This article first appeared in Forum, digitaledge Weekly, on September 21 - 27, 2015.
MALAYSIA'S cocoa bean sector is on the edge. After a stellar performance in the 1990s, the decline of cocoa cultivation and bean production has been unstoppable. From a peak of 247,000 tonnes of cocoa beans produced in 1990, the figure dropped to a mere 3,000 tonnes in 2014, a reduction of more than 98%. The country fell from fourth place in the world as a cocoa bean supplier in the 1990s, to 28th in 2013.
The sector has undergone a complete commodity cycle. It declined as fast as it grew. Also known as the “boom and bust” phenomenon, this has affected an industry that has overused its carrying capacity.
Is this the end? Is there a room for a reversal? Diagnosing its past may provide clues to the future.
The decline occurred despite the upward trend of prices from the late 1990s and strong fundamentals forecast by the International Cocoa Organisation. By 2020, world demand for cocoa may outstrip supply, which is constrained by problems such as pests and diseases, unstable prices, competition from other crops, threats from climate change and other structural problems. With growing affluence in developing countries, the prospects for cocoa-based products have, in fact, never been better.
During the 1980s, the industry underwent a spectacular transformation. With low production costs and good prices, cocoa production was a profitable venture. It attracted the estate sector to invest in cocoa plantations, taking “estate farm management technology” into cocoa planting.
At its height, productivity here reached more than one tonne per hectare. In the early stages, the cocoa industry enjoyed the soil fertility of first-time cocoa planting in new areas. However, over time, fertility decreased due to intensive application of chemical fertilisers and pesticides.
The widespread insect infestation by the cocoa pod borer (CPD), in particular in the early 1990s, was the turning point for the local industry. The increase in price of cocoa beans could not compensate for the losses caused by CPD. This occurred due to a failure to detect infestation early and poor control of the disease. Good monitoring of farms and extension systems would have been able to identify early symptoms and precautionary measures could have been taken. However, this was not the case.
The above push factors were complemented by pull factors, particularly better returns from oil palm farming and non-cocoa ventures.
The grinding sector, on the other hand, saw an opposite development. Due to good foresight, the country was able to develop the grinding sector into a global player. Cocoa processing is highly profitable, as the value of processed cocoa such as cocoa block and chocolate product is between 5 and 20 times the value of cocoa beans, respectively.
At the early stage of development, the local supply provided cheap raw material to the grinders. However, by the beginning of the 1990s, the grinders had to obtain additional supply from the international market.
After peak production in 2008, grinders, too, began to experience a downward trend due to unstable supply.
Clearly the two sub-sectors have developed along different paths. While the cocoa bean sector struggled with local challenges, the grinding sector became a global player. They are independent of each other, particularly after the local cocoa supply dwindled. The separation of the two sectors is one of the characteristics of the domestic cocoa industry that is partially responsible for the decline in the production of cocoa beans.
Like everywhere else in the developing world, there are two distinct market systems for cocoa in Malaysia — the primary (cocoa beans) and the secondary (cocoa-based and chocolate products) markets. The two stand in stark contrast in all facets.
The primary market is made up of largely smallholders (95%) who are plagued with problems such as limited bargaining power, low productivity, low price and income, limited opportunities for further investment, unability to address pest and disease attacks and poor farm marketing arrangements. Without reforms, low income may push them out of the industry in the long term.
The secondary market is the opposite, in that the players are large in scale, such as the grinders, chocolate manufacturers and big retailers who deal with high-value cocoa products. With the exception of cocoa SMEs, the market structure of grinders and chocolate manufacturers is highly concentrated.
For instance, Barry Callebaut accounted for 40% of world chocolate manufacturing, followed by Cargill (14%), Blommer (11%) and ADM (8%). The concentration ratio of the top four firms, or CR4, is 73%. In Malaysia, there are only three grinders and chocolate products are largely marketed by big brand names. The market share of top brands by CR4 (Cadbury, Vochelle, Kit Kat and Hershey’s) was estimated at 71% in 2014.
