi Vietnam’s international-trade policies have been gradually liberalized, private businesses have been acknowledged and got free access to markets, including foreign markets. However, in coffee industry the liberalization seems to take place just in production processing sphere only, international trading activities, up to 1998, had been dominated by SOEs’ cartel.

II.4.2. Characteristics of Vietnam’s coffee exporters

1. In Vietnam, coffee export business up to mid-1998 had been dominated by SOE cartel. Private enterprises have been restricted. Transnationals’ roles are insignificant.

The export of 20 largest companies accounts for 94% of all coffee exported from Vietnam (Vietnam Economic Times, Feb 1998, p.30), the remaining companies (more than 100) export less 2000 tons each, with some exporting only a few hundred tons.

2. Although the export of coffee has been concentrated in SOEs, these enterprises are always in lack of capital and have to depend on bank loans which mostly in medium terms.

3.     In the transition to market mechanism, Vietnam’s coffee exporters, who are nearly inexperienced in international competitive market, have to export coffee indirectly through a third country (especially Asian countries) for re-exporting. Vietnam coffee exporters are still learners in the world market.

4.     Despite Vietnam was ranked the third place of the largest coffee-exporting countries in the world, the exports are small (around 6%). So it can be assured that Vietnam’s coffee exporters are price-takers and their exports are unlikely to influence the world market.

II.4.3. Performance of Vietnam’s coffee exporters

Since Doi moi Vietnam’s coffee exporters have achieved acknowledgeable results as mentioned above. However, Vietnam’s coffee export seems to grow in quantity but not in quality. Although the taste of Vietnamese coffee beans is considered good for robusta, it does not fetch as much as the world price. The difference between Vietnam’s export price and the world price appears to be stagnant and even worsened over the period.

            These problems may be explained as follows.

1. One of the reasons is the low quality of coffee exported. Furthermore, the dominance of SOEs’ cartel in coffee export generates no incentive to enhance the quality of coffee. Because if export price is lowered by importers, the exporters in turn lessen the farm-gate price to maintain their marketing margin through assemblers.

2. Shortage of working capital and meager internal development fund have limited the management of these SOEs to short-term investment. The profit-transferring into the development fund is small because either profit is tiny (2-4%) or it is dissipated on the management’s and workers’ wage package and bonus.

3. SOEs are in lack of techniques, ability and ‘sense of purpose’ to run the enterprises in the competitive environment. They are still influenced by the thinkings which was prevailing in centrally-planned economy: the management of SOEs is understood as that of a factory, where business activities concentrate mostly in production while marketing is either not perceived or ignored. In Vietnam’s coffee industry, the rapid expansion of harvested area proved that in situation of capital constraints, these SOEs have invested concentratedly in production (planting) of coffee and left very insignificant investment for storage, processing facilities and others. So in spite of lowering export price coffee planting still bring about high profit.

4. Lack of storage facilities, of capital, and pressures from repaying loans to banks force the exporters to sell up their coffee beans in harvest seasons, even in the time of price slump, thus nullifying their adjustment of supply subject to market signals and the stored coffee failing to satisfy quality requirements. As a result, the coffee exporters usually have to accept the price lower than the world price to quickly dispose of goods and collect money back.

5. Inexperience in competitive environment, meager investment in marketing activities result in Vietnam’s exporters ill-informed of and inflexible responsive to international market. Consequently, their bargaining power, then prices in dealing with foreign importers are reduced.

6. In addition, Vietnam does not have a reputation for reliability, because:

+ Objectively, inexperience and lack of promotional services and activities deter Vietnam’s coffee exporters from conducting the contracts as exactly as the experienced do.

+ Subjectively, it is the principal-agent problem. The purpose of the manager of a state company is to maintain his position and prestige, and the company’s long-run targets are pushed back to junior priority. Then, when signing a contract with a foreign importer, the manager knows that he will lose his position and prestige if he makes loss. So if market sours on him (the case which more likely happens in the notoriously fluctuated markets like that of coffee), he will probably walk away and leave the importer with a worthless contract and no coffee.

