IndoDairy Activity 1.5.1: Identify and analyse inclusive business models (IBMs)

between smallholder farmers and private companies

July 2020

The Centre for Global Food and Resources

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Acknowledgements

This report and underlying analysis were funded by the Australian Centre for International Agricultural Research (ACIAR), whose overarching research project AGB/2012/099 titled ‘Improving milk supply, competitiveness and livelihoods in smallholder dairy chains in Indonesia’ (IndoDairy) is led by the University of Adelaide’s Centre for Global Food and Resources (GFAR) and collaborates with Indonesian institutes, including IPB University, the Indonesian Center for Animal Research for Development (ICARD) and the Center for Agricultural Socio Economic Policy Studies (ICASEPS). The overarching IndoDairy project targets a 25 percent increase in milk production, coupled to increased quality, for 3,000 smallholders by 2020. Under Objective 1, the project will identify and recommend strategies and policies to support development of sustainable, profitable and smallholder-inclusive dairy supply chains. This report aims to “Identify and analyse inclusive business models (IBMs) between smallholder farmers and private companies” and constitutes Activity 1.5.1 of IndoDairy.

The authors thank and acknowledge the project team, in particular Dr Arief Daryanto and Dr Sahara of IPB for analysis and field work and Dr. Erwidodo from ICASEPS for his contributions to the analysis. Additionally, a special thanks to the farmers and the staff of dairy cooperatives, processing companies and retailers for their considerable efforts to supply the information that is the foundation of this report on whole-of-chain opportunities for investment by industry and Government.

For more information:

Contact Professor Wendy Umberger, Project Leader – wendy.umberger@adelaide.edu.au

Visit the project website – www.indodairy.net

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Table of Contents

Acknowledgements ........................................................................................................................ 1

Executive summary ......................................................................................................................... 3

1.0 Introduction .......................................................................................................................... 4

2.0 Inclusive business principles................................................................................................... 6

3.0 Why inclusive business principles in the agricultural sector? .................................................. 8

4.0 Thesis of this report ............................................................................................................... 9

5.0 Case studies - analysis of key relationships in dairy sector value chains, in East and West Java 10

5.1 Case studies - the examples .......................................................................................................... 12

5.2 Case studies - commercial and relationship analyses ..................................................................... 14 5.2.1 KPS Bogor- West Java ...................................................................................................................................... 14 5.2.2 PT Nestlé Indonesia - East Java (Kejayan) ........................................................................................................ 15 5.2.3 PT Greenfields - East Java ................................................................................................................................ 18 5.2.4 PT Cimory - West Java ..................................................................................................................................... 20 5.2.5 KPBS Pangalengan - West Java ........................................................................................................................ 23 5.2.6 Contract farming model .................................................................................................................................. 26

6.0 Gap analysis - IBM models in East Java compared with KPS Bogor, West Java ...................... 29

6.1 Model comparison ............................................................................................................................ 29

6.2 Impacts on and benefits to smallholder farmers ................................................................................ 35

6.3 Framework for an inclusive and commercially viable dairy sector ....................................................... 37

6.4 Broadening inclusive principles to social inclusion ............................................................................. 39

7.0 Conclusions and recommendations ...................................................................................... 42

Recommendations ................................................................................................................................. 44

References .................................................................................................................................... 45

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Executive summary

Public investment and policy support are essential to build a viable dairy industry in tropical countries

like Indonesia when exposed to free global competition, especially imports of dairy products from

temperate zones. Indisputably, the aspirational national expansion of smallholder dairying in Indonesia

depends on significant government support. Central to these national goals are import substitution and

the livelihoods of the smallholder communities, that despite serious challenges, already contribute 77

percent of raw milk produced in Indonesia – or 13 percent of the country’s total demand for dairy

products. More targeted government support with clear delineations of the roles of national, provincial

and local bodies will significantly increase smallholder milk production.

In this context, contrasting and diverse case studies of smallholder dairying on the island of Java were

analysed using (1) inclusive business modelling of the triangle of engagement and power relationships

among smallholders, industry and the public (or state) sector; and (2) flows of inputs, outputs, services

and information along dairy chains. Key weaknesses in these value chains were addressed in strategies

to:

• maximise social and economic uplift at the level of the rural household — the “grass roots”;

• increase profitability, confidence and stability to all the value chain;

• revamp existing and under-performing dairy value chains;

• guide sustainable foundations for dairying in new regions of the country; and

• underpin national production goals.

Additional and ongoing state investment in extension services, policy and dairy infrastructure is critical

to maintain a dairy sector in Indonesia. Investment often incorporates repayment of loans, including

those to cooperatives for physical assets and to smallholders for farm improvements. Private processors

may invest in smallholder cooperatives, with a case history in this report demonstrating successful

outcomes for both parties. Further research on scaling out such beneficial relationships is required.

Intensive private investment is generally restricted to smaller regions than those covered by state

entities with national or provincial mandates and with a role in public spending.

A wide range of information on best practices for dairying and associated principles of entrepreneurship

can now be delivered, using multiple formats, to a broad community of farmers’ associations and

cooperatives, processors, marketers and consumers. Information technology and digital tools for on-

farm decision-making and many other on-farm innovations, can stimulate active participation of young

farmers. For deeper engagement of women in smallholder dairying, issues of animal-based products,

nutrition and family welfare can be powerful points of contact. Some specific pilot activities for catalysing

this broad dairying coalition for Indonesia are identified and include competitive grants for audio visual

presentations using existing model dairy farms. With more than 30 local and foreign-controlled dairy

processing companies competing for market share, Indonesia’s downstream industries are well

developed. For the challenge of harnessing and harmonising the diversity of the national dairying sector,

analysis of value chains and inclusive business models proved powerful tools to formulate specific

recommendations on whole-of-chain opportunities for industry and government for advancing

smallholder livelihoods.

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1.0 Introduction

The Indonesian dairy sector consists of large multinationals, local milk processors, village level dairy

farmer cooperatives (KUD – Koperasi Unit Desa) and many smallholder farmers, the majority of whom

are KUD members (with some non-KUD supply groupings emerging). Since the 1970s, cooperatives

have been central to the national government’s drive to enhance dairy value chains and empower

smallholders (Sulastri & Maharjan 2002). Collective bargaining and representation, through

cooperatives, can successfully buffer the essential inequality of smallholder negotiations with large and

powerful conglomerates. However, governance of dairy farmer cooperatives is unwieldy and

complicated by responsibilities to three Ministries: Cooperatives, Agriculture and Industry. Wijers (2019)

noted that “The Ministries’ national and regional activities vary in effectiveness”. Limitations in defining

logical institutional roles in the transfer of technology and extension are further exacerbated by a lack

of cohesion between provincial and district services. The umbrella organisation, the Union of Indonesian

Dairy Cooperatives (GKSI) is a semi-government coalition focused on the cooperatives, with board

representation from the larger ones. GKSI has a national and regional presence and participates in both

the dairying components within community-based KUDs as well as the dedicated dairy KUDs.

Indonesian milk is produced on two very distinctly different scales: 1) A small, yet growing group of

modern, productive, and integrated dairy companies own about ten percent of the dairy herd yet

contribute 23 percent of fresh milk production; and 2) Smallholders with typically only three to five cows.

The integrated dairy companies average 5,000 lactating cows per farm and are driving modest growth

in milk production. In general, output on these farms is 20 litres per animal per day, with one large

company yielding more than 30 litres. Calving intervals for the companies range between 13 to 14

months. Although 99 percent of production occurs on Java, where the processors are located, new

farms have been established on Sumatera Island. By contrast, smallholder production units are

characteristically inefficient, yielding on average less than 10 litres per animal per day, and with calving

intervals between 18 to 20 months. Study of economic returns to smallholder dairying is ongoing in

ACIAR’s IndoDairy project. Profitability is sufficiently low from dairying to trigger cow culling by

smallholders when beef prices are high. Nonetheless, the somewhat fragile base of small farms delivers

77 percent of Indonesia’s milk production and is therefore pivotal to reducing imports of dairy products.

To serve the aims of both producing more milk and improving rural livelihoods, this report addresses

optimising benefits to smallholders from Indonesia’s diverse dairy value chains.

Most smallholder farmers are dairy cooperative members, who produce milk for processors, however

in addition to the dairy cooperatives, other supply groups are emerging in the market through which

smallholders are able to access buyers. Processors usually pay producers through the cooperatives in

accordance with quality parameters (protein and fat content, and bacterial count). The cooperatives

deduct management fees, animal health and artificial insemination services and feed costs. The GKSI

estimates that only 30 percent of their members own land to produce forage for animals, and only 10

percent provide sufficient forage to their dairy cows. Large cooperatives have tried to overcome this

systemic shortfall in forage by collaborating with state plantation companies to plant forage on adjacent

and available fallow land. Recently, however, the plantations revoked the cooperative’s use of the land.

Large farms supplement local forage with imported lucerne, an option that is unavailable to

smallholders, some of whom do use maize silage, which is also insufficient. The processing companies

arrange low or no interest loans to cooperatives for maintaining milk supplies and upgrading cold chain

infrastructure, collection points, handling equipment and transport vehicles. Some processors also

provide business and production management training for young farmers, the details of which are

described further below.

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Protective tariffs on imports of milk powder from Australia and New Zealand were removed recently,

underlining that smallholder dairying is increasingly vulnerable to exposure from free global competition,

especially imports of dairy products from countries in temperate zones that are highly mechanised and

capture significant economies of scale.

Long-term and ongoing investments associated with the Bill and Melinda Gates Foundation (BMGF)

through the East Africa Dairy Development initiative (EADD Phase I 2008-13: USD 51 million for Kenya,

Uganda and Rwanda) were lifelines for smallholder dairying in East Africa. In EADD Phase II (USD 26

million; Tanzania, Kenya and Uganda), BMGF partnered with Heifer International, the International

Livestock Research Institute and the World Agroforestry Centre. Without underwriting and investment

by government and/or industry, in a manner comparable both in size and in focus to EADD, dairying is

even less viable in tropical countries like Indonesia, where environmental conditions, chiefly higher

temperatures, are less suitable for dairying than in East Africa. In Vietnam, dairying struggled to become

established except in cooler highland zones. Indisputably, the aspirational national expansion of the

smallholder dairy industry in Indonesia depends on significant government support; or an interventionist

rather than laissez-faire model. Central to the national goals, are import substitution and the

advancement of smallholder communities.

Indonesia’s yearly dairy consumption approaches 4 billion litres, with local production between 600 and

700 million litres, or around 17 percent of total demand (USDA Foreign Agricultural Service 2019) and

annual imports now routinely costing more than US$1 billion to address shortfalls. These trade and

production statistics are consistent with FAO’s (2019) independent estimate of imported dairy products

of 3.2 million metric tons of milk equivalent in 2019.

The growing middle class and changes in lifestyle (Valenta 2018) and diet have fuelled yearly dairy

industry growth of 10 percent. With per capita milk consumption approaching 15 litres per annum

compared with the Philippines and Thailand with 22 and 31 litres respectively, there is a huge potential

for growth of the dairy sector (Valenta 2018). Indonesian smallholders often express concerns about

rates of return from dairying. The average profit by smallholders without costing any household labour

was IDR 1,967 or US 14 cents per litre of milk in a study of four districts in West Java (The Centre for

Global Food and Resources 2020b). Positive non-price stimuli for adopting dairying include a relatively

shorter time to first sales or returns when compared to forestry or perennial crops, an income stream

that is distributed to households throughout the year rather than being aggregated into a short post-

harvest period as for many cropping enterprises and relatively fast payment after delivery.

This report analyses the activities of selected key actors in the dairy industry and their interactions with

the smallholders in the dairy value chains. The key actors include PT Nestlé, and PT Greenfields,

located in East Java and KPBS Pangalengan, PT Cimory, and KPS Bogor in West Java. The

commercial and relationship models between processors and smallholder farmers along with their

influences on household livelihoods, the community, and the economy at large were analysed.

Government inputs to develop the value chains were examined and recommendations were made. The

broad role of government in agriculture in other fast-growing economies was also examined. This

provided insight on the validity of the models for engaging smallholders and processing firms and on

strategies for improving the value chains.