If there had been a close backward linkage between the local grinders and the producers, the decline would have been minimised. The rapid development of the grinders did not trigger further development of cocoa beans, either in the form of close networking between the two or support in terms of input provisions and advisory services that could have ensured continuous supply from the producers.
Besides, the grinders require a large quantity of cocoa beans, which cannot be met by the small producers, particularly after the 1990s. This has resulted in a dysfunctional marketing system as middlemen left the market, creating a vacuum at the farm level, which demotivated the producers.
This situation seems unfair. The profits of high-value cocoa products are reaped by the large firms, while the condition of the smallholders has deteriorated. This gap has further widened, resulting in inequitable distribution of values across the supply chain. Unless this division is rectified, the fate of the smallholders will remain unchanged, if not diminished.
One is tempted to disregard the cocoa bean sector in the future on the grounds of a depleting competitive advantage as other ventures give better returns. However, this reasoning has a structural flaw in that it assumes the industry and all of its components are no longer profitable.
Despite cocoa areas under cultivation and production almost collapsing, there are pockets of cocoa farming that are active and profitable, particularly in Sabah and Sarawak. With commitment, resources and institutional support, the remaining cocoa farming areas have the potential for further improvement in productivity and income, and hence, livelihoods of the farmers.
Besides, cocoa is an ecological-friendly crop in that it thrives in a natural environment and habitat. In the long term, cocoa farming, particularly in a multi-crop environment, contributes more to the environment and ecology compared with mono-cropping.
In short, reviving the cocoa bean industry would yield a triple advantage: economic, livelihood and environmental benefits.
After the bad experience of crop damage and unstable prices, reviving producers’ confidence and hope is a tough task. A new paradigm is needed to assure higher returns await if they continue with cocoa farming.
An inclusive supply chain holds the key to better returns for producers, as proven in Taiwan and South Korea. Since profit lies in high value-added cocoa-based products, producers should expand their farming activities to include integrated processing and manufacturing that will bring better prices.
This requires institutional reform, reorganising the farmers to work collectively either through a farmers’ association or cooperative vehicle to produce and process cocoa beans. Under this business model, the farmers’ association or cooperative is expected to produce cocoa beans as well as cocoa-based products (such as chocolate blocks) by acquiring small-scale processing machines. The chocolate blocks are in high demand by chocolate manufacturers as they are the major ingredient for the manufacturing of chocolates or related products.
This inclusive supply chain would improve the producers’ bargaining power and prices and raise their income. Price instability is then internalised and at the same time, provides opportunities for them to venture into supply businesses as well as cocoa-based manufacturing and related ventures.
In terms of marketing strategy, this model offers the possibility of capitalising on the “fine flavour chocolate” advantage by focusing on “single origin cocoa” or SOC from one locality, and facilitates extension services more efficiently. The SOC characteristic is sought after by chocolate connoisseurs in advanced countries. SOC by locality is a potential “unique selling proposition” for Malaysia’s cocoa promotion. Local grinders and chocolate manufacturers are currently using mixed beans from various sources.
However, this institutional reform requires comprehensive support. This includes increasing productivity, R&D to improve variety and value added, investment in input production to reduce production cost, training and education to increase producers’ capacity as farmers-cum-entrepreneurs, market information, financial incentives and credits and infrastructural support. Without these, reform of the sector would be meaningless and the smallholders and the cocoa industry would be at risk again.
Malaysia may not be able to regain its 1990s glory, but reorganising the smallholders through an inclusive and integrated supply chain, equitable distribution channels and nurturing entrepreneurship may hold the key to a sustainable cocoa industry.
Fatimah Mohamed Arshad is head of Bioresource and Environmental Policy Laboratory, Institute of Agricultural and Food Policy Studies, Universiti Putra Malaysia