7.     The leading corporation VINACAFE has to carry out too many unfunded non-commercial functions. In general, it is responsible for promotion of the coffee industry, including implementing government’s policies regarding the expansion of arabica area, research and extension, quality certification, and representing Vietnam at international forum. These functions are not profitable under the point of view of VINACAFE as a commercial state enterprise, however, they almost certainly benefit the economy as a whole. However, the difficulty in separating the social functions that should be funded by the government and the commercial functions that should not be subsidized in order to impose market discipline on the enterprises leads to insufficient subsidies from the government and misuse of these subsidies (if any) in SOEs. Consequently, these SOEs poorly perform both commercial and non-commercial functions.

 

To conclude:

1. The monopoly of SOEs’ cartel in Vietnam’s coffee industry has not brought about desired results. First, it cannot moderate supply and price fluctuations in domestic markets by buying into, and selling from, buffer stock because of capital, storage facilities, etc. Even in case these requirements are met, buffer stock operation will not be efficient because Vietnam’s export of coffee is small relative to the world trade, this kind of operation is unlikely to influence the world market. In addition, the fluctuations in the world coffee market are completely irregular, thus for both said reasons, buffer stock operation will certainly be very risky since it can hardly be foreseen how much and when to buy into and sell from the stock. Second, exporting-marketing monopoly failed to increase the return for coffee growers as mentioned in Chapter 1, but even squeezed them. Third, the monopoly was given to SOEs in expectation:

n      to assist farmers in terms of credit, technical and other services;

n      to enhance Vietnam’s export price in the world market.

n      to gather large quantities as well as low price of input to generate favorable conditions for the development of Vietnam’s processing sector.

However, both have not been successful: farmers do not get rid of the lack of capital, knowledge, experience, etc. and also, the processing sector is standstill.

 

2. Vietnam’s coffee exporters cannot command higher prices for their coffee until they get proper storage facilities, until they can assure a smooth flow of coffee from the producers to the buyers, and until they can guarantee quality control. All of these requirements can be met only if all agents in coffee industry are well-informed and working smoothly and fairly.

Chapter 5: Other considerations

I. Introduction

This  chapters will consider three questions. First, should Vietnam carry out more processing in the country, particularly secondary processing? Second, how can Vietnam promote arabica? Third, what consequences will Vietnam’s entry into the ASEAN free trade agreement (AFTA) have for coffee industry?

II. Promotion of roasting industry

As mentioned in Chapter 2, coffee roasting is a capital-intensive and increasing-return-to-scale industry, requiring a huge package of capital for processing factories and networks of retail outlets while capital and technology are two relatively scarce resources in Vietnam. Thus, according to Heckscher-Ohlin theory, Vietnam has a comparative disadvantage in coffee roasting.

            Assuming that the quality is homogeneous, Vietnam can increase its value added only if it can produce roasted and soluble coffee at a lower cost than other countries. Obsolete technology, inexperience, capital shortage, lack of domestic packaging materials, smaller plant size, higher transaction cost in retailing, and many other reasons are likely push up Vietnam’s roasting cost, consequently the value added would be negative.

            Another factor is that foreign markets for roasted and soluble coffee are dominated by a few giant corporations (see Chapter 2). It is impossible for new infant comers like Vietnam to penetrate into or compete in these markets.

            Finally, roasted coffee is a highly differentiated product, with consumers’ preferences varying sharply across countries, particularly the high-income countries that form most of the world demand for coffee. In Europe, international trade in roasted coffee is limited because the consumers will rarely accept coffee roasted in other countries.

            In brief, at least in the medium-term, the promotion of coffee roasting industry may not be economically justified.

III. Arabica promotion

Coffee produced in Vietnam is almost robusta which fetches lower prices than arabica in the world market. However, to promote arabica coffee, it is necessary to have a comprehensive study on both technical and economical aspects. In recent years arabica coffee has been planted in  many provinces. However, the result is very poor because the planners just focus on the technical aspects while economical aspects are nearly ignored. A survey conducted by Yen Bai Provincial People’s Committee reveals that the proportion of alive coffee planted in 1994-1995 was just 24% (in some communes, the figure was even lower than 10%). 30-50% of those newly planted (1997-1998) have already died (Thoi Bao Kinh Te Viet Nam No.20, 10 March, 1999, p.9). These problems may be explained economically as follows:

1.Planting arabica coffee requires very high initial investment around VND70-80 million/ha, 2 times higher than that for robusta (Ibid.), and depends largely on scarce rationed credit from the government. Therewith, the capital per hectare is usually lower than requirements. As a result, those technical requirements such as fertilizer, irrigation systems, land preparation, etc. cannot be met, then the coffee is inevitably malnourished, faded and even died.

