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Georgian Tea: Finding New Strength in Unity?

After many years of chaos and utter collapse, Georgia’s once glorious tea industry is again showing signs of life. More and more individual farmers and businesses – mostly very small, but some quite ambitious, such as Geoplant (known for its “Gurieli” brand) – grow, process and pack tea. Despite competition from major producing countries and international brands, Georgian tea has great export potential because of the value attached to it all over the former Soviet Union. 

While the potential is clearly there, it is not at all clear what strategy should Georgia pursue in developing the sector. The old Soviet model of large scale sovkhoz-based production is dead. What we have instead is a multitude of extremely fragmented plantations in need of recultivation and technological upgrading. The million dollar question is how one can integrate these plantations into a modern and internationally competitive value chain.


IN SEARCH OF THE RIGHT ORGANIZATIONAL MODEL

One alternative would be to have smallholders gradually replaced by large industrial farms. Yet, while perhaps ‘efficient’ in the narrow technical sense (particularly for low-quality teas that don’t require many manual processes), this scenario carries very large social, economic and political costs associated with a massive dislocation of Georgia’s rural population. 

Another possibility is provided by the likes of Avtandil (Avto) Lomtatidze and Giorgi Trapaidze who are performing the critical aggregation function by collecting and processing tea leaves produced by Guruli smallholders. Avto and Giorgi live and operate in Kvenobani and Khidistavi, two neighboring villages in the Chokhatauri municipality. Among their suppliers are more than a hundred small farmers each owning between 1000 sqm to one hectare. In this way, they provide the link between these small guys and the market – local, national, and even international.

Against all odds, in part out of love of his profession and in part thanks to his Guruli character, Avto was among the first Georgian farmers to start a private tea processing business soon after the Soviet Union’s collapse. He was fortunate to find a great friend and colleague in the person of Merab Dolidze – an experienced engineer who passed away in 2015. Merab was instrumental in assembling the tea processing line. Avto was a chemist by education and a tea technologist by training. His main responsibility was to operate the line and make sure that the final product met the desired quality standards. The small factory Avto and Merab set up in Kvenobani processed and sold tea in the local market. Very far from breaking into the global markets, but good enough to help themselves and many of their fellow neighbors.

Their success inspired others. In 2005, a very similar processing operation was set up in the nearby Khidistavi village by Giorgi Trapaidze. Being new to the tea business (his prior experience was in wood processing), Giorgi relied on his friendship with Avto and Merab to acquire the necessary knowhow. The trio cooperated on many dimensions, sharing transportation and distribution costs and engaging in joint marketing abilities. As Giorgi knows to tell, “If I had more tea leaves than I could process during the harvest, I could rely on Avto and Merab to process them to avoid waste. We were mixing each our teas and selling them together so as to cut distribution costs and exploit economies of scale.” 

In 2007, Merab and Avto’s business was lifted by the wave of new entrepreneurial activity which swept Georgia in the early years following the Rose Revolution of 2003. A partnership with Mikho Svimonishvili’s newly established Marneuli Food Factory (MFF) helped them to the national scene. “This was like infusing new blood into the company”, recalls Avto Lomtatidze. Mikho agreed to purchase their tea and sell it under the MFF brand. By 2010, Lomtatidze and Dolidze felt the time was right to launch a private company. Lodo Ltd (combining the first two letters of the founders’ names) was born that year. In 2012, while continuing their cooperation with MFF, Lodo and Giorgi Trapaidze agreed to package and sell their tea through Shota Bitadze – a tea broker selling tea locally as well as internationally, particularly in Ukraine.


REDISCOVERING FARMER COOPERATION?

Aggregation by tea processing and packing businesses, such as Lodo (and, on a much larger scale, by Gurieli), certainly helps small farmers to bring their product to the market. Yet, it does not solve the fundamental problem of low productivity and quality at the farm level. The lack of high quality raw material – tea leaves – is THE major constraint for Lodo and other Georgian processors as they seek to scale up and enter international markets. 

