NB Financial Health

Monday
August 26
2013

Max Pichulik

NexThought Monday – Back to the Future: Why micromilling could make a juicy impact investment

My agriculture colleagues joke by telling me that grain milling is the second oldest industry in the world.

Their smiles reduce to a smirk as they explain how, after deregulation, South Africa’s food oligopoly has reached its radical economies of scale and technological efficiencies at the expense of smallholder farming and South Africa’s poor. To my surprise, I discover how important milling is to the heart of agriculture and food production, and how the demise of its “profession and art”, hurts all of society in some way.

They explain this is a problem because with an ever-fluctuating globally based maize price, price increases in the local market are almost always immediately passed onto the consumer, while price decreases lag as long as possible and are absorbed as profit for the food industry.

They add that retailers would welcome new entrants, since there are effectively only three main suppliers to choose from, who are caught up in almost continuous price-fixing scandals.

Meanwhile, the price of oil hits $100 per barrel, large scale milling equipment starts to age and intense labour pressure is forcing government to assess whether serious structural changes to the agricultural sector aren’t necessary to stem the tide of food price inflation.

At an emotional level, it is easy to look at this snapshot of South Africa’s large agricultural problems and lay blame on South Africa’s large commercial oligarchs. But, in fairness, the trend of industrialization and consolidation is global in nature. Besides, we need the big players now more than ever to maintain stability in our economy, which is why the South African government will protect them in the short- term.

Solutions and innovation however, won’t come from the established. It will take new models and entrants that will shift the agriculture sector. A new wave of entrepreneurial innovation needs to grip the food value chain as it has the technology sector. And so my agriculture colleagues’ smiles return as they explain how the “silver bullet” for South Africa’s agricultural sector might be the reinvigoration of the milling industry and a return to “what was” for 21st century global value chains.

Bigger is not always better

South Africa has the largest and most sophisticated industrialized farming and agri-processing capabilities in Africa, and the country’s strong road, rail and port infrastructure attest to why the industrial-scale model should work here. And it does for some, but not all.

The agricultural sector’s share of total jobs has dropped from 10.6 percent in 2002 to 4.7 percent in 2012, or 30,000 jobs lost each year. This trend has been influenced by a variety of factors, but it has been fundamentally driven by the industrialized nature of the sector; small farms now only represent 10 percent of overall production in South Africa. In a country facing 25 percent unemployment nationally and 52 percent in rural areas, this is not a favorable trend.

What’s more, agriculture’s negative employment trends have had other negative impacts by fueling a rural to urban migration. Today, over 60 percent of the country lives in urban centres compared to just over 50 percent in 1990. This rapid rate of urbanization has brought with it-increased demands for welfare support, urban food insecurity and rising crime levels. These migration patterns have been particularly problematic for smaller cities, which do not have the civil or economic capacity to absorb so many new entrants.

Agricultural industrialization has hurt those that have stayed in the rural areas as well – primarily from a food affordability standpoint. Highly refined maize meal is the cornerstone of the South Africa’s food industry and also the food staple for many South Africans and most poor South Africans, of which there are 11 million chronically poor in this country, 80 percent of whom live in rural areas. But because of how the maize milling industry has shifted and been restructured over time, those who rely most on this key food item end up paying more for it than their wealthier urban counterparts. We’ve also experienced increased levels of protest action in municipalities like De Doorns and the widespread use of seasonal workers on farms to reduce costs. Unions and agriculture sector bodies are starting to say that the long-term sustainability of agriculture is under threat in South Africa. As a society, we should stop looking at symptoms and putting Band-Aids on the problem. We need to start addressing systems, which need shifting.

An explanation starts with the deregulation of the maize industry in 1997. The government’s intention was to increase competition across the value chain for maize products. The actual result was the opposite. Due to the capital intensity of maize-milling, deregulation solidified a 60 year-old oligopoly by forcing the concentration of the entire maize supply-chain around the country’s three largest milling facilities, as owned by the big three located in the Gauteng province. Existing privately owned mills were consolidated and merged onto larger sites while gradually, regional mills disappeared and large mills found it inefficient to deal with small maize producers.

Randfontein, where the largest mill was based became the centre for grain trading on the SAFEX grain market and a new maize pricing structure was set, based on the theoretical cost of delivering the product to Randfontein from its storage facility. As a result, maize silos started to consolidate around this new commercial centre and the rest of the industry followed suite. Small farmers across South Africa, who once provided maize to hundreds of local mills and the big three’s former regional plants during regulation, were crippled under the new structure by the cost of transporting their product to the large commercial mills. In turn, the large mills found it inefficient to deal with small maize producers.

This is why today, in spite of South Africa’s favourable climate for maize growing, approximately 83 percent of all of the country’s maize comes from only three provinces – the Free State, Mpumalanga and the North West province – and why 65 percent of the nearly 5 million tons of maize meal consumed each year in South Africa by the domestic maize meal market is produced by only three companies.

However, the craziest thing is that transport and logistics can account for close to 35 percent of the final cost of maize products. Therefore consumers in rural Eastern Cape pay significantly more for a five-kilo bag of super maize meal than patrons of a central Johannesburg grocery store. This results in roughly a 20 percent price differential, according to the National Agricultural Marketing Council’s August 2012 report.

The new ’old’ opportunity

To me, there is something wrong with our society if we consciously enable a system where the poorest in the population pay the highest prices for their staple food source.

But what if we began localizing the maize (and wheat) value-chain, particularly in rural areas? This would significantly reduce transport needs and costs, and positively impact final product prices for consumers by at least 20 percent. …

What’s more, putting up a network of micro-mills in rural South Africa could be a radical innovation, creating thousands of downstream jobs and driving job creation to South Africa’s most poverty stricken areas, since on average, each new mill would need to be supported by 3,000 hectares of (ideally, within a 100km radius of each mill) farmed maize and 25-30 mill workers.

The South African Department of Trade and Industry has caught on. Recognizing the potential benefits of micro maize milling projects for food security and job creation, the DTI has made these projects a priority for its Manufacturing Investment Programme. So far, it has committed R60 million of grant funding and reports to have created 740 jobs and retained 1,100 more through these initiatives. But, a movement is required here to shift our food system.

And even outside of the DTI, there is some localized infrastructure in place already. Not quite the couple thousand mills there used to be decades ago, before industry regulation kicked in, but currently, there are an estimated 180 micro-mills dotted throughout South Africa. These can process 1-5 tons of maize per hour. The problem is they have not typically been able to produce the high quality super maize meal that sells to the consumer market.

With improvements in technology over the last 10 years, micro-mills now have the potential to generate more than 60 percent premium quality “super” maize-meal and an additional 10-15 percent of the slightly more coarse “special” meal with the right equipment. The remaining product can still be sold on as animal feed.

Localisation in the context of agriculture cannot only be created through the re-distribution of inputs and products, but also the participation/shared ownership of local communities and emerging farmers. Agriculture, like mining, needs to shift to a construct of shared value creation. In reconstructing these value chains, we need to break the construct of employer vs. labour and create the notion of partnerships and shared interest.’.

At a systems level, if food value chains are to be inclusively recreated, a value-based and ethical approach must be taken. In food value chains of the future, racism and abuse are punishable via access to opportunities and markets, and incentives are rewarded through productivity and efficiency.

The bottom line is food localization has to happen in South Africa to help alleviate some of the very serious socio-economic issues the country faces. Micro milling provides an opportunity to do this without charity or handouts, without heavy government intervention; rather, with a sustainable market based solution with the potential to make expansive financial returns and achieve social gains at the same time.

Max Pichulik is the co-founder of Impact Amplifier, a high-impact small business accelerator based in Cape Town.

Categories
Agriculture, Entrepreneurship
Tags
agribusiness, impact investing