2. Furthermore, arabica coffee can keep its special flavor and high quality only if it is processed by the wet method which is rarely used in Vietnam. The usage of dry method by spreading coffee on the ground impact harmfully on the quality of arabica coffee .

3. In addition, the assistance in terms of techniques and other advice is weakly funded and cared by concerned authorities. Thus, the peasants rarely receive theses assistance and have to plant and look after the coffee subject to their knowledge and experience, consequently adversely affecting the quality of coffee.

      4. Finally, farmers are mostly living at subsistence level, where most of outputs are produced for family consumption. In these localities, farms are extremely small and cultivation is dependent on uncertainties of a highly variable rainfall, average output will be low, and in poor years the peasants and their families will be exposed to the very real danger of starvation. In such circumstances, the main motivating force in the peasants’ life may be the maximisation not of income, but of their families’ chance of survival. Accordingly, those peasants may be reluctant to shift from a traditional technology and crop pattern that over the years they have been familiar with and known that could keep them to survive, to a new one that promises higher yield but may entail greater risk of crop failure. When sheer survival is priority, it is more important to avoid a bad year (total crop failure) than to maximize the output in better years. Thus, peasants living at subsistence level are often resistant to technological innovation in farming techniques or to the introduction of new seeds or different cash crops. Vietnamese peasants are not exceptional: parallel to planting coffee under the program, peasants in the mentioned localities share their efforts and resources (land, credit capital) for traditional crops to at least keep them from starving. This is made even more so by the fact that the insurance against risks of crop shortfalls in Vietnam is still absent. Consequently, coffee planted in these areas is not only poorly invested in terms of capital, but also has to share the trivial credit and inter-cultivate  with other crops.

IV. Entry to AFTA and its impact on Vietnam’s coffee industry

In the entry in to AFTA, the tariff phasing out process is expected not adversely affect the coffee sector. There are reasons to believe that:

1.First, thanks to the climate, natural resources and labor cost, Vietnam has comparative advantage in coffee production. So the movement towards a more liberalized trade regime in the area can only benefit coffee farmers in particular and the whole industry in general.

2.Second, Vietnam is a traditional tea-drinking country, domestic coffee consumption is trivial, then green coffee imports (if any) would not create noticeable affect on the coffee sector.

3.Third, green coffee beans are a bulky commodity, then the transport cost usually takes a significant proportion in the total cost. This surely pushes prices of imported coffee beans up, thus would not allow them to successfully compete with the domestic green coffee.

      4. Finally, primary processing sector is also neutral to the tariff changes due to:

            + Dried cherries are more perishable than green beans, creating incentives for processing to take place near the producing areas.

            + Primary processing reduces the bulk of the product, so that transportation costs are minimized by processing as close to the farm as possible.

            + In this sector, the economies of scale are not very great. [14]

            These strongly suggests that even in the free trade environment, coffee primary processing will continue to take place in the coffee zone of Vietnam and be free of competition from ASEAN countries.

            However, soluble coffee producers who is being highly protected by tariff barriers will likely be adversely affected, but there would be no effect on coffee farmers because local demand for soluble coffee is negligible in comparison with the total Vietnam’s coffee output.

            Finally, the domestic roasters are also protected by the barrier of high packaging and transportation costs which imported roasted coffee must bear. Then, the reduction of tariff protection is expected not affect domestic roasters.

            In brief, entering to AFTA will not adversely affect Vietnam’s coffee industry in general. Only the secondary processing sector probably will. However, as discussed in Chapter 4, this sector should not develop in at least medium-term.

Chapter 6: Conclusion and recommendations

I. Conclusion

The salient feature of markets for green coffee beans is high price-volatility.

The collapse of ICA in 1989 has forced coffee markets to be more competitive. It allows small coffee exporters - price takers - like Vietnam to compete fairly with those price leaders.

Vietnam has a great comparative advantage in producing coffee. Reforms in land use policy, price policy, private ownership and foreign trade policy have made that great potential advantage come true. Open-door policy has cleared the ‘vent’ of obstruction for Vietnam’s coffee surplus. This in turn pushes up coffee production.