To undertake additional investment and improve coordination at the processing stage, in 2014 Lomtatidze, Dolidze and Trapaidze, together with four other partners, formed an agricultural cooperative, “Guria Company 14”, which was officially recognized by the Agricultural Cooperative Development Agency (ACDA) and received funding support from an NGO coalition led by CARE-International as part of EU’s ENPARD program.

For lack of raw materials, the processing capacity of Guria Company 14 – 2 tons of fresh tea in 24 hours – is very far from being fully utilized. During harvest time, they employ up to 15 workers, who operate in two shifts, day and night. Yet, all they were able to process in 2015 was about 10 tons of fresh tea leaf (they bought an additional 2.5 tons of dry tea to fulfill obligations to their marketing partners). To make use of excess capacity, the cooperative would occasionally process tea leaves for other producers, charging for the service. That, however, is far from their ideal.

Just like its business parent, Lodo Ltd, the new cooperative is focused on processing. With all the new EU-financed equipment (an aroma oven, a tea drying and sorting machines, green tea fixation equipment, and a truck), Guria Company 14 is now well-positioned to produce large quantities of higher quality teas. Yet, as far as raw material supply is concerned, Lomtatidze and Trapaidze remain totally dependent on neighboring farmers, whose productivity is a major drag on their business. The cooperative’s own tea plantations total a meager 5ha (fenced and recultivated with ENPARD’s support) but what are these 5ha compared to the processing capacity of Guria Company 14, which is large enough to cater for hundreds of hectares?!

According to Giorgi Trapaidze, “with a bit of fertilizer, farmers would be able to harvest tea 6 instead of 3 times per year and thus double their yields.” Yet, operating outside any cooperatives, lacking in skills and financial resources (access to credit is a major constraint given that the collateral value of a tea plantation is a miserable 500 GEL per ha), smallholders’ attitude to innovation has been described to us as nihilistic. Instead of maximizing profits, they minimize inputs. Not spending and not investing, they fail to do well for themselves and supply the downstream industry.

Incidentally, this is not a problem that is unique to the tea industry or Georgia. As has been found in recent experimental studies, myopia or present-bias is a common smallholder malaise (see a seminal paper by Duflo, Kremer & Robinson, "Nudging Farmers to Use Fertilizer: Theory and Experimental Evidence from Kenya." American Economic Review, 2011).


MAKING COOPERATION WORK FOR THE POOREST

The manner in which farmer cooperation is being currently developed in Georgia is leaving the poorest Georgian farmers outside the fledgling cooperative movement. It is only natural that the most capable and entrepreneurial – such as Merab, Avto and Giorgi from our story – would be the first to get organized in small groups and prevail in the competition for ENPARD or government funding. It is only natural that they would have better business ideas, and the resources to hire grant proposal writers.

The fact that the more entrepreneurial and capable farmers get additional support is perfectly fine from the ethical point of view. After all, selection and survival of the fittest is what evolution is all about. The problem with this approach is that its leaves behind the large mass of Georgian smallholders who are badly needed as suppliers of raw materials for the food industry. This is a problem of economic policy, not of ethics or morality. 

The latest proposed amendment in the Law on Agricultural Cooperatives is apparently aimed at addressing this gap. The lawmakers’ idea is to NOT allow processing cooperatives to source more than 30% of raw materials from non-members. The choice to be faced by such cooperatives will be to either shift to the Ltd (business) mode of operation or expand membership. 

Membership in a processing cooperative would provide smallholders with the long-term incentives to invest in skills and technology, thus helping overcome the chronic present-bias from which they suffer. It may also provide them with the resources (subsidized loans or grants) and knowhow (learning from other members or ENPARD) to undertake the necessary technological adjustment. Additionally, significant gains could be associated with better coordination and division of labor, resource sharing and mutual help.

But what about the founding members and initial investors in a processing coop? How are their rights to be protected in a larger cooperative? 

It is quite obvious that what stands in the way of enlarging existing cooperatives is the prospect of new members outvoting the founders and stripping them of their assets. Therefore, if our goal as a society is promote inclusive farmer cooperation, cooperation that works for the poor while at the same time supplying the food industry with the raw materials that it needs, the Law on Agricultural Cooperatives would have to allow farmers like Giorgi and Avto to expand membership without losing control. This can be achieved by creating different classes of members (voting and non-voting) or making voting rights proportionate to initial investment and/or labor inputs.