This report also analyses the existing dominant models for engaging smallholders in dairy value

chains, identifies gaps and flaws in these models and then proposes viable business models and

industry strategies. These enhanced models, by embracing principles of inclusiveness, strengthen the

commercial viability of smallholder entities, improve the livelihoods of smallholder households and

communities, and build resilience, quality and productivity in the supply of raw milk. The lessons learnt

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from dairying in Java will inform decisions regarding expansion of dairying to new regions of the

country.

Snapshots of dairy value chains

Most commonly, smallholders produce raw milk (with limited inputs of feed and forage sourced locally),

deliver to milk collection points (MCPs), are generally operated by local cooperatives (KUDs), and

receive payment directly from processors or through KUDs. Processors primarily purchase the

smallholders’ raw milk, via KUDs, and market either fresh milk or processed products (such as long

shelf-life milk, condensed milk, yoghurt and yoghurt products, confectionery etc.). KUDs have strict

geographic boundaries eliminating competition for markets between them. Alternatives to the dominant

model include PT Greenfields, a joint Australian/Indonesian company which has vertically integrated

milk supply and processing in East Java, and PT Cimory in West Java that invested in large commercial

farms to ensure supply. This report addresses the extent to which the different models integrate

inclusive business principles that benefit the smallholder sector.

In addition to the main supply models, there are a few retail producers, such as Susu Mbok Darmi, in

the city of Bogor, who purchase raw milk directly from several medium-sized farms to produce

sweetened and flavoured, fresh milk products in their own facilities for sale through their network of

street vendors. Although small players in the broader dairy sector, such businesses reflect growing

consumption of fresh milk rather than long shelf-life and processed milk in the market.

2.0 Inclusive business principles

The agricultural industry is highly reliant on investments and improvements in research and

development, productivity and processing. The ability to sustainably source sufficient raw materials that

meet required quality standards is a major goal of global agribusinesses. More than 80 percent of food

consumed in most of the developing world (International Fund for Agricultural Development 2013) is

produced by smallholders who are therefore pivotal to agricultural value chains. Smallholders are

farming households that cultivate or own less than two hectares of land (Rapsomanikis 2015),

depending on the crop and country. Smallholders are often not included in agribusiness and decision-

making for several reasons including their often remote location, high transaction costs of doing

business, information asymmetry and inconsistent production and quality. Asymmetrical information

refers to information deficiencies whereby the buyer and the seller at any point in a value chain have

unequal access to information, especially prices that impact on transactions. Often internationally, small

farmers without access to prices paid by other processors or in other places have been exploited by

processors with whom farmers lose trust. Mobile phone networks supplying such information to farmers

have corrected several instances world-wide of this imbalance. Conversely, information is asymmetrical

when an agribusiness cannot observe and understand farmers’ practices that impinge on the quality of

the product sold.

Around 87 percent of the world’s more than 500 million smallholder farmers live in the Asia Pacific

region (Oxfam 2015). Most of them are geographically scattered and have limited access to modern

farming technology, market access, information, and agribusinesses. Due to the increasing number of

intermediaries in agricultural value chains, smallholder profit margins are continuously being squeezed

and farmers are left in poverty. These issues have driven innovation in sourcing raw materials. For this

report, relevant and contrasting case-studies from the Indonesian dairy industry are analysed using

inclusive business models and reviewed in the light of previous agricultural development in Japan,

China, Taiwan, and South Korea.

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The Asian Development Bank defines inclusive businesses as generating high development impact by

providing access to goods and services for the ‘base of the pyramid’ and/or providing income and/or

employment opportunities to low income earners as producers, suppliers, distributors, employers and

employees. The ‘base of the pyramid’ is the large proportion of businesses, workers and consumers

who are excluded from normal commercial opportunities through a lack of capital, assets or education.

Smallholders who typically farm small allotments are often excluded from value chains because of

physical remoteness and poor access to markets. As well as geographic isolation, sociological or

cultural differences with traders and the business community may inhibit profitable and harmonious

transactions from developing. Smallholders constitute about 85 percent of farmers globally but earn the

least (Oxfam et al. 2015). In the Indonesian context, a smallholder dairying household would usually

manage six cows or less. A large percentage of smallholder farmers worldwide are illiterate, limiting

access to information on best practices and collaborative opportunities. They are characterised by low

production levels of heterogeneous quality. Their supply is often haphazard and aggregation into a

steady stream of product of constant quality is difficult. Firms are often discouraged from working with

small-scale farmers by the transaction costs associated with aggregation of highly heterogeneous raw

materials (Oxfam et al. 2015). Also, access to information about the farming activities of smallholder

farmers is another constraint that discourages their inclusion.

Smallholders’ inability to secure credit for expansion and intensification is a major constraint that

impedes their scaling up and makes it very hard for them to access new technologies, more efficient

inputs and production requirements of major players in value chains.

From the perspective of buyers and processors, the risks highlighted above (poor access to knowledge,

practices and new technologies) create an equivalent risk to their own businesses. A weak supply chain

delivering inconsistent quality and supply, risks a failure to meet consumer demand, their own quality

standards, and their own profitability. Thus, we can see an interdependence between smallholders and

commercial entities in all agricultural value chains.

This interdependence between smallholders and processors therefore creates a synergistic

relationship, one where improvements in smallholder access to knowledge and techniques leads to

improved reliability and consistency of supply for processors.

Thus, we can see that models of relationships between supplier and processor that improve the

productivity and quality of supply, benefit both processors profitability, while improving the productivity

and livelihoods of smallholders. While not the only principle implicit in inclusive business models, a fair

and balanced relationship between buyer and seller is fundamental to inclusive business models and is

the main focus of this report.

In the context of the Indonesian dairy sector, those at the bottom of the pyramid are typically small

farmers supplying raw milk, and with whom value chains begin. Empowering these farmers to innovate,

through extension and other inputs, is central to building robust value chains. One approach to

implementing smallholder extension work aims to target as many farmers from communities as possible

– an extensive model – as opposed to an intensive model in which “champion farmers” are identified

for education on emerging farm practices and operations, mainly by processors and other buyers, and

provided with a comprehensive perspective and first-hand experience of the operation of their value

chain as well as familiarity with potential providers of extension by government and private entities. In

fact, in many instances of the broader community, targeting natural leaders also emerges to play a

larger and more catalytic role in implementing technology advances than their peers. While Indonesia

is culturally diverse and heterogeneous, peer learning from the “champion farmers” has generally been

associated with a rapid advance in capacity of those at the bottom of the pyramid. Judicious

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identification of key individuals, who are respected and lead communities by example, was credited with

highly effective transfer of technology in ACIAR’s forestry projects in Indonesia, e.g. FST/2016/141 –

that broke new ground through appointing a female champion farmer – and FST/2015/040. Networking

is a key ingredient of the “champion” approach that seems more flexible than mass education in linking

to diverse and often restricted government agencies for assistance and collaboration.

3.0 Why inclusive business principles in the agricultural sector?

Historically in developing countries, and particularly East Asia after the Second World War,

strengthening agricultural capacity and output was critical in developing robust market economies

(Studwell 2013). Studwell (2013) discusses how agricultural development and land reform formed one

of three central planks in the economic development of Taiwan, Japan and South Korea following the

Second World War, and in China after 1975.

In Taiwan, Japan and South Korea state interventions for smallholders through land reform, technical

assistance and financing was critical in forming a regulated buffer between small landholders and larger

commercial interests (e.g. large landholders leasing land to individual households). This buffering and

protection of smallholders stimulated agricultural growth through households leveraging their own

labour and maximising outputs from small plots of land (often around one hectare per family).

Inclusive business principles focus on providing commercial value to those at the ‘base of the pyramid’

through goods and services. Inclusive agribusiness models can target all segments of the value chain

from production to market access and creating access to inputs, finance and extension, in the countries

noted above. In South Korea, the protection of smallholders was implemented by land reform which

resulted in a subsequent increase in farmland ownership from 5 percent to 70 percent and a reduction

in land tenancy from 95 to an average of 10 percent (Boyer & Man Ahn 1991). With tenancy issues

resolved, most smallholders focused on other vital factors for increasing productivity and profitability.

The transformation of farmers from tenants to owners stimulated increased efficiency and productivity

and sparked major economic surpluses from these agricultural sectors in East Asia.

Inclusive business principles in the agricultural sector provide smallholder farmers access to

information, improved inputs and technology, land, better markets, and shortens the longer chains of

intermediaries, whose participation decreases returns farmers. Equipping farmers with these resources

reduces poverty, develops agriculture and industry and improves food security and economic growth.

In some instances of economic uplift, smallholder communities evolve to employ their own advisers.

This interventionist development model for emerging economies is contrary to the tenets of the laissez-

faire economics that dominated international development and aid agencies in the 1980s and 1990s

and favours reduced government participation. By contrast, Studwell (2013) asserts that intervention to

reinforce the role of smallholders, improving their productivity, profitability, and livelihoods, not only

improves the economic well-being of a large proportion of the rural poor during the growth of the

agricultural sector, but also contributes significantly to the national economy through increased

agricultural output. National, regional and district policies which fail to recognise the importance of the

smallholder production in the economy, jeopardise shaping a strong, viable and growing agricultural

sector from the ground up. A government role is critical to expanding the base of production of an

emerging agricultural sector and there can be significant synergies between private sector investment

(in this report through larger commercial companies in the dairy sector) and government policy that

supports and invests in smallholder farmers. Regional and district policies matter and the skills

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associated with decentralisation are evolving in the public sector. This government/public sector role is

the third key component analysed.

4.0 Thesis of this report

By studying various commercial models for the relationships between smallholders and the agricultural

supply chains in the dairy sector in Indonesia, we assess the relative balance between smallholder

farmers, larger commercial and corporate players (e.g. processors or large vertically integrated

companies) and the state (in various forms of intervention).

Where there is a clear state role (normally public funding of extension programs or a similar structure),

the balance of the market power and economic benefits may be more evenly distributed across the

value chain than when the state role is diminished. State investment is not the only mechanism for

achieving equitable benefits and, in one case history, a balanced distribution of benefits results from a

commercial entity (PT Nestlé) investing in smallholders. Especially as Indonesia is ranked as having

the sixth worst inequality of wealth in the world, it is prudent that scrutiny for any evidence of larger

companies gaining undue market control should continue, such that the balanced relationships with

smallholders as typified by the Nestlé example become the norm. Fortunately, today there are major

commitments by companies globally so that consumers’ concerns regarding food safety and ethical

behaviour are addressed by audits of supply chains that reach back to the farm. Dairy sectors in

developed and developing countries have played a key pioneering role in auditing supply chains, with

carbon emissions and environmental sustainability now scrutinised with respect to global public good in

the very broadest international contexts.

The successful application of models with balanced benefits for processors and smallholders requires

one of two pre-conditions:

• State support for increasing smallholder productivity, through investment in extension training,

infrastructure, and support for solutions for market barriers (e.g. supply of forage and silage, or

quality animals). The state provides inherent support to farmers through the KUD structure as

the governance, accreditation, monitoring, and reporting requirements provide a level of

collective market power and accountability to the KUDs. This is built into our assessment of state

support in the system. We also note that the KUD structure provides a strong framework for the

strengthening of the market position of smallholders, but it is not necessarily sufficiently well-

funded to provide the required infrastructure support.

• Strong commercial operators that channel investment in financial and extension support to

smallholder organisations, resulting in stronger commercial returns for both sides of the

transaction (commercial company and the smallholders), and therefore returning macro-

economic benefits such as improved productivity, and improved livelihoods for smallholders and

improved tax revenues, reduced reliance on imports and increased export opportunities. A

deterrent to corporate investment, in support to smallholders, has been identified as an absence

of confidence that those farmers who receive support will not shift allegiance and sell to other

commercial enterprises for higher short-term prices on offer.

With their wider breadth of vision, state extension services are more able than local institutions to

leverage relevant cross-cutting information from other regions of Indonesia and abroad for local dairying

enterprises. For example, the findings from the ACIAR project targeting smallholder beef fattening

systems based on forage tree legumes on calcareous soils in eastern Indonesia and northern Australia

(Project no. LPS/2008/054) can provide innovations for dairying. Silage production, information on

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forage quality as well as the commercial potential for association with forestry and larger farmers for

forage production can also be strengthened by government-wide connectivity. Similarly, there is a

wealth of information to be gleaned from many sources on catalysing women’s engagement in

smallholder agribusiness.