Coffee exported from Vietnam is always claimed to be of low quality, unreliable and thus being discounted in the world market. This is mainly due to the fact that coffee production has expanded more quickly than the institutional transition:

n      The marketing system has been dominated by SOEs, who have the right to export coffee directly. The monopoly was given to these SOEs in expectation that: first, they could improve the price of coffee export in the world market; second, to enhance the capacity of coffee processing sector, then coffee quality by gathering dried coffee cherries into a handful of their processing factories; third, they could render assistance such as credit, capital etc., to the farmers, which are supposed that private sector was not willing to do. However, over the last 12 years, none of them is fulfilled.

n      The monopoly allows SOEs to squeeze farmers enough to maintain their super-profit regardless of their export price. Thus, there are nearly no incentives for SOEs to improve export price.

n      As a principal-agent problem, managers of SOEs tend to be in favor of their own benefits and reputation while those of SOEs themselves are put into junior position. Therefore, in the world market, Vietnamese exporters are considered to be unreliable.

n      Capital shortage, high concentration of investment on production resulted in insufficient investment on marketing actitivities. Thus competitiveness of Vietnam coffee is reduced. 

n      Other promotional services such as techniques, technology, quality control and information to farmers are concentrated in one enterprise - VINACAFE, these activities are seen as non-commercial and thus unfunded. This fact has made the services under-developed. Thus, quality control in Vietnam is not reliable enough, so Vietnam’s coffee is not sold according to international standards, but to the importers’ requirements under each contract. Vietnam’s processors have, therefore, lost their initiatives in doing business internationally.

n      Finally, in Vietnam coffee can be produced with high yield, thus bringing in high profits. Farmers, therefore, usually invest their resources in growing coffee which results in the serious shortage of facilities necessary for primary processing at farm-gate level. This directly increases the processing cost of coffee, and indirectly reduces the quality of Vietnam’s coffee products.

It is inadvisable to develop roasting industry in Vietnam for the time being.

Arabica coffee may have a great potential. However, it is necessary for Vietnam to conduct a comprehensive study in both economic and technical sides to assess (mainly economically here) the capital demand and fund available, farmers’ difficulties and their behavior, markets and prices for the products, etc.

Finally, entering AFTA does not so much affect Vietnam’s coffee industry when Vietnam mostly produces green coffee beans for export.

II. Policy recommendations

a.      Government should not limit the number of companies that are allowed to export coffee. The increase in number of coffee exporters will reduce marketing margin and improve the prices received by farmers. In the short-term, this might have modest effect, but a large effect will be coming in the long-run. Initially, the competition from numerous small enterprises may reduce export price of Vietnam. However, in the long-run the competition will encourage exporters to develop, so only the most efficient and profitable enterprises can keep operating, by that time Vietnam’s export price will be fairly equal to that of the world.

b.     To win in the competition, some SOEs had better be equitized. Promotional services should be separated from a commercial enterprise and assigned to a non-government specialized institution. The operation of this institution will be funded by a small tax on coffee export.

c. Research and extension is an activity of great importance in the sustainable development of coffee industry. The institutions should concentrate on 3 areas:

+ farm-level post harvest assistance: The research and extension activities should encourage farmers to enlarge their yards, develop low cost method for drying and storing coffee in order to avoid problems of foreign materials, mold, and uneven drying. Especially, these institutions should provide farmers with information about how to re-invest their income into upgrading product quality, then increasing income.

+ coffee diseases: Coffee plants can massively die due to some diseases which research and extension should equip farmers with measures to prevent.

+ maintaining water resources: In Vietnam, roughly 30% of water used to irrigate the coffee in Dak Lak is ground water. Unplanned expansion of coffee planting areas have destroyed forests which are the decisive factor to maintain water resources. In addition, under such a expansion the rate of water extraction may exceed the sustainability of water supply. Sustainability of  Vietnam’s coffee industry is largely dependent on finding the way to reduce the usage of ground water.

d. Price-shock restriction: It is suggested that to authorize the farmers to limit price shocks by allowing them to receive higher price (super-profit) and prepare themselves for the eventually decline. In order to make use of this mechanism, the institution is required to provide farmers with information about the market and encourage them to save for the decline in price.

e. The government needs policies to encourage export of high-quality coffee. These may include high tax-imposition on low-quality coffee export, and tax exemption or even subsidies for high-quality one.

f. It may be necessary to establish farming cooperatives to increase the farmers’ bargaining power. These cooperatives are effective tools to assist farmers in terms of capital, techniques, market information.