Despite all the challenges, the future of Georgian tea looks quite bright. Local and international demand is an inexorable pull factor driving investment throughout the entire value chain. It is only a matter of time before the right organizational model emerges in a process of trial and error. However, it is in our hands to nudge the process in the direction of greater or lesser inclusivity, greater or lesser preservation of Georgia’s rural traditions and landscapes.


 

 

The article was produced with the assistance of the European Union through its European Neighbourhood Programme for Agriculture and Rural Development, Austrian Development Cooperation, CARE Austria or CARE International in the Caucasus. The contents are the sole responsibility of the authors and can in no way be taken to reflect the views of the European Union, Austrian Development Cooperation, CARE Austria or CARE International in the Caucasus.

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Irakli Kochlamazashvili on Sunday, 08 November 2015 17:05

Those outstanding players of the industry (like Giorgi and Avto) might be given a special status/share in the cooperatives to give them motivation to stay as a cooperative, while not losing the control mechanism. The amendments of the law propose the "associated member", but the owners of this status won't have any voting rights, thus power in decision making. The main idea behind the associated member (according to ACDA/MoA) is to attract the financial resources for the cooperatives (one of the most scarce resource for coops to date), as well as, it allows the foreigners to become members of the cooperatives.

In reality, the tea processors are establishing the second level cooperatives, which are focused on production - in this case - on tea growing. But the puzzle here is in numbers again. According to the law amendments (what version I have seen so far) only 3 and 5 cooperatives (3 in mountains and 5 in lowland respectively) can establish second level cooperative. In this case, the coop "Guria-Company 14" could find another 4 tea cooperatives to establish a second level cooperative...

BTW, the cooperative "Guria-Company 14" must increase their number of members up to at least 11, when the law amendments go into force.

Those outstanding players of the industry (like Giorgi and Avto) might be given a special status/share in the cooperatives to give them motivation to stay as a cooperative, while not losing the control mechanism. The amendments of the law propose the "associated member", but the owners of this status won't have any voting rights, thus power in decision making. The main idea behind the associated member (according to ACDA/MoA) is to attract the financial resources for the cooperatives (one of the most scarce resource for coops to date), as well as, it allows the foreigners to become members of the cooperatives. In reality, the tea processors are establishing the second level cooperatives, which are focused on production - in this case - on tea growing. But the puzzle here is in numbers again. According to the law amendments (what version I have seen so far) only 3 and 5 cooperatives (3 in mountains and 5 in lowland respectively) can establish second level cooperative. In this case, the coop "Guria-Company 14" could find another 4 tea cooperatives to establish a second level cooperative... BTW, the cooperative "Guria-Company 14" must increase their number of members up to at least 11, when the law amendments go into force.
Irakli Kochlamazashvili on Tuesday, 10 November 2015 23:16

A good case on second level (or second-tier) cooperative from Peru:
http://ica.coop/en/media/co-operative-stories/peruvian-cooperative-brings-small-producers-together

A comprehensive report on the coop development (including second-tier) worldwide:
http://uir.unisa.ac.za/bitstream/handle/10500/11882/dissertation_malomane_ma.pdf?sequence=1&isAllowed=y

A good case on second level (or second-tier) cooperative from Peru: http://ica.coop/en/media/co-operative-stories/peruvian-cooperative-brings-small-producers-together A comprehensive report on the coop development (including second-tier) worldwide: http://uir.unisa.ac.za/bitstream/handle/10500/11882/dissertation_malomane_ma.pdf?sequence=1&isAllowed=y
Eric Livny on Tuesday, 10 November 2015 19:38

Thanks for your comment, Irakli!