Active support for organisations such as the independent youth-focused dairy network, PERPAMI and

gender-focused programs, will provide secondary support and strengthening for emerging

entrepreneurial business models. Such entrepreneurship and associated inclusive business activities

require specifically targeted policy support. We emphasise the need for more active support and

engagement for networks like PERPAMI that can catalyse youth and gender involvement in the

agricultural sector, and the need for structured policy that can build this support directly. Social evolution

is the enabling environment for technology transfer. Currently, major disincentives for youth

engagement in agriculture include drudgery of operations, limited opportunities, and a poor social image

of subsistence and smallholder farmers. Further specific actions, including support for professional

development through travel that address the disincentives, are detailed in section 6.4 of this report.

Our thesis is that where smallholder and inclusive-focused models are supported (principally by some

state intervention linked to other government policies such as food security and rural development, but

also commercial investment), economic benefits accrue broadly to establish a more robust agricultural

sector. This in turn builds a more resilient economy with a strong foundation of small landholders. In

models where the state involvement is diminished, economic benefits may tend to accrue to the

corporate players in the value chain, with fewer broad gains in the wider economy. There is a worldwide

trend to reduced state funding of extension, especially for mature industries in developed countries. In

Bangladesh, however, the Department of Agricultural Extension remains that country’s largest institution

and, in the case of Indonesia, the fledgling dairy industry that is part of the government’s aspirations for

rural development will fail without public support for extension.

Accordingly, for the development of the dairying sector the recommended approach (below and with

specific recommendations in 7.0) includes strong support through infrastructure investments and

extension training programs, and policies that increase the quality, consistency, and reliability of supply

of raw product. This will improve the productivity of both smallholder producers, and downstream

processors in the supply chain. Notwithstanding that some companies invest as part of their commercial

strategy, the support should come primarily from increased state involvement and not be left to the

private sector to carry the load in emerging and developing industry sectors, as the dairy sector is

currently positioned. Since the 1970s, dairy cooperatives have been central to the Indonesian

government’s drive for dairy value chain improvement (Wijers 2019), to the extent that KUDs dominate

the current dairy landscape – but not to the exclusion of others – and with smallholders supplying 77

percent of the milk produced in the country. Beyond that, partitioning the “success” of smallholder

dairying between government and commercial investment is beyond the scope of this report, but in the

case studies that follow, viable value chains are associated either with commercial investment or

significant levels of foreign aid.

5.0 Case studies - analysis of key relationships in dairy sector value chains, in

East and West Java

As noted, this report focuses on analysing existing value chains East Java, identifying the strengths of

these models, describing benefits associated with inclusive business practices, and through a gap

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analysis of value chains in West Java (near the city of Bogor), determine the necessary pre-conditions

for applying the inclusive business principles to the existing value chains.

The analysis assesses the relationships between three key actors in the value chains: smallholder

farmers (and women and young members of farming households); commercial operators (mostly

processors and large vertically integrated farms); and public institutions (referred to as the ‘state’: i.e.

policy settings, public infrastructure investment, organisations supporting cooperatives, and national or

international development donors or investments).

For each model under analysis, we present two figures describing these relationships. The first is a

simple value chain analysis with the key players identified inside the circles, connected by arrows

indicating the flow of product (inputs as well as milk) from one to another. The smaller curved arrows

indicate a flow of beneficial goods from one to another, normally from a processor back to the

smallholder in the form of service over and above money. For example, Nestle provides finance and

training to smallholders as well as purchasing their product.

The second figure determines the balance of the relationship between three parties: the public goods

provided by state support (infrastructure, financing, regulation etc), the corporate sector (processors)

and the smallholders. The size of the circle for each party indicates a high-level assessment of the role

played by each party in the relationship, with the arrow indicating net flow of benefits. For example, in

a balanced relationship between processor and farmers, the farmers supply a necessary input to the

processors, and are paid for it, and the processors may invest in extension training to secure a reliable

supply of quality input, and the public sector (state) gains through increased domestic production and

tax receipts. In this situation, both parties gain, and the relationship is balanced. In an unbalanced

relationship, the processor may leverage an external milk supply (imported) to drive the supply price to

farmers downwards, minimising the benefits for the farmers, maximising benefits for processors, but

also, in turn, increasing import volumes, and reducing doestic food security at a national level.

Dashed lines connecting parties in the figures indicate an indirect link, for example, between Greenfields

main product line of fresh milk, and their secondary line of lower quality milk which is used for processed

milk products. In the case of the three-way relationship model, where one party (eg processors) may

dominate, it can have the effect of weakening the link between the farmers and the state, indicating that

this relationship requires strengthening.

This relationship analysis allows ranking of the examples in terms of the relative degree of inclusiveness

implied in the models, providing two preferred examples to be used for the gap analysis comparison

with KPS Bogor.

For business models to be considered successful in terms of integrating inclusive business principles,

value (commercial, financial, market influence, etc.) needs to be distributed fairly between the two

commercial entities, farmers and commercial operators. If this is the case, it can be argued that the less

powerful actors (particularly women, and young farmers) are provided with a commercial framework

that gives them voice in negotiations, market influence, and protection of their interests. Ideally, the

beneficial gains of the value chain would be distributed upwards through the economy through broader

macro-economic gains for the nation resulting in better access to export markets, reductions in imports,

and a reduction in poverty. These last elements, can be considered as the fundamental elements of a

robust, market-based development model (Studwell 2013). Inclusive business principles will therefore

fundamentally benefit the least powerful players in the value chains and, within agricultural industries,

support the participation of smallholders in the national economy. Models that partition equitable

benefits from the value chains to smallholders, dairying businesses and the state are considered

successful.

12 | P a g e

Figure 1. A ‘Balanced Relationship’ using the inclusive business principles.

Figure 1 presents a balanced or ideal relationship between the three value chain actors, against which

the value chains of the case histories are compared. The analytical tool overlays each real value chain

– or case history – on the ideal model to help capture the distribution of benefits. Figure 2 depicts an

unbalanced relationship that constrains implementing inclusive business principles, with the relative

size of the processors in the model reflecting their greater market influence, for example, unilaterally

setting prices for buying milk from smallholders and on-selling to other processors; while providing no

incentives nor support to enhance productivity. Such skewing of power towards processors typically

precludes an equitable distribution of benefits right along the value chain and fails with respect to

inclusive business principles.

Figure 2. An 'Unbalanced Relationship' using inclusive business principles.

5.1 Case studies - the examples

For this study, the IndoDairy team visited examples of dairy value chains in East Java and West Java:

State

ProcessorsSmallholder

farmers

Balanced relationship

State

ProcessorsSmall-holder

farmers

Unbalanced relationship

13 | P a g e

1. PT Nestlé Indonesia

2. PT Greenfields Indonesia

3. PT Cisarua Mountain Dairy (Cimory)

4. KPS Bogor (‘Dairy Production Cooperative of Bogor’; -- KUD)

5. KPBS Pangalengan (‘Dairy Farmer Cooperative of South Bandung, Pangalengan’; -- KUD)

KPS Bogor provides the baseline for the gap analysis, as the broader IndoDairy research specifically

identified KPS Bogor, and the West Java KUDs in general, as underperforming in comparison with the

value chains of East Java. (Nonetheless, KPBS Pangalengan in West Java is considered a success

story in Indonesia’s dairying history and the comparisons below between KPS Bogor and KPBS

Pangalengan, the latter with a significant long-term contribution from Dutch aid, highlight the

differences.)

In addition, two small start-up businesses targeting the consumer markets of Bogor and the owner of a

medium-sized farm near Bogor who convenes a youth-focused farmers’ network, PERPAMI, were

interviewed:

6. Susu Mbok Darmi (‘Mrs Darmi’s Milk’)1

7. Rumah Kopi Ranin (‘Ranin Coffee House’)2

8. PERPAMI (’Indonesian Association of Young Livestock Farmers’)3

The last three interviews provided a framework for broader inclusiveness in the supply chains.

The key question that this report addresses is whether inclusive principles from highly performing value

chains in East Java can be applied in such as KPS Bogor. The remaining four examples (Nestlé,

Greenfields, KPBS Pangalengan and Cimory) are therefore assessed in terms of their relative success

at implementing inclusive business principles, using the analysis described above.

We then compare the baseline model for KPS Bogor with these models, the gaps in the value chain are

subsequently highlighted, enabling us to better understand what is required to successfully apply

successful models, as well as further strengthen these with policy recommendations to improve the

value chain rating for inclusiveness and balance.

Table 1 lists the case studies modelled using KPS Bogor as a baseline as well as contract farming, for

which an hypothetical model is considered.

Table 1. Case studies and the KPS Bogor baseline

Model Location Description

KPS Bogor Bogor, West Java Underperforming KUD in Bogor

PT Nestlé Surabaya, East Java Private processor and privately

funded extension program

PT Greenfields Malang, East Java Vertically integrated large-scale

farming and processing

operation

1 https://www.facebook.com/Susu-Mbok-Darmi-385946975099091/ 2 http://rumahkopiranin.com/ 3 https://www.facebook.com/perpami/

14 | P a g e

PT Cimory Bogor, West Java Private processor and privately

funded model farm program

KPBS Pangalengan Bandung, West Java Foreign government funded

program through KUD

Contract farming No examples visited Generic contract farming model

discussed

5.2 Case studies - commercial and relationship analyses

Each of the examples above are analysed in terms of firstly, the commercial structure between the key

actors as a high-level value chain analysis following the flow of money and product. Then secondly, as

a ‘relationship analysis’, to determine the relative power relations, between the actors, and assessing

the relative benefits to each actor, reflecting the implied application of inclusive business principles

(initially in commercial terms only, not social or environmental).

5.2.1 KPS Bogor- West Java

The KUD structure of KPS Bogor provides the baseline for scope improvement analysis .

KPS Bogor operates a typical structure of KUDs in the dairy industry by operating a number of milk

collection points (MCPs) and purchasing milk from farmers through these MCPs. The KUD sells the

milk to several processors in the region (eg Indolkato and Friesian Fag in South Jakarta), at a IDR1,000

per litre margin on the price paid to the farmers. The processors will pay a higher price for higher quality

milk, based on total plate count (TPC), which is reflected in the process they pay the farmers. This

ranges from IDR4,100/L for a TPC of >1.0Mppm, to IDR5,300/L for a TPC of <500ppm.

Figure 3. Value chain map for KPS Bogor farmers.

The KUD has indicated that the key challenge for their farmers is increasing and maintaining a higher

quality milk supply. To achieve this quality standard consistently (for example a TPC of less than 500

ppm) requires increased skills and training for farmers, improved logistics including the use of stainless

steel pails for transport, improved chilling and storage capacity at the MCPs, and improved access to

new technologies for maintaining healthier animals, better testing of animals and milk, and improved

feed supplies to the farmers. Although the KUD is funded through milk sales, they do not generate the

sort of revenues required to fund these improvements in the supply chain. Farmers express the

frustration of lower prices by trying to increase the volume of their production through more cattle, rather

KPS Bogor MCPs

Farmers deliver Milk Collection Point (MCP)

Smallholder farmers (milk)

PT Friesian Flag

PT

Indolakto

15 | P a g e

than the quality of the product. Local processors hedge against the lower quality of locally supplied milk

by purchasing their inputs from further afield and using the lower quality milk for products other than

high-margin fresh milk.

Thus the driver for change in the supply chain is not driven by the processors, as they can source better

quality milk elsewhere, nor is it being driven by the KUD as their revenues do not provide the capacity

to invest capital where it is needed, and the farmers, through a lack of knowledge and training, cannot

make the changes themselves.

Through this analysis, we can see that market forces alone are not enough to drive change in the

industry in Bogor. If there remains a policy direction to strengthen and improve the domestic dairy

industry, then support needs to be provided to supply basic infrastructure of extension training, farm

inputs, and capital investment in logistics to provide a baseline for the market to build on.

Figure 4. KPBS Bogor relationship model

5.2.2 PT Nestlé Indonesia - East Java (Kejayan)

Commercial and Relationship Analysis

For more than 140 years, Nestlé has been leading the world in nutrition, health, and wellness with their

range of food products. Nestlé is the largest producer of fast-moving consumer goods and has presence

in 189 countries, including Indonesia. To save a neighbours’ child unable to accept breast milk, Henri

Nestlé developed the world’s first milk food for infants. Since then, Nestlé has consistently developed

other milk products with small farmers supplying the value chain. Nestlé commenced dairy operations

in Indonesia in 1970 in West Java. A factory was established in 1971 in West Java and another in

Kejayan, East Java in 1988. Currently Nestlé works via cooperatives with more than 26,000 farmers

owning 70,000 cows.

