Direct Cost Recovery from Services vs Scale
Key Messages
FarmFit
believes that an important component of any successful
smallholder-inclusive business model is that it is able to operate at
The story behind the data, however, is very nuanced. Three main findings are highlighted in this section:
Reverse causality: Cost recovery as a pathway to scale. Value chain dynamics: High cost recovery regardless of scale. Farming and business models allowing high cost recovery at smaller scale.
Keep reading to find out more.
Understanding how scale relates to cost recovery
Inherent in FarmFit’s thinking on building better smallholder-inclusive business models is the importance of scale; models need to reach a minimum size to be efficient and investable, and able to work with a greater number of farmers. Data on direct recovery of service costs supports this, as we see that large-scale models recover a lot more of their costs by charging farmers.
The differences are substantial; scale seems to be
positively correlated with direct cost recovery. These results are
validated using rigorous machine learning methods. (
However, there remains quite some spread in the results and the nuance behind the data is important. Whilst, overall, the data strongly suggests that large-scale models are associated with higher direct cost recovery, there are unexpected insights when diving deeper. These are as follows:
- Contexts exist in which scale appears not to matter
- There are specific types of business models that are able to have high cost recovery even at small and medium scale
- Cost recovery might be a driver of scale rather than vice versa.
These patterns are explored further below.
Link to other outcomes
When looking at the relationship between Scale and the other two outcomes analyzed in the Hub, we find that:
-
For
Service Delivery Cost , our data finds that the cost of service delivery and scale are inversely related; small-scale models are much more costly on a per-farmer basis than large-scale models. Click here for more details -
For
Farmer Value Created , FarmFit data shows that smaller-scale models create a lot more absolute value for farmers than medium and large-scale models. Click here for more details
In the following sections we take a closer look at possible explanations and nuances behind these results, as well as their implications.
Diving deeper: what might explain these results?
Our quantitative and qualitative data suggests there are a few compelling reasons explaining the pattern behind these results.
Reverse causality: Cost recovery as a pathway to scale – Higher cost recovery can be a driver of scale, in particular in contexts where heavy subsidization of smallholder services is widespreadValue chain dynamics: High cost recovery regardless of scale – Within certain value chain dynamics, cost recovery can be high regardless of scale.Farming and business models allowing high cost recovery at smaller scale – Specific farming and business models – such as block farms – allow high cost recovery at small and medium scales. This helps explain some of the outliers apparent in the data
Clicking on each of the preceding reasons provides a longer overview of our thinking, including more supporting qualitative and quantitative insights.
Implications – so what does this mean for you?
Based on our findings to date on this topic, we see the following implications for different audiences:
- Consider
whether low cost recovery – direct or indirect – is inhibiting
you from scaling your model. We recommend:
- Identify ways in which you can optimize your direct cost recovery. Are you able to charge (some) farmers for (all or part) of the services provided? FarmFit analysis suggests this may require the provision of more complex and costly services beyond those that are rarely charged for, such as training, to better meet the needs of (and thus provide more value to) farmers.
- Assess
and quantify all direct and
indirect sources of value from your smallholder-inclusive business model. Are there indirect sources of value that you have not yet considered which could help strengthen your business case for investment? This in turn could allow you to decrease what you charge farmers and/or invest more. - Assess how these sources of value – as well as your costs – will change if you scale your business model.
- Look
beyond your peers for examples of how to structure cost recovery in
your business model:
- If you are operating in a context characterized by low direct cost recovery, seek inspiration from companies who achieve high direct cost recovery while still creating high value for farmers. Are you able to benefit from any of their best practices? If you are operating at small or medium scale, are there examples of companies of a similar scale that achieve higher direct cost recovery? Can you replicate any of their best practices? FarmFit can help you identify relevant benchmarks.
- If
you are operating in a context characterized by low direct but
(potentially) high indirect sources of cost recovery, assess if and
how you can (or already are!) benefiting from indirect sources of
value.
- Discuss with your investees operating at low and medium scale if low cost recovery is one of the barriers to scale. Are there opportunities to increase direct cost recovery without jeopardizing the value created for farmers? Could this increase in direct cost recovery unlock greater scale or are there other factors that also need to be tackled?
- Identify
with investees
indirect sources of value of their service delivery to smallholder farmers and include these in the business case. Do they recover enough value indirectly to justify continued subsidization of services?And when subsidization is vulnerable to business results like volumes, quality and price, you may still want to explore that investees start to charge farmers to charge for (part) of the service costs to make the business model less vulnerable. - When supporting earlier-stage or smaller-scale models, be aware that longer-term patient capital is needed to allow your investees a sufficient chance to reach commercially viable scale, without compromising farmer value created. Understand the unintended consequences of trying to reach scale too quickly.
- Small scale models can be interesting opportunities to invest in when they have a “controlled” business model like a block farming scheme where several risks are better managed. Direct cost recovery in such models tend to be high.
- Assess whether your support to small- and medium-scale business models with low direct cost recovery is helping to build (long-term) viable business models, through higher direct cost recovery at scale and/or through higher indirect sources of value.
- Support companies in increasing their direct cost recovery, which in turn helps them scale their business models. Rather than scale driving higher direct cost recovery, our analyses suggest the opposite might be the case: Higher direct cost recovery can enable scaling. Therefore, support companies to understand how to drive higher direct cost recovery, for example by designing more holistic service packages where farmers have higher willingness to pay.
- Building
on the previous point, support companies in assessing their
indirect sources of value . If indeed high direct cost recovery enables scaling, then a credible understanding of the indirect value can do the same. One FarmFit study found that companies massively underestimate the indirect sources of value they derive from investing in smallholder farmers and that better insights on this topic can help incentivize more investment. - Especially in contexts where there are fewer indirect sources of value (mainly regulations and sustainability premiums), identify ways in which you can encourage the emergence of such sources of value. For example, support governments in developing appropriate regulations to encourage company investments in smallholder farmers, or invest in consumer awareness campaigns to promote interest in sustainable products (and a willingness to pay more for them).
- When working with the private sector, besides focusing on farmer value created, consider also the (direct and indirect) cost recovery of the business models that you support. Encouraging higher cost recovery can incentive companies to invest more, build demand-driven accountability into service delivery, and lay a solid foundation for scaling business models to reach more farmers.
- Work with governments and public actors to build strong enablers for private sector engagement and commercial viability (see below), by helping to make the case for how greater profitability drives increased reach of farmer services - and the implications for broader sector and macro development.
- Design
smart incentives that create
indirect sources of value for companies to encourage them to invest in smallholder farmers at larger scale. This could include:- Regulations that companies would need to comply with, such as traceability, deforestation or living income standards.
- Sustainability standards that both consumers and businesses can use to promote the production and consumption of more sustainable agricultural products – and encourage more investments into smallholder farmers to meet the conditions required for these standards.
- Invest
in enablers of private sector commercial viability that can enable
greater cost recovery even at small and medium scales. This can
include:
- Predictable and stable regulations and broader economic and agricultural policy that reduces the cost of risk.
- Strong public infrastructure and public agricultural services that can reduce operational costs for private sector providers.
Reflections on data limitations and further research
The Hub is an interactive resource that we are constantly updating with new data, new analysis, validation by our partners, etc. For the results on this page, we would like to emphasize the following:
Major caveats and limitations of out current approach
Next steps: Updating our findings
Suggestions for additional research by our peers and partners
Page content
Strength of Relationship 4/5
- Strong relationship between driver and outcome variables
- Results are consistent across analytical models used
- Few limitations regarding sample or indicator
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