My sense is that processors could be included in a growers cooperative as associated members. They could provide the capital, the knowhow, and the market linkages. And doing so would be in their interest. Giorgi and Avto would be interested in securing raw material supply from a growers' cooperative that includes 500 tea growers. It would be a simple case of vertical integration giving them the incentives to work with their neighbors to improve their productivity, provide them with credit to recultivate, replant, etc. The size of the pie would increase for everybody through increased quantity and quality of the final product (which could also be better packed and branded). The jointly owned/rented and operated machinery (and trucks) would reduce production costs, making them more competitive in the domestic and international market.

The question is then how to design ownership, decision-making and profit sharing arrangements so that such producer-processor coops are a sustainable win-win. I hope there would be some international best practices to consider.

Thanks for your comment, Irakli! My sense is that processors could be included in a growers cooperative as associated members. They could provide the capital, the knowhow, and the market linkages. And doing so would be in their interest. Giorgi and Avto would be interested in securing raw material supply from a growers' cooperative that includes 500 tea growers. It would be a simple case of vertical integration giving them the incentives to work with their neighbors to improve their productivity, provide them with credit to recultivate, replant, etc. The size of the pie would increase for everybody through increased quantity and quality of the final product (which could also be better packed and branded). The jointly owned/rented and operated machinery (and trucks) would reduce production costs, making them more competitive in the domestic and international market. The question is then how to design ownership, decision-making and profit sharing arrangements so that such producer-processor coops are a sustainable win-win. I hope there would be some international best practices to consider.
Lasha Lanchava on Tuesday, 10 November 2015 22:07

Ineed, in Lithuania for example the Law on Cooperatives establishes "One man one vote" practice.

However, if the size of the cooperative is large, there are ways to circumvent the law. In particular, if the number of coop members exceeds 100, then, members 'elect' representatives trusted with a vote and instead of all 100 members only the representatives can vote.

Similar governance rules could be applied in Georgia with some modifications like the size threshold and number of representatives. This kind of arrangement would ensure that main decision-making power is in the hands of most entrepreneurial members while other small scale farmers would also have their say.
http://www.lafranceagricole.fr/var/gfa/storage/fichiers-pdf/Docs/2015/Cogeca121015.pdf P.223

In Denmark a Member Council elects the Board of Directors in large size cooperatives. However, Denmark does not have a law on cooperatives.
http://ec.europa.eu/agriculture/external-studies/2012/support-farmers-coop/fulltext_en.pdf P32

Ineed, in Lithuania for example the Law on Cooperatives establishes "One man one vote" practice. However, if the size of the cooperative is large, there are ways to circumvent the law. In particular, if the number of coop members exceeds 100, then, members 'elect' representatives trusted with a vote and instead of all 100 members only the representatives can vote. Similar governance rules could be applied in Georgia with some modifications like the size threshold and number of representatives. This kind of arrangement would ensure that main decision-making power is in the hands of most entrepreneurial members while other small scale farmers would also have their say. http://www.lafranceagricole.fr/var/gfa/storage/fichiers-pdf/Docs/2015/Cogeca121015.pdf [i]P.223[/i] In Denmark a Member Council elects the Board of Directors in large size cooperatives. However, Denmark does not have a law on cooperatives. http://ec.europa.eu/agriculture/external-studies/2012/support-farmers-coop/fulltext_en.pdf [i]P32[/i]
Irakli Kochlamazashvili on Tuesday, 10 November 2015 22:58

EU report, Data on internal governance [p. 60]
"About 80% of all cooperatives in the sample still used the one member one vote principle. Only 20% of the sample use proportional voting, of which half apply an upper limit to the number of votes one member may hold. Around 12% of the cooperatives have subsidiaries, and more than half of the cooperatives do engage in trade with non-members".

EU report, Data on internal governance [p. 60] "About 80% of all cooperatives in the sample still used the one member one vote principle. Only 20% of the sample use proportional voting, of which half apply an upper limit to the number of votes one member may hold. Around 12% of the cooperatives have subsidiaries, and more than half of the cooperatives do engage in trade with non-members".
Irakli Kochlamazashvili on Tuesday, 10 November 2015 23:03

Interesting data on internal governance [p. 60]

"The performed statistical analysis reveals the key characteristics of the contemporary cooperative system and its internal governance features in the EU-27. Overall, cooperatives in the EU are still serving a mainly regional membership, while their activities are rather specialized. Most of them trade predominately with their members, about 90% of whom are active. Roughly a fifth of the cooperatives in the sample use a holding structure. In only 14% of the cooperatives, professional managers serve on the board of directors. Decisions on who is eligible to serve on the board of directors are mostly based on expertise. In more than 60% of all cooperatives the operational business is run by professionals. Cooperative supervisory boards contain outsiders (non-members) in about a quarter of the cases".