Public

Processors

Small-holder

farmers

Benefits:

• Few benefits currently flowing to smallholders

Strengths:

• Can source milk from other regions or import;

• No incentive to support local farmers

Benefits:

• Limited direct benefits to national economy;

• No reduction in importation of powdered milk

Support:

• Limited direct state support for farmers.

16 | P a g e

Website: https://www.nestle.co.id/id

Operating principles

The fundamental relationships that Nestlé build with their raw commodity suppliers is a model used in

other parts of Asia in other commodities. It has been successfully used with rice farmers in Malaysia to

improve the farmers productivity, but more critically to improve the supply quality and consistency of

farmers’ raw products. This in turn provides a commercial benefit to Nestlé by creating a more reliable

supply of raw products, where reliance on a smallholder network can put at risk the quality and reliability

of supply.

Nestlé’s goal of reliability of supply is built on the principle of ‘Creating Shared Value’, and involves

investment by Nestlé through assistance with capital purchases, or providing finance for capital

purchases, as well as investment in extension support to farmer networks through co-operatives.

However, while the principle is driven by commercial outcomes and requires a financial commitment,

and corresponding return on investment, the principle recognises the reciprocal nature of accrued

benefits. Nestlé understands that by improving the productivity of their supplier farmers, they not only

improve the livelihoods of the farmers, through an increase in their profitability, but they also improve

their own commercial outcomes, providing a robust platform for responding to increasing product

demand. Daily demand grew from 300 t/day in 2007 to 1150 t/day in 2017 and production of participating

smallholder farmers increased from 9.5 litres/cow to 11.8 litres/cow.

Description of model

Through Nestlé’s ‘Creating Shared Value’ strategy, farmers experience increased productivity and

quality to meet Nestlé’s demands and specifications. Nestlé provides interest-free finance to

cooperatives to setup and manage milk collection centres. Specifications such as time between milking

and chilling, purity, cleanliness, and handling are strictly adhered to by the cooperatives to ensure

consistency in quality of fresh milk. For consistency to be achieved, Nestlé invested in the purchase of

cooling tanks, stainless steel collecting cans and transportation. Investments further down the value

chain have been made by distributing seeds/nurseries of fodder species to cooperatives, developing

fodder farms, and providing water ad-libitum to cowsheds. Extension agents from Nestlé ensure

compliance by farmers with the recommended practices in feeding, milking and handling of animals.

The approach fosters self-reliance and engagement of farmers, rather than a habit of reliance on welfare

payments. Nestlé’s investments have increased the quality of farmers’ milk, strengthened cooperatives

and delivered a reliable source of high-quality milk.

Nestlé purchases milk from a number of KUDs in the vicinity of Kejayan, and pay nominally higher than

KUD prices for the milk, indicating that their investment is not directly recouped through lower farm-gate

prices. They pay IDR5,250/L for TPC of <500K ppm, as compared with IDR4,950/L through KPBS

Pangalengan, and around IDR4,700 ithrough KPS Bogor fo the same quality milk.

17 | P a g e

Figure 5. Value chain map for Nestlé East Java.

Relationship model

Overlaying Nestlé’s operating model on the generic relationship diagram described in the introduction

to this section and analysing the resulting benefits, highlights two significant factors. First, because there

is a well-balanced relationship between smallholders and Nestlé, both benefit economically and mitigate

their risks in the market.

Figure 6. Nestlé East Java relationship model

Nestlé provides extension training, access to finance, logistics and milk handling.

KUDs supports and implements extension training, access to finance, logistics to farmers.

Smallholder farmers

KUD Milk Collection Centres

Nestlé

Other suppliers (Greenfields)

KUDs

State

NestléSmallholder

farmers

Balanced relationship

Benefits: • Access to finance • Access to training and

extension • Improved productivity • Improved livelihoods

Some state role in KUD accreditation and monitoring, but no direct support.

Benefits: • Improved supply quality • Improved productivity

and profits • Increased market share

Strong corporate returns to national economy

• Import reduction • Export opportunity • Poverty reduction

18 | P a g e

Second, there is no significant role played by any state or public entity (other than through the

organisational framework of the KUD structure, accreditation, and monitoring; whereas generally three-

way models reflect the state – through funding, policy, and infrastructure – playing a major role in

positive outcomes). The Nestlé model reflects a balanced relationship between smallholders and Nestlé

(based on the ‘shared value’ concept), strong benefits to all parts of the supply chain and the broader

economy, and little intervention from the state.

5.2.3 PT Greenfields - East Java

Commercial and Relationship Analysis

Australian and Indonesian entrepreneurs founded PT Greenfields’ large-scale dairying operations in

East Java. The first farm was established in the Malang Highland at 1,200 metres above sea level in

1997 and their milk-processing plant came onstream in 2000, producing about 20,000 litres of milk per

day. Construction of Greenfields’ second farm commenced in 2017 at Wlingi. The feed processing and

silage systems of the farms support optimal nutrition, a core component of the package of best practices

in dairy husbandry that is recognised as the hallmark of Greenfields operations. Products include

pasteurised extended shelf life (ESL) and pasteurised ultra-high temperature (UHT) milk that exceeds

the highest international qualities standards, with Greenfield’s products sold in Indonesia, Malaysia,

Hong Kong, the Philippines and other Asian markets. PT Greenfields currently meets 5 percent of the

entire milk demand of Indonesia and will supply a further 6 percent when the second farm reaches full

capacity.

Website: https://greenfieldsdairy.com/

Operating principles

Greenfields sources fresh milk from their two farms but do not process any milk from smallholder

farmers because of quality issues. Nonetheless, Greenfields brokers the purchasing of smallholder milk

through a single, local, independent MCP (not directly through a KUD) for supply to processors including

Nestlé, Indolacto and Real Good. Greenfields has no contractual relationship with KUDs, nor obligations

to follow price floors for smallholders’ milk, nor provide extension. Greenfields has, however, a dairy

institute and a demonstration farm where farmers from across Indonesia are taught best practices. The

institute delivers a common good, namely to improve farmer husbandry, rather than to drive contractual

or commercial compliance with Greenfields’ product standards.

Description of model

Greenfields aim to provide high quality milk and milk products for the local and international market. In

their bid to achieve this, there has been a conscious or subconscious displacement of smallholder

farmers from the value chain, as Greenfields sources all raw milk from their own production rather than

from smallholder farmers. Their operations have led smallholder to shift from producing milk to selling

forage to the Greenfields dairy.

19 | P a g e

Figure 7. Value chain map for Greenfields

Although this trade relationship may seem inclusive to smallholder farmers, it is also inadvertently

increasing farmers reliance on Greenfields for their livelihoods and distorts the markets. Smallholder

farmers are at risk of losing out entirely, particularly in the event that Greenfields no longer required

their services due to unforeseen circumstances, such as subsequent vertical integration to provide

feeds or Greenfields losing their license to produce milk products due to regulatory, political or other

reasons.

Relationship model

Greenfields hinge on the productivity of their farm and adherence to their established principles and

management practices. Greenfields prioritisation of feeding and nutrition includes smallholder farmers

as suppliers of inputs for its primary production and excludes the same smallholders from the market

for raw materials for milk. This model creates a relatively low impact to smallholders but assures its final

consumers of high-quality products. Greenfields’ relationship with other processors as a milk supplier

also benefits Greenfields, but not smallholders directly. Greenfields, however, has invested in

“demonstration” training for local smallholders, which although outside their core business model,

improves the capacity of local smallholders. The direct relationship between smallholders and

Greenfields contains balancing elements, while the main business model benefits Greenfields more

than smallholders. The state’s participation via funding, policy and infrastructure is not clear in this

example, and the Greenfield’s model does not rely on direct government support, while returning

benefits to the public.

Smallholder farmers (farm inputs)

Milk Collection Points (Greenfields managed)

Greenfields Many local farms now supply forage and other inputs to Greenfields, and so are increasingly reliant on success of a single farm.

Some farmers sell to MCPs, and onto Greenfields, but not through KUD. Resulting in no extension training or collective bargaining power to farmers.

Smallholder farmers (milk)

Greenfields processes its own milk

Retail and export markets

Processors: Nestlé, Indolakto, Real Good

Greenfields sells local farmers’ milk to other processors, but without any extension support to improve quality.

20 | P a g e

Figure 8. Greenfields relationship model

5.2.4 PT Cimory - West Java

Commercial and Relationship Analysis

PT Cisarua Mountain Dairy (or Cimory) was established in Bogor, West Java in 2004 and buys raw milk

from 20 KUDs; including KUD Giri Tani and KPS Bogor, with whom the IndoDairy project collaborates,

as well as KUDs in East Java. Their products include pasteurised milk derivatives such as yoghurt

drinks, yoghurt sets and cheese. Cimory has the second highest production nationally behind

Greenfields and also sells locally and internationally. A portion of their input supply comes from imported

reconstituted milk powder, as well as local fresh milk. Their target is to become the highest producer

within three years and to start using cheaper transportation for their operations. Cimory has a strong

and unique marketing strategy that sees them employ female sales agents often called ‘Miss Cimory’

who implement door-to-door sales methods to increase sales of their range of products. This method is

the traditional mode of marketing in Indonesia. Their products are also sold through a range of retail

pathways such as supermarkets, mini markets, and direct retail outlets.

Website: https://cimory.com/

Operating Principles

Cimory acknowledge that smallholder farmers are crucial to their business model due to the reliance on

them for the majority of their milk supply. Farmers’ produce is reached via cooperatives and paid based

on the quality of their milk. Despite the importance of these farmers to their operations, Cimory has

invested minimally in smallholders by establishing a 150-cow model farm in Ciawi and investing in

cooling tanks at KUDs, although this farm is only accessible to farmers who are directly linked to it and

they are not necessarily the farmers supplying the KUDs Cimory buys from. Due to the very low levels

of investments in farmers and the focus on buying the highest quality milk for the lowest price, farmers

Public

Green- fields

Small- holder

farmers

Benefits:

• Access to training for improved animal health

• Ability to provide feed inputs to Greenfields

Benefits:

• Dominant role in region;

• Can secure input supply,

• Can on-sell farmers’ milk production, with margin

Strong corporate returns to national economy

• Import reduction • Improved food

security

Support:

• Limited direct state support for farmers beyond existing KUD structure

21 | P a g e

are not obliged to supply KUDs that supply Cimory. This makes the constant supply of milk a major

challenge for Cimory as KUDs are always looking forward to selling to the highest bidder.

Description of model

Cimory potentially has two models, one of which invests in cooling tanks and buys from KUDs, the other

is vertically-integrated model and sees the development of their model farms and the subsequent

development of more farms.

Investment in cooling tanks and purchase from KUDs

In this model, farmers supply to KUDs and Cimory purchases from different KUDs in West Java. Cimory

deals with smallholder farmers from different cooperatives. Cimory purchases 250 tonnes of milk per

week from these cooperatives in West Java. The cooperatives place a 20 percent margin on the price

of the milk before selling to Cimory, and the price offered to cooperatives is based on the quality of the

milk they receive. Milk samples with less than 1.0million Total Plate Count (TPC) – a measure of

bacterial contamination – get as much as a 13 percent price premium (paid to the KUD), thus the lower

the TPC, the higher the price. Milk with less than 1.0m TPC is used for fresh milk production while that

which has more than 1.0m is processed into yoghurt. Thirty percent of the milk is processed as fresh

milk while 70 percent is used in the production of yoghurt. On arrival at the MCPs, milk is weighed,

tested and chilled. To retain the milk’s quality, PT Cimory has invested in the procurement and

installation of cooling tanks at the various KUDs from whom it purchases.

This investment, however, favours Cimory and does not benefit the smallholders directly, although

Cimory does pay farmers (via KUDs) a slightly higher price for milk than other models (IDR5,200/L

compared with IDR4,550/L by KPBS Pangalengan and IDR 4,100/L by KPS Bogor (all for <1.0M TPC).

