Agricultural industrialization is changing the structure of China’s agri-food sector at an unprece- dented rate. Change began with the introduction of the household contract responsibility system
Chapter 2. Sannong Challenges (HCRS) in 1978. The HCRS gave small farmers the right to generate an income from the pro- duce grown on their land. As outlined above, the resulting incentive caused a major increase in agricultural productivity.
Since then, China’s agriculture has transitioned from subsistence farming to commercial agriculture, with most farm produce now sold on the market. As a consequence, small farmers have to deal with a host of business players along the food supply chain including traders, middlemen, market inspectors, processors, and supermarkets.
Recent rapid changes are driven by China’s rapid population growth and urbanization. The emergence and rapid growth of an urban middle class, with disposable income, has lead to stronger consumer demands for high-value food products with adequate safety and phytosanitary standards. The rapid development of integrated supply chains in China is supported by liberalized agricultural markets, China’s access to the WTO and an openness to international trade.
The commercialization and industrialization of agriculture has left many small-holder farm- ing operations unable to meet the demands of large-scale commercial food processors, partic- ularly those that are export-oriented. From the outset of market reforms, agricultural products were the top source of foreign exchange income for China. Japan, the most important foreign market for Chinese produce, desires specific and stringent quality attributes, ones that are very different from those of Chinese consumers.
To meet these demands, some firms developed specific supply chains to meet the regulations and consumer needs of the Japanese market. Likewise, similar chains were developed for other foreign markets. Trade in agricultural products was the first important factor in the trend to increase the vertical coordination of the agricultural supply chains in China. This was particularly true in coastal regions, and suburban areas where large-scale processors are concentrated.
When China began experimenting with agricultural industrialization, the focus was initially on areas where there was relatively high commercialization and potential for exports, and areas that already had a reasonably well-developed production chain. These areas were conveniently also ones where product specialization and higher production efficiency already existed.
The first agricultural industrialization efforts occurred in Shandong province in 1993 where the Weifang municipal government formulated the first agricultural development strategy. Thanks
to its geographic location, Shandong is the leading exporter of agricultural products to Japan and Korea. The main elements of Shandong’s agricultural development strategy were: (1) the identification of a leading commodity or industry in accordance with regional comparative ad- vantages; (2) the designation of zones where production of this commodity would be carried out; and (3) the identification of so-called dragonhead processors that would take a leading role in mobilizing this industry. The processors were viewed as the head of the supply chain (which was conceived of as a dragon; the long body and tail were the small farmers who supply products to the processor) and the ones best able to mobilize and drive the large number of small producers. Their role was to provide a market outlet for small producers.
New policy initiatives in China are often introduced as trials or experiments that are tested in a small number of locations. Higher-level government officials, or researchers sent by them, evaluate these trials and often replicate them elsewhere. If they prove to be successful, they are then implemented as national policies by the central government.
Experimentation with agricultural industrialization followed this pattern. Following the intro- duction of the dragonhead model, the Agricultural Commission of Shandong (ACS) organized a field study in Weifang and submitted a report to the provincial government entitled “Recommen- dation for Industrialization of Agriculture as Agricultural Development Strategy.” This report was followed by articles in the federal Ministry of Agriculture’s Farmers Diary that called for the industrialization of agricultural as a key strategy for market-based agriculture. These arti- cles were the first attempt to promote agricultural industrialization in China (