Interesting data on internal governance [p. 60] "The performed statistical analysis reveals the key characteristics of the contemporary cooperative system and its internal governance features in the EU-27. Overall, cooperatives in the EU are still serving a mainly regional membership, while their activities are rather specialized. Most of them trade predominately with their members, about 90% of whom are active. Roughly a fifth of the cooperatives in the sample use a holding structure. In only 14% of the cooperatives, professional managers serve on the board of directors. Decisions on who is eligible to serve on the board of directors are mostly based on expertise. In more than 60% of all cooperatives the operational business is run by professionals. Cooperative supervisory boards contain outsiders (non-members) in about a quarter of the cases".
Irakli Kochlamazashvili on Tuesday, 10 November 2015 23:10

About outside investors (like future "Associated Members" in Georgia [p. 103]

>In the EU Member States, raising equity from outside investors is still in an embryonic stage>

"The virtual absence of raising equity from outside investors is not caused by the lack of an adequate legal structure. Only seven Member States (Belgium, Bulgaria, Cyprus, Estonia, Portugal, Romania and Slovakia) did not allow outside investors to participate in the equity capital of the cooperative. Accordingly, in these Member States voting rights could not be allocated to non-patron members. However, it remains questionable whether in these Member States there is a genuine demand for this legal facility. The other Member States allowed or, more accurately, did not forbid outside investors to participate in raising equity. However, in a substantial number of these Member States this facility was not aligned with the allocation of voting rights to outside investors (Finland, Greece, Hungary, Latvia, Lithuania, Malta, Poland, Slovenia, Sweden and the UK). But even in Member States with both facilities, raising equity from outside investors is still in an embryonic stage. Hence the conclusion that the legal structure of the cooperative is not a dissuasive factor for obtaining equity capital from outside investors".

About outside investors (like future "Associated Members" in Georgia [p. 103] >In the EU Member States, raising equity from outside investors is still in an embryonic stage> "The virtual absence of raising equity from outside investors is not caused by the lack of an adequate legal structure. Only seven Member States (Belgium, Bulgaria, Cyprus, Estonia, Portugal, Romania and Slovakia) did not allow outside investors to participate in the equity capital of the cooperative. Accordingly, in these Member States voting rights could not be allocated to non-patron members. However, it remains questionable whether in these Member States there is a genuine demand for this legal facility. The other Member States allowed or, more accurately, did not forbid outside investors to participate in raising equity. However, in a substantial number of these Member States this facility was not aligned with the allocation of voting rights to outside investors (Finland, Greece, Hungary, Latvia, Lithuania, Malta, Poland, Slovenia, Sweden and the UK). But even in Member States with both facilities, raising equity from outside investors is still in an embryonic stage. Hence the conclusion that the legal structure of the cooperative is not a dissuasive factor for obtaining equity capital from outside investors".
Eric Livny on Wednesday, 11 November 2015 12:54

The issue for Georgia is that grower lack organization, capital and skills. And in the absence of outside investors (buyers) they will remain very unproductive and poor, even if organized in forma coops. Hence, it would be good for Georgia to remove any barriers for vertical integration between growers and processors (or retailers). Whether this will happen or not is a different matter. However, we should definitely remove any legal barriers to give it a chance.

The issue for Georgia is that grower lack organization, capital and skills. And in the absence of outside investors (buyers) they will remain very unproductive and poor, even if organized in forma coops. Hence, it would be good for Georgia to remove any barriers for vertical integration between growers and processors (or retailers). Whether this will happen or not is a different matter. However, we should definitely remove any legal barriers to give it a chance.
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