This model helps smallholder farmers to sustain their livelihoods and is somewhat inclusive, but does

not necessarily prioritise them as major stakeholders in the value chain.

We note also that Cimory implement a practice where imported reconstituted dairy product is

reprocessed and marketed as a fresh milk product. This practice is not currently regulated by any

national government policy covering branding and consumer protection, which in turn leaves

smallholders exposed, as this works against their interests. Improved national policy in this area will

help to strengthen the market position for smallholders, and increase the competitiveness of their

product in a globalised market.

Development of a model (‘demo’) farm

Smallholders are fundamental to PT Cimory’s growth as their procurement methods may not be

appealing to big companies. This has spurred investments in the establishment of a farm with 150 cows

to serve as a model farm for farmers. For the farm to run successfully, a partnership has been

established with the Forestry Department to sustainably provide forage for the farm by thinning trees

instead of clear felling, allowing the growth of grass for silage within the forested areas. A drawback of

this model is that many farmers who supply the KUDs, from whom they purchase milk, do not have

access to the farm, therefore limiting the reach and impacts of the farm.

PT Cimory has plans for two more farms in West and Central Java with herds of 500-1,000. These cows

will have an average production of 15-20 litres per cow per day. This investment will most likely reduce

Cimory’s reliance on smallholder milk.

22 | P a g e

Figure 9. Value chain map for PT Cimory in West Java

Relationship model

Although the relationship established from Cimory’s operating model is beneficial, measures can be put

in place to make it even more efficient. Cimory and smallholder farmers face risks in this relationship

model as the price smallholders receive and the availability of milk for Cimory is never assured. Cimory’s

investment in model farms benefits the farmers who are fortunate to be able to access it, although these

farmers are a fraction of those involved in its supply chain. This translates to a partially balanced

relationship between smallholder farmers and Cimory. As is typical in Indonesia, the government plays

no direct significant role in the value chain except for regulation and monitoring of KUDs.

KUD Giri Tani

KPS Bogor

Many farmers sell milk to KUDs who sell to Cimory.

Smallholder farmers (milk)

Cimory

Cimory medium-size model farm- Ciawi

Cimory medium-sized ‘model farms’ supply smallholder extension to improve the milk supply of farmers trading with Cimory, rather than targeting the broad KUD membership.

Retail and export markets

Limited investment by Cimory back to KUDs or farmers for productivity improvements, other than model farms below.

Smallholder farmers (milk)

Individual Large scale dairy farms (milk)

23 | P a g e

Figure 10. Cimory relationship model

From the above, we conclude that Cimory’s model is partially beneficial and requires modification for

full inclusiveness of smallholders.

5.2.5 KPBS Pangalengan - West Java

Commercial and Relationship Analysis

KPBS Pangalengan was established in 1969 for smallholder dairy farmers and with current membership

exceeding 2,500, KPBS is considered one of the more successful dairy cooperatives in Indonesia.

KPBS operates seven digitally automated MCPs to drive a responsive testing and pricing protocol for

their suppliers and higher quality milk for their buyers. The KPBS fleet of 19 milk collection trucks also

improves farmers’ access to the collection network. Besides supplying fresh milk to PT Friesian Flag

Indonesia (FFI) and other processors, KPBS is also involved in the production of about 18 dairy

products.

Operating principles

The KPBS cooperative operates a beneficial business relationship with their smallholder dairy farmers

to broker low cost credit for equipment updates and to continuously grow their competencies for higher

quality milk supply. KPBS access to both public and private fund streams positions it as a driver of

innovation for smallholder dairies. KPBS is supported by Dutch government aid via FFI - an Indonesian

subsidiary of a Dutch multinational company, FrieslandCampina, to train dairy farmers. FFI continuously

invests in smallholder farmers meeting standards for milk quality and provides farmers with access to

extensionists, a dairy extension manual and trains KUD staff. Cooperation among smallholders,

cooperatives and FFI has occurred for more than 20 years, with FFI’s commitment to smallholder

dairying further consolidated through its MoU signed in 2018 with KPBS and other cooperatives in West

Java. The following activities were included:

State

CimorySmall-holder

farmers

Partially balanced relationship focus on commercial strength by vertically linking model farms with processor

Some state role in KUD accreditation and monitoring, but no direct support

Strong corporate returns to national economy • Import reduction • Export opportunity • Poverty reduction

Benefits: • Access to training

and extension through KUDs and model farm

• Improved livelihoods

Benefits: • Improved supply

quality • Improved

productivity and profits

• Increased market share

24 | P a g e

• sharing knowledge and experience among farmers in Indonesia and in the Netherlands;

• an academy promoting networking among young farmers;

• machinery for automating MCPs;

• a dairying radio program for communication among farmers, the extension service and cooperatives; and

• a dairy village to demonstrate sustainable dairying with cutting-edge technology. Despite the long-term positive relationship between FFI and KPBS Pangalengan, the latter is still

perceived as inefficient rather than a cutting-edge enterprise. The above activities covered in the MOU

largely parallel those of PERPAMI and stimulation of synergies between such like-minded initiatives is

recommended for maximum benefit to the broader rural community. The commercial dairy industry has

often invested in smallholders for philanthropic reasons related more to global public good than to profit.

These contributions, and those of aid programs of developed countries, have dramatically augmented

access to modern technologies for dairying beyond the advances resulting from Indonesian public

investment. The elements for innovation seem to be in place, but often the dynamism engendered by

R&D projects finishes with the project and stagnation seems pervasive, for example as referred to above

with the long-term collaboration between FFI and KPBS Pangalengan.

Description of model

KPBS model focuses on providing extension, finance and ready markets for smallholder dairy farmers.

This has led to an increase in productivity and profitability of their farmer members. KPBS operations

are digital to ensure farmers receive a fair and transparent payment for their produce and the method

of milk collection is flexible and closer to farmers. Through FFI, KPBS is able to invest in farmer training.

Rather than using model farms, FFI deploys extension workers and extension materials to the farmers,

which has led to a high adherence by farmers as they have one-on-one sessions with extension agents

who can help to solve issues unique to them. The provision of inputs such as concentrates and water,

coupled with the extension services, helps to achieve regularity among the members, while the provision

of low-cost finance leaves no farmer lacking basic equipment for production. This inclusive business

model spurs farmers to be active decision-makers but can encourage the reliance on foreign

government for development. KPBS does, however, have the ability to supply their processors and

produce milk products effectively using this model.

KPBS Pangalengan pays farmers on a sliding scale based on TPC, the price increasing from IDR4,550

for 800K-1.0M ppm TPC up to IDR5,250/L for < 100K ppm. Using a quality benchmark of <500K ppm,

the KPBS price (IDR4,950/L) is lower than the price paid ny Nestle (IDR5,250/L).

25 | P a g e

Figure 11. Value chain map of KPBS Pangalengan

Relationship Model

An analysis of the KPBS model shows successful balance between smallholders, processors and the

public sector, notwithstanding that the public sector role here is undertaken through foreign funding. All

parties benefit strongly and risks are evenly distributed. The Dutch Government underwrites the

technical development of smallholders and the KUD to deliver a constant supply of high-quality product

to serve the processing industry and local and international trade. This relationship exemplifies the

importance of government in the growth and development of a sector.

17 KPBS MCPs

19 KPBS milk collection trucks

Farmers deliver to a truck or Milk Collection Point (MCP) atruck

Smallholder farmers (milk)

The KPBS-owned processing facility, sells to 2 producers of non-milk products

KPBS processing facility

PT Friesian Flag

PT Ultrajaya

PT Indolakto

Dutch funded

program

PT Friesian Flag participates in a Dutch-funded program for extension training and lab facilities

26 | P a g e

Figure 12. Relationship model for KPBS Pangalengan

5.2.6 Contract farming model

Commercial and Relationship Analysis

Contract farming has existed for more than 100 years and is increasingly deployed by large agricultural

processors and development practitioners due to a high level of smallholder inclusion and the mutual

benefit provided to both buyers and farmers. Often referred to as an ‘’outgrower scheme’’ (Eaton &

Shepherd 2001), it is defined as a contractual arrangement between a farmer and a firm (buyer) (Rehber

2007), whether oral or written, which provides resources and/or specifies one or more conditions of

production, in addition to one or more marketing condition, for an agricultural product, which is non-

transferable.

There are five different models of contract farming (Eaton & Shepherd 2001), but all share the same

basic structure, which usually involves a buyer and the farmer and sometimes intermediaries such as

government bodies acting as regulators or 3rd party companies who help with sourcing and aggregating

of farmers. These models include: the centralised model where the sponsor purchases crops from a

number of smallholder farmers and processes or packages them into marketable products and are

heavily involved in production where they often take control of most production aspects; the nucleus

estate model is a variation of the centralised model where the sponsor manages a plantation or central

estate; the multipartite model usually involves statutory bodies and private companies jointly

participating with farmers; the informal model applies to individual entrepreneurs who make simple

informal production contracts with farmers on a seasonal basis and whose crops usually require a

minimal amount of processing, with material inputs often restricted to seed and fertiliser provision; and

the intermediary model which is very common in Southeast Asia and where large food processors

Public

Processors Small-holder

farmers

Benefits:

• Farmers receive extension support to improve quality of milk, and individual farm yields;

• Higher incomes and profitability.

Benefits:

• Consistent supply of satisfactory quality raw milk;

• Reliability in supply chain while external funding is maintained.

Benefits:

• Strong tax receipts;

• Reduced reliance on import;

• Improved domestic food security

Support:

• Strong public support for KUD model where funding program underpins extension support

27 | P a g e

enter into contracts with collectors or farmer committees and cooperatives who have informal

arrangements with farmers to source crops for them.

The success of a contract farming model, where benefits are shared by both buyer and seller, is

conditional on adequate levels of protection for the buyer in the contract. These levels of protection

(such as equitable price, price rises over time, reasonable payment terms, and the absence of any

coercive conditions in the contract) are generally only secured if the weaker party (seller) is well

represented in contract negotiations. As a result, in jurisdictions where contracts are not supported by

legal structures, or there is little recourse for dispute, the system can be weakened. Where contracts

are mediated by a third party (government, or an impartial regulator) the contract model will be more

beneficial to the seller.

The intent of the contract model is to provide certainty for both parties - certainty of price, and ability to

negotiate terms for the seller, and certainty of volume and security of supply for the buyer. Where

successful, this leads to more secure longer-term arrangements, enabling farmers to reinvest profits

back into their production, and therefore improving their livelihood over time. The longer-term nature of

a contract agreement removes the risk of trading on ‘spot-markets’ while potentially lowering the

maximum price obtained for their product. However, there is a risk for farmers if the buyer is not

challenged by other buyers in the market, creating a monopoly market, in which case buyers have a

greater ability to set the prices, and push down farmers’ profits. This risk cannot be mitigated in the form

of contract, as it is a function of the market conditions in which the trade occurs.

For buyers searching for the lowest priced inputs into their supply chain, there is a commercial

advantage to processor in ensuring the price is pushed so low that it precludes a profit opportunity for

the farmers, enabling reinvestment in quality and consistency in product. A buyer that offers a price

including reasonable profit, is investing in the longer-term sustainability and quality of their supply chain.

As noted above, the risk remains that the buyer assesses its financial benefits over the shorter rather

than the longer term, pulling down the value of the smallholder network with their own business.

In the following, we briefly reference an example of contract farming in Bali.

PT Pertani in Bali

An Indonesian example of a contract model is PT Pertani, a government owned agribusiness in

Indonesia, which is in contract with 300 smallholder rice farmers in Bali for seed rice production. This

model is based on the multi-partite contract model described above. PT Pertani produces certified seeds

for smallholders. Their mission is to produce and deliver competitive agribusiness support to the

agricultural sector in Indonesia. This has driven PT Pertani to be inclusive in most of their activities.

28 | P a g e

Figure 33. Value chain map of PT Pertani (contract farming model)

Operating Principles

PT Pertani enters into contracts with farmers via Pekasehs who represents a group of about 50 farmers.

Pekasehs are in charge of irrigation areas and represent the interest of smallholder farmers in those

areas. These Pekasehs negotiate with PT Pertani on general contract terms such as desired planting

area, price, volume, and the supply of inputs for the planting season, etc. They make almost all of the

technical and important decisions such as cropping areas for seed rice and consumption rice, and leave

the minor production decisions to smallholder farmers. PT Pertani does not make direct contracts with

farmers throughout this season, they do, however, recruit and send extension agents to monitor the

production activities of farmers to ensure that quality and quantity requirements are met. In this model,

the government of Indonesia is involved by providing input and extension services. PT Pertani

aggregates these farmers and performs the due diligence needed to make these farmers eligible to

access these inputs.

In this contract, PT Pertani provides smallholder farmers with foundation seeds and extension advice

while farmers are obligated to remit at least 75 percent of their production to PT Pertani. The remaining

25 percent of rice produced may be used by the farmer for their own use. Deflection on the farmers’

end via selling a portion of the seed production to other markets is forbidden. Payments for the produce

are made in cash to the Pekaseh who then remits the money to farmers. Prior to 2001, no advances of

farm inputs or cash were paid to the farmers. This changed in 2001 due to the introduction of a policy

instrument by the Indonesian Government, which granted farmers access to funding for farm input from

Bank Mandiri. Through this policy, PT Pertani accessed the funds and procures inputs which are

advanced to farmers through the Pekaseh.

Farmers in this contract also receive four visits during the growing season from extension officers

contracted by PT Pertani to undertake monitory and advisory roles. These extension workers ensure

that the rice produced meets the standards of PT Pertani. Rice that does not meet the quality standards

can be sold for consumption, but not as seeds, by the farmers.

Smallholder farmers

PT Pertani Market

State

PT Pertani supports and implements extension training, access to finance, logistics to farmers.

PT Pertani is a state-owned enterprise (SOE)

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Figure 44. PT Pertani (contract farming) relationship model

6.0 Gap analysis - IBM models in East Java compared with KPS Bogor, West

Java

6.1 Model comparison

In undertaking a gap analysis between the key operating models from East Java, and KPS Bogor in

West Java, we compare the triangular relationships and the lists of relative benefits. The diagrammatic

analyses are separated below with the benefits tabulated, along with the two key variables: the role of

public institutions, and power balance with private operators.

PT Nestlé, PT Cimory (two operating models), KPBS Pangalengan and a contract farming model are

used for this comparison.

Exclusion of Greenfields from gap analysis

We have excluded the vertically integrated PT Greenfields model despite the commercial success of its

operations, as we do not believe it represents a viable inclusive farming model. The key reasons for this

are that although a large number of localised smallholder farmers are involved in the supply of raw

produce (mainly silage ingredients) to Greenfields, this is not equitable on several levels. First, the

livelihoods of these smallholders who supply silage are now dependent on the success of a single buyer

for raw product. If Greenfields were to suddenly go out of business, or change its business model (e.g.

find alternative input supplies, such as importing feed), then a large number of smallholders would

immediately be driven out of business themselves, with no easy path back to farming the dairy cattle

that they were used to farming, prior to supply Greenfields. In comparison, Nestlé would be unlikely to

suddenly find a new supply chain of milk, and if they were to go out of business rapidly in East Java, it

is likely that another processor would step in to fill that void. This is less likely in the export driven,

Strong corporate returns to national economy

• Profitable SOE

• Security of rice seed production

• Secure and growing smallholder farmers

Indirect state support to small-holders through contract farming arrangement.

Benefits:

• Improved supply quality

• Improved productivity and profits

• Increased market share

Benefits:

• Access to finance

• Access to training and extension

• Improved productivity

• Improved livelihoods

Balanced relationship

State

PT PertaniSmallholder

farmers

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vertically integrated Greenfields model. Second, where Nestlé has accepted the commercial risk of

providing lines of credit to smallholders with the explicit aim of increasing the farmers production,

Greenfields have not committed to improving the productivity of existing dairy farmers, or even those

that shifted their activities to supplying forage to Greenfields. The relationship between Greenfields and

their adjacent farmers is therefore not as interdependent as we see in the Nestlé model.

While this is a viable, commercial business model, our specific focus here is to investigate models that

bring a livelihood benefit to both smallholders as well as a commercial benefit to the larger corporate

entities. The Greenfields model therefore does not meet these criteria, and thus we exclude the model

as a potential for application to West Java.

To understand the variables at play, we noted above that to develop a robust framework that supports

the growth and development of smallholder farmers, it is important to acknowledge that they are a

fundamental and critical part of the dairy industry supply chain, and this framework must assist farmers

to supply milk at a minimum quality and consistency of volume that benefits the processors. Without a

consistent and quality milk supply, processors cannot invest in their own growth and commercial

development. However, the capacity for smallholder farmers to invest in their own productivity is limited

due to a number of external factors (which affect smallholder farmers worldwide). These include a lack

of education, a lack of access (by price or knowledge or both) to new technologies and practices, poor

access to quality inputs, and poor infrastructure to deliver their product to processors.

This gap in knowledge, infrastructure and access to technology is a fundamental weakness in

agricultural value chains.

As we identify above, there are several models where this gap is being filled, and as noted, it is being

filled by either the corporate sector (processors) or by government, or a combination of both. Without

external investment in the supply chain infrastructure, input supply or knowledge for farmers, local value

chains are weak, as in the farming communities around Bogor. This is highlighted in the graphic below

which illustrates that the state has little role, and the processors hold an unbalanced position with

respect to farmers.

Our thesis is that without an increased investment by government or by the corporate sector, the

opportunity for the smallholder farmer sector to grow is limited. The analysis below identifies investment

to strengthen the role of smallholders, the benefits from such investment, and the conditions required

to further encourage the growth of production capacity in the smallholder sector in the Bogor area.

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Table 2. Summary of each case study, including key elements, and listed benefits

Model Role of public institutions

Power balance

External investment from

Benefits/consequences for farmers

Benefits/risks to processing companies

Economic benefits

Comparative milk prices paid to farmers (IDR / L)1

Commercial benefits

KPS Bogor Weak In favour of processors

None

• Very limited access to finance or training and extension

• Diminished marketing power

• KUD is in weakened position in market for pricing influence

• Dominant role in value chain;

• Price-setters for local seller

Risks:

• No investment in supply chain- cannot control quality or volume.

• Some tax revenue benefit, but commercial risks weaken market position for export growth/ or food security improvements;

• Little contribution to poverty reduction

4,100 – 5,300 (>1.0M ppm - < 500ppm)

• Nil

KPBS Pangalengan

Strong public role

Balanced Public sector (bilateral aid)

• Access to finance

• Access to training and extension

• Improved productivity

• Improved livelihoods

• Limited financial exposure (risk carried by Dutch government program)

• Improved supply quality

• Improved productivity and profits

• Increased market share

• Strong corporate returns to national economy

• Import reduction

• Export opportunity

• Poverty reduction

4,950 • Improved quality and consistency of supply to participating processors, at no commercial risk to processors until funding program ends;

PT Nestlé Minimal public role- private sector driven

Balanced Private sector (Nestlé)

• Access to finance

• Access to training and extension

• Improved productivity

• Improved livelihoods

• Improved supply quality

• Improved productivity and profits

• Increased market share

• Strong corporate returns to national economy

• Import reduction

• Export opportunity

• Poverty reduction

5,250 • Improved quality and consistency of supply to Nestlé, improved profits and security of supply chain;

• However, includes a corresponding financial implication to Nestlé;

PT Cimory- model farm

Minimal public role-

Private sector (Cimory)

• Some access to extension advice to farmers, but limited associated with model farm;

• Improved control of quality of supply inputs;

• Some opportunity for scaling, however it is limited, therefore broader economic

5,200 (>1.0M TPC count)

• Improved quality and consistency of supply to Cimory, improved profits

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Model Role of public institutions

Power balance

External investment from

Benefits/consequences for farmers

Benefits/risks to processing companies

Economic benefits

Comparative milk prices paid to farmers (IDR / L)1

Commercial benefits

private sector driven

• Improved productivity and profits

• Increased market share

returns are limited.

and security of supply chain;

• However, includes a corresponding financial implication cost on farm set up;

PT Cimory- extension and support

Minimal public role- private sector driven

Private sector (Cimory)

• Some access to extension advice to famers, but limited, and not coordinated broadly to improve yields of more famers;

• Some improved supply quality, although extent is limited as scope of investment in extension appears to be limited;

• Some limited returns but not extensive enough to represent opportunity for broader returns;

• Likely some but limited improvement of quality, without broader investment across all farmer groups;

Generic Contract farming

Public role varies- can be critical in regulatory protection of sellers.

Varies • Security of contract for product;

• However, security is sometimes at cost of higher prices;

• Ability to negotiate with open market and other buyers;

• Security of supply quantities and quality;

• Security of price;

• Some cost implications in providing technical assistance, however cost is contained and amortised across all participants

• Strong corporate returns to national economy

• Import reduction

• Export opportunity

• Poverty reduction

NA • Secure return of profits and profitability to both buyers and sellers, improved livelihoods for famers;

• strong ability for buyers to control supply chain and maximise profitability and expand scale.

PT Greenfields

5,050- 5,255

1.0 Prices vary according to milk quality, prices quoted here are for a median grade based on Total Plate Count (TPC), of around 500ppm.

Note: PT Greenfields is included only for comparison of milk prices paid to farmers (farm-gate).

33 | P a g e

Analysis

Underpinning successful value chains are inclusive business models that invest in the less powerful

actors in the value chain, building their skills, power and value, rather than providing cash injections.

Interviewees from each of the successful case histories stressed the importance of focusing on

productivity gains, as opposed to increasing herd numbers.

In the successful case studies (PT Nestlé, Cimory, KPBS Pangelangan), relationships among the public

sector (bilateral funding programs, support for KUDs), corporate sector (processors) and smallholders

vary. The following analysis and application of these models to the KUD in Bogor identifies the key

requirements in these relationships to develop viable models of supply that support the smallholder

sector.

The gap analysis above provides a framework to apply these key requirements to an existing production

sector, and enables definition of a broader strategy to stimulate growth in a particular geographic region.

This strategy also delivers a template to best leverage the value of smallholder farmers in new regions

for dairying.

The strategy recognises the need for a fundamental relationship between the public sector, private

commercial sector and the smallholder sector. This relationship requires public investment to establish

and form the infrastructure fundamentals, while also mapping out an exit for public investment, shifting

the risk for industry growth to both the smallholder sector and commercial processors. This stage of the

strategy relies on the value of the interdependent relationship between processors and their key supply

chain for raw milk.

Private sector investment – PT Nestlé

Nestlé commenced operating in East Java in 1975 and has developed a long-term position in the market

and strong relationships with local smallholder farmers. Globally, Nestlé focusses on developing their

upstream supply chains, again taking a long-term view of not only their own inputs, but also of the

resilience of the suppliers. This inclusive approach to their supply chain is integrated into their

commercial strategy, and forms a fundamental part of how they do business.

Therefore, it is no accident that the farmers and cooperatives that Nestlé draw from have benefited from

the business models that Nestlé apply to their supply chains, nor is it implicit in the supply chains of all

dairy processors. Indeed, we do not see the same deep integration of this model in any processors in

Java. We can therefore conclude that the private sector will not automatically make the investments

required to build up the smallholder farm capacities, even if there is a viable long-term commercial

strategy to do so. While there are commercial benefits to making investments in inclusive business

models in their supply chains, it is impractical to build a strategy on the assumption that market drivers

will open up these investment decisions. This is particularly the case where the dairy supply is more

developed than when Nestlé first began their engagements with suppliers.

With respect to a pathway for private sector investment in input supply chains, a partnership model is

more likely to gain traction with the private sector, where a component of the risk is removed from the

investment. The Nestlé model also suggests that with the right commercial strategy, the private sector

can be encouraged to make long-term commitments to the supply chain to ensure their supplies of

inputs. The key lesson from the Nestlé model, is that the governance structures of these investments

need to be prepared in a way, which, on building on inclusive business principles, ensures value is

retained by the farmers, and the relationship with the farmers is balanced and benefits both parties.

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These measures are more easily implemented and monitored in the establishment of the programs, if

the establishment is publicly funded.

Private sector investment – PT Cimory

PT Cimory’s model farms target strengthening the company’s role in the value chain, rather than uplifting

smallholders. By contrast, when Nestlé invests in equipment, extension training, or productivity gains

(even if under financing models), they are placing their capital at risk in the assets over which they have

no control. Therefore, they are investing in the improvement of downstream assets in the value chain,

not their own assets. This is an important distinction, as it demonstrates a commitment to the whole

value chain, not just their component.

We do not need to expect that the private sector will take on the role played by the Dutch Government,

and there is no need to test the sustainability of this partnership model. Rather, empirical evidence is

needed to demonstrate that the partnership is successful, so it should be continued, and the Indonesian

Government should then take over the role of the Dutch Government.

Joint public/private sector investment – KPBS Pangalengan

Investment in the KUD Milk Collection Point and establishment of pricing structures, is driven by the

Dutch Government aid program. In this case, the core commercial risk is not carried in the first instance

by the private sector investors (Ultrajaya and Friesian Flag) as the lending structure will be underwritten

by the program funding. This analysis reinforces the argument above that it is unlikely the private sector

will risk investment in the input supply chains, unless the risk is underwritten by another source. In

addition, it is unclear whether the private companies would continue their involvement in the KPBS

scheme if the Dutch Government’s funding ceased. We were not able to test this question with either

Ultrajaya or Friesian Flag. We assert that without underwriting and investment by government and/or

industry, dairying is not competitive in lowland tropical areas of the world such as in Indonesia. Even

with environmental conditions more suitable for dairying in Kenya, Rwanda, Tanzania and Uganda,

major long-term and ongoing investments from the Bill and Melinda Gates Foundation through the East

Africa Dairy Development initiative have been pivotal to underpinning the smallholder dairy sector there.

This sustained investment through KPBS Pangalengan, has lifted milk quality standards for a broad

community of smallholders, to a significant degree but not yet to the exacting standards that PT

Greenfields, for example, apply to their own milk production on their corporate farms. This illustrates

there are potential benefits to livelihoods to be gained through KPBS raising the bar even further on

milk quality. At the same time, it appears that the success of technical innovation in improving raw milk

quality was not matched in parallel to developing the business acumen and entrepreneurship of the

KUD and its members. Similarly, adaptive management is also proving an ongoing challenge for dairy

cooperatives in East Africa. A stronger emphasis on targeting more efficient business practice in KPBS

Pangalengan is necessary to sustain uplift of the KUD and its members.

KPS Bogor

Paradoxically, the proximity to large centres of population has not translated to economic gain and

positive business experience for KPS Bogor. The salient difference between KPS Bogor and KPBS

Pangalengan is that the latter has benefited from unbroken flows of Dutch aid via FFI, while the former

has struggled to operate on funding based significantly on membership fees.

In addition to the strengths of the Nestlé, Cimory and KPBS Pangalengan models, we note that the

value chain in Bogor has poor infrastructure (transport linkages, trucking, etc.), as well as poor quality

milk collection facilities with inadequate chilling units, little or no testing facilities, little extension work,

35 | P a g e

and significant problems with forage supply. Many of these issues are experienced in other parts of the

province, including issues with forage availability that is common with farmers who supply Nestlé;

however, with no direct connection to public or private sector investment in the value chain, these

problems exacerbate or perhaps define the underlying weakness of local dairy farming.

It is recommended that a disciplined and audited “rescue package” for under-performing KUDs be

explored, building on the experience of revitalising dairying value chains for smallholders after the

Merapi eruption (Sembada et al. 2019) and using KPS Bogor for pilot implementation. The intervention

described by Sembada et al. (2019) achieved more than restoring dairying to the status quo from before

the disaster in Merapi, as is often achieved by initiatives that target disruption from natural disasters.

Significantly, among improvements and innovations, the intervention catalysed new and improved

business relationships. The social factors in remediation after a specific natural disaster will vary from

and perhaps prove easier than for revitalising a business that has slowly languished in under-

investment. It is suggested that KPS Bogor draft a new and more compelling business plan to re-open

trade with small processors, like Susu Mbok Dharmi, that lost confidence in supply from KPS Bogor.

The potential for a mutually beneficial association between PERPAMI and KPS Bogor merits critical

examination, particularly with respect to engaging youth from KPS Bogor households in decision-

making. The proximity to the national capital is also a compelling reason to reposition KPS Bogor as a

dynamic cooperative that deploys cutting-edge technology and inclusive business models.

6.2 Impacts on and benefits to smallholder farmers

The main theme of this report is to identify more effective business models to benefit smallholder

farmers, as well as improving engagement for women and younger generations in the agricultural supply

chain. To this end, we will set out the logic for supporting inclusive business models in the economy,

and analyse the examples described above for their direct benefit to smallholder farmers.

As noted, the Nestlé, Cimory and KPBS Pangalengan models deliver, to varying degrees, direct benefits

to smallholder farmers through Nestlé and Cimory’s focus on improving their supply inputs, and through

the KPBS working with farmers on better quality milk to increase payments from processors.

In all examples, we see that the benefits accruing to farmers originate from a ‘whole of supply chain

approach’, focused on quality of product. That is, in these cases, the driver for improvements to milk

quality supply lie in securing better quality milk production facilities upstream for farmers. Investment in

smallholder capacity results in a chain of higher quality and greater consistency and delivers higher,

more consistent volumes. These factors are critical to processors, as their profitability relies on their

quality of supply, leading to stronger corporate businesses, improved domestic food security, and the

potential for increased exports and therefore national level tax receipts. We have also shown through

the Nestlé, Cimory and Pangalengan models that the smallholder farmers also benefit through improved

productivity, security of sales and better livelihoods.

However, this approach can be compared with a corporate model of production, such as Greenfields

whose production is not reliant on the capacity of existing smallholder dairy producers in the region. The

Greenfields model is not intended to directly support smallholder farmers, and indeed the development

of these large-scale enterprises can have a direct and positive impact on the local population through

the creation of jobs, supply of inputs such as feed, and the introduction and dissemination of new

farming technologies and skills, some of which are passed on directly to farmers in the immediate area.

Over the longer term, as the industry and economy develops, there is also potential for these larger-

scale enterprises to offer profit sharing and equity ownership to employees, both of which represent

36 | P a g e

inclusive approaches to industry development. Greenfields also support the local smallholder network

beyond their main product line of fresh milk, but purchasing the lower quality product from local farms,

and using this in the processed product range, further strengthens their position in the area.

From a national economic perspective, the corporate Greenfields model still delivers strong business

potential and valuable tax receipts, and therefore benefits the national government. The two approaches

to farming and milk supply, smallholder and large-scale production are complementary and necessary

for the resilience of the industry more broadly.

The theory of inclusive business approaches is based on the principle that there is significant broader

economic benefit in using the productive capacity of smallholder farmers, particularly in developing

economies, as this scale of production is widespread throughout developing economies. Wealthier

smallholders across a rural economy mean greater spending power in the economy of a significant

proportion of the population. Therefore, to strengthen these individual producers in aggregate is to

strengthen the economy as a whole, as well as to strengthen the agricultural sector, which underpins

the growth of national wealth in emerging economies.

So, to explore the principle of inclusive business models in dairying is to determine the best models for

strengthening the role of smallholders, and the best policies that underpin these models in the broader

economy. Evidence from many agricultural sectors globally shows significant benefits from broadening

participation in decision-making beyond the traditional senior male of the household.

Effective inclusive models

The table above includes existing models that are effective in supporting smallholder supply chains and

the field work identified a number of emerging business models with innovative approaches to small-

scale businesses and improved smallholder engagement.

These include the three noted above: Nestlé, Cimory and KPBS Pangalengan; small business

enterprises, such as Susu Mbok Darmi; and, the young dairy farmers’ association, PERPAMI. All of

these examples can provide a foundation point for a number of new models for business in the dairy

sector.

However, the secondary theme we have explored in this report, is that these business activities rarely

succeed in a policy vacuum. We note that the Nestlé example is one where a corporate entity has taken

various commercial and financial risks with their smallholder supply chain for the benefit of the

smallholders. It is likely, though, that the driver for Nestlé over the time of these investments was not

specifically to benefit the smallholders (although there is clearly an understanding that secure farmers

benefits the business), but was principally to improve the security of the company’s supply chain. With

a more secure supply chain, Nestlé can deliver the value-added products downstream, with reliable

input costs and quality. Thus, the driver for Nestlé (and Cimory), is a commercial one, which is part of

the global multi-national’s corporate philosophy. In contrast, Indolakto, Freisian Flag and Greenfields

do not appear to share the same philosophy, as they have not taken the same commercial approach to

their supply chains.

Market forces and corporate common sense will not catalyse increased support for smallholders nor the

growth of inclusive business models in the farm sector. A resilient smallholder network requires a strong

policy framework to support for extension, small business and financial management training,

entrepreneurial business ideas, investment in supply chain infrastructure such as a network of fully

capable MCPs, and innovative loan and finance schemes for farmers to make capital investments in

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productivity. Some regulatory instruments may need to be applied over the short-term such as minimum

quality standards for milk handling and production, and pricing mechanisms to establish better trading

systems for quality control.

Strong markets result from the right balance between statutory and regulatory controls, some early

stage government investment, and freedom of market opportunity for commercial enterprises to explore

their own approaches to increasing productivity. The analysis of the relationships between the corporate

players, smallholders and the state noted in the diagrams above, indicate that at present this balance

has not been struck to achieve the best commercial outcomes for the sector.

State and private sector inputs

Having identified that policy reform is required to underpin support for inclusive business models, we

consider the elements of the models explored to be developed and supported. The following section

describes what elements should be included to establish an effective balance between these

components, if specific areas of West Java or elsewhere were “clean slates” on which to develop viable

dairy sectors. We close with recommendations that can contribute to this outcome.

6.3 Framework for an inclusive and commercially viable dairy sector

As noted, to develop a strong, reliable dairy sector, input is required from the state in two areas: policy

reform to create a number of regulatory controls and initial, early stage investment and financing of

industry infrastructure, and ongoing extension support. These inputs can then form the basis for

improved supply chain arrangements between processors and farmers, based on the models

discussed.

Taken together these inputs and arrangements are a benchmark for expanding dairy production in

existing areas such as West Java or to establish new areas of production such as in North Sumatra.

Government infrastructure support

In the context of establishing emerging industry sectors, our analysis demonstrates that simple market

forces will not create the initial investment required to accelerate improvements in supply chains.

It is clear that some public investment is required to remove the initial barriers and close fundamental

gaps in the supply chain. These investments will, in turn, encourage the private sector to consider

specific investments and ultimately take over the operations of these initial investments. An example of

this is the establishment of a network of MCPs, which require some capital investment in milk cooling

units, handling equipment, and staff. This initial investment could be a state initiative, but with the

intention of selling the asset to one of more private operators, such as local KUDs to run as profitable

businesses. The establishment of effective MCPs alignewith either processors or the KUDs benefoits

both suppliers and buyers. For the KUDs, supporting the investment of chilling, testing and storage

facilities means the ability to pay higher prices for higher quality milk, while for processors, investing in

milk collection facilities is a mechanism to ensuring quality and consistency in their input milk supply,

which will improve their margins over the longer term. This approach, however, needs regulatory support

to encourage processors to replace importation of milk powder with fresh milk supply and for farmers to

be properly trained in techniques that improve quality and yields of their operations, rather than

increasing the number of cattle.

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In addition to these capital investments, state funds should be directed to ongoing and effective

extension programs covering technical and productivity skills related to dairy farming, as well as small

business and financial management skills, entrepreneurial training, and gender-specific skills training

for women in all areas.

These extension programs can be delivered by a range of providers including KUDs, youth associations

such as PERPAMI, women’s associations and the private sector processors through arrangements

such as model farms, as well as the Department of Agriculture. Regulatory provisions will therefore

need to be in place to ensure that a range of providers are accessed, which are given equitable access

to funding sources in order to deliver on an open and fair basis.

Regulatory frameworks for broader participation and supply quality

In addition to this initial infrastructure investment, it is critical to establish a robust trading mechanism

that creates some commercial separation between suppliers (smallholder farmers/KUDs) and

processors. While the Nestlé model demonstrates a working model without this separation, there

remains a high risk that this relationship can be exploited by the corporate side of the arrangement. We

therefore believe the principles for inclusive business development dictate that separation between

smallholder businesses and processors needs to occur.

This separation should occur at the transaction point, in this case the milk collection point. If the MCPs

are controlled by the processors, the smallholders lose any influence in price negotiation. If the MCPs

are controlled by KUDs to achieve buying power for the smallholders, the transaction is better balanced,

resulting in a fairer means of pricing for the raw supply. A number of competing KUDs supplying to a

number of processors in any single region creates the competitive market place that will improve prices

and maintain quality. This is the underlying goal of establishing inclusive business models.

Some regulatory mechanisms may be required to ensure a fair and competitive point of transaction.

These include:

• Regulations to ensure independence of MCPs from processors; and

• Quality and pricing standards for raw milk supply.

Ongoing government involvement

To ensure an ongoing strengthening and building of inclusive principles in the smallholder network,

there needs to be continued funding for providing effective extension services in all areas of business

and farm management, as well as financing solutions that assist with the continuing growth and

productivity improvements of smallholder farmers.

Currently, KUDs are the vehicle of this service, however the current structure requires that the service

is paid for through the collection of dues through the KUDs, often resulting in under-funded services. As

this extension work serves the supply chain as a whole, it is more practical to fund this work through a

levy on downstream high-value products, which is directed back to smallholder extension work through

an industry fund. This fund would need to be state-controlled to remain independent of both processors

and smallholder networks, but could continue to be channelled through the KUDs as well as other

delivery agents, including farmers associations such as PERPAMI or specifically established women’s

associations to focus skills directly at women in farming families.

The KPBS model shows that extension schemes are extremely effective when delivered through the

KUD structure, when they are well-funded. However, we believe it is critical to ensure a separation

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between the corporate entities, the KUDs and the smallholders to deliver this, and it is the role of

regulation and ongoing funding support to maintain this barrier.

Complementing support through well-funded extension programs and access to finance is critical for

farmers to improve their productivity and profitability.

Various mechanisms exist to assist farmers to access finance. The models explored in this report cover

a number of options, including the provision of credit through commercial transactions, as demonstrated

by the Nestlé model and KPBS Pangalengan model. Credit arrangements can be funded through

government-backed guarantees for lending organisations or purchasers of supply (either processors

milk distribution agencies, or KUDs), or as low-cost, no-deposit loans through a government-backed

credit agency.

Ongoing government support for an emerging dairy sector should include:

• Funding programs for extension services and business skills training;

• Support for a range of delivery vehicles for extension services, including youth and gender

specific agencies that can target women and youth in business; and

• A range of finance tools to increase access to otherwise inaccessible loan structures for

smallholder farmers, including government guarantees for transaction lenders or government-

backed loans for credit providers.

• Optimal/adequate import policy (not only on milk and dairy products but also policy on heifer

importation). Milk and dairy product import policy must be able to guarantee the fulfilment of milk

needs by processors (IPS) and at the same time IPS voluntarily is willing to absorb fresh milk

produced in the country. This is a necessary condition for the inclusive model of dairy industry

to work successfully.

6.4 Broadening inclusive principles to social inclusion

A broad pre-competitive social coalition for the national dairy industry, with linkage and communication

among the diverse dairy chains and participants, will facilitate effectively deploying the principles of

inclusive business models within chains. Such a network is especially important for a non-traditional

sector such as dairying that lacks the strong cultural underpinnings associated with centuries of

traditional production, for example of rice or aquaculture, in rural communities.

A weakness of existing supply chains, including the successful models of KPBS Pangalengan and

Nestlé, is restricted engagement in smallholder businesses by women and adolescents of the

households. Further efforts to increase the direct participation of women and the younger generation

will strengthen the Indonesian dairy sector. Global evidence shows that increased engagement of

women, particularly in financial administration, improves family livelihoods. From a survey of four

districts in West Java (The Centre for Global Food and Resources 2020a), 97 percent of dairying

households’ primary decision makers were male with an average age of 47 years and 94 percent of

households had a secondary decision-maker, almost exclusively female, with an average age of 41.

While numbers may not be strictly comparable among countries, evidence indicates that female

membership of Indonesian KUDS is much lower than the dairy hubs of East Africa, where the EADD

initiative reports female representation of 30 percent. In India, where emigration of rural males for

employment has led to the “feminisation” of agriculture, women similarly constitute one-third of more

than 16 million farmers in dairy cooperatives (Sharma 2020). By contrast, only 10 percent of KPBS

Pangalengan members are female, partly because membership was limited to one household member

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in 2015 (Wijers, 2019). Other criteria for KPBS membership are that the farmer be 17 or more years

old, have one or more cows and a stable for the cow(s).

A young farmers’ group, PERPAMI, is stimulating engagement of youth around common issues for

young dairy farmers. Many children of farming families leave agriculture for alternative income sources,

with family landholdings remaining the exclusive domain of the older generation. PERPAMI works to

reverse this trend by connecting a younger generation of famers who bring fresh ideas to the sector.

These younger farmers have a strong inclination to learn from each other, and take potentially greater

risks to scale up and grow their businesses. However, as noted throughout this report, growth in

productivity does not necessarily mean bigger herds or scale of farming, but rather changes in practices

to accommodate the requirements of processors and retail buyers.

Where the opportunity exists for younger farmers to connect to extension programs and each other, it

brings a higher degree of interconnectivity within the industry. Organisations such as PERPAMI

demonstrate that the younger generation are more likely than their parents to take up new technologies

and new learnings, and search out new information through the internet and social media.

While this does not provide a solution to the question of how to further broaden access to extension

services, or how to fund them, we can see through improved connectivity that platforms like PERPAMI

can be leveraged as one element within a broader system that provides a community of support for the

dairy industry as a whole, and especially for families of smallholders engaged in dairying.

Public investment is required to deliver skills, knowledge and training to the dairy sector, with groups

like PERPAMI important in catalysing the dissemination process. Such farmer groups, with corporate

support, may eventually approach self-sustainability for funding a framework of ongoing extension, with

minimal dependence on the public sector.

There are a multitude of creative options for stimulating a broadly connected dairy community that

specifically mentors women and youth and disseminates knowledge and extension materials broadly.

We suggest commissioning competitive grants for producing training videos on subjects identified as

key production constraints (and in concert with the training-specific Activity 3.1 of the overarching

IndoDairy project). Along with laboratories and processing plants, model farms can often provide the

stage for such training materials along with a focus on best farm practices. PT Cimory’s model farm

could be accessed on a fee-for-services basis to provide access beyond its current focus on farmers

with whom it has a direct business relationship. PERPAMI activities parallel many of those in the MOU

between FFI and KUDs, suggesting that cross-visits of such groups can be profitable both for

dissemination of knowledge and for building networks. Similarly, international visits (as conducted by

FFI to the Netherlands) stimulate professional development and importantly raise the esteem of young

dairy farmers. Australia, New Zealand and East African countries in the BMGF dairy initiative are

alternative destinations. As well as looking outward, better synergy and connectivity is required at a

local level, for example in West Java where PERPAMI in Bogor interacts more closely with the giant

international conglomerate Fronterra than with FFI in Bandung.

West Java is home to ICARD, PERPAMI, IPB University, PT Cimory that buys raw milk from KPS Bogor

and 19 other KUDs, Susu Mbok Dharmi and other small and agile processors, and a huge consumer

base. KPS Bogor underperforms in this rich, but atomised, dairying landscape and the development of

a KUD rescue package is flagged above and as a formal recommendation in Section 7.0. The proximity

to the national capital strengthens the case for transforming this dysfunctional cooperative into a thriving

one that deploys cutting-edge technology and inclusive business models and provides a powerful

example for cooperative renewal.

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7.0 Conclusions and recommendations

The commercial dairy industry has often invested in smallholders for philanthropic reasons related more

to global public good than to profit. These contributions and those of aid programs of developed

countries and have dramatically augmented access to modern technologies for dairying beyond the

advances resulting from Indonesian public investment alone. The elements for innovation seem to be

in place, but often the dynamism engendered by R&D projects finishes with the project and stagnation

seems pervasive, for example as referred to above with the long-term collaboration between FFI and

KPBS Pangalengan, which is none-the-less deemed to one of the most successful KUDs in Indonesia.

Simultaneously, inclusiveness within value chains must be linked to synergies among value chains.

The proposed strategies highlight the key public investments necessary to underpin dairying in new

regions of Indonesia and where dairying already occurs, as well as detailing the optimal co-investments

by the private sector for long-term sustainable growth and productivity improvements of the industry.

Private sector processors can generate significant returns on investment to support smallholders

through the financing of capital purchases and through ongoing technical support. However, this support

to smallholder farmers is more effective when delivered at a state level, as initial seed investment that

reduces processors’ risks in building supply chains. In general, across all business models, state

involvement should engender balanced and inclusive relationships.

A robust approach to out scale the Indonesian dairy industry for increasing demand requires significant

investment in capital purchases for farmer cooperatives combined with a very strong commitment to

extension. Meeting rigorous minimum quality standards for milk is crucial for long-term economic

benefits for both farmers and industry as well as goals for national production. With an optimal balance

between the interest of smallholders and industry, both parties recognise mutual benefits, as seen in

this study in the business model of Nestlé in East Java. This model also appears to be the most effective

in empowering those at “the bottom of the pyramid”. While corporate investment in the Nestlé case is

effective and develops and strengthens smallholders producing for Nestlé, state investment can deliver

broader returns to smallholder networks, leading to stronger economic returns and more processors to

maintain competition in the market. State investment in extension is a fundamental underpinning of

agricultural economies, including western economies such as Australia, and ongoing investment in

extension is critical to strengthen supply chains. Stronger supply chains benefit processors and

upstream production of value-added goods and more resilient and wealthier smallholders stimulate local

economies through spending.

A government role is fundamental to expanding the productive base of the emerging dairy sector of

Indonesia and to managing its exposure to globalised markets. This report flags highly positive

synergies between private sector investment and the public support base for smallholders. As noted,

since the 1970s, dairy cooperatives have been central to the Indonesian Government’s drive for value

chain improvement (Sulastri & Maharjan 2002; Wijers 2019). However, the successful case studies

demonstrating viable value chains in this report are associated with either commercial investment or

with significant levels of foreign aid. If the government replicates this level of non-governmental

investment in cooperatives, beyond its predominantly administrative focus, success on a broader

national scale will follow. In this context, KPS Bogor provides a test case for the government and specific

recommendations for its rehabilitation follow.

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Recommendations

1.0 Increase state investment in supply chains to strengthen capabilities of smallholder farmers to

deliver a more consistent volume of milk that meets required standards quality.

2.0 Strengthen policy frameworks and funding streams to farmers’ organisations (such as

PERPAMI) and KUDs, to deliver basic extension services and milk handling equipment, above

and beyond those services delivered by typical cost recovery tools such as member subscriptions

for KUDs.

3.0 Encourage and support the Governmet of Indonesia in harmonising contributions to

smallholder dairying via extension from the public sector at the national, provincial and district

levels.

4.0 Introduce more innovative financing models that smallholders can access through corporate

processors (as in the Nestlé model) or through cooperatives or associations.

5.0 Introduce policy structure supported by modest funding streams to farmers’ associations to

deliver business training and financial management to women and youth groups to allow deeper

engagement of these groups into traditional business activities dominated by older males. SMEs

like Susu Mbok Darmi in East Java can stimulate milk processing and retailing activities and

position new dairy products in retail markets.

6.0 Strengthen smallholder access to feed supplies through measures such as rights to use of

public pasture and frameworks for commercial arrangements with larger land holders.

7.0 Strengthen information flows to reduce knowledge asymmetry in supply chains. Also promote

digital-based extension delivery through multiple associations and social media tools.

8.0 Compile an inventory of all services and inputs available to households involved in dairying.

Subsequently, key synergies to be extended should be identified. For example, information on

family nutrition and animal-based products could be an appropriate entry point for raising

awareness of rural women regarding milk quality. ICT tools that primarily target younger

household members can stimulate and support record-keeping and technology adoption for village

dairy enterprises and the co-development of dairy modules with PERPAMI is recommended.

9.0 Research the current and potential roles of women in the dairy sector for maximising their

positive impacts and engagement. It is recommended that PERPAMI be invited to focus on

changes required to address the current gender imbalance in field and on-farm activities for youth

in the dairy sector.

10.0 Deploy climatic metrics among other considerations to investigate areas for potential

expansion of the dairy industry in Indonesia, specifically for minimising the deleterious effects of

high temperatures on dairy production.

11.0 Design an integrated rescue package for under-performing KUDs, building on the experience

of revitalising dairying value chains for smallholders after the Merapi eruption and using KPS

Bogor for pilot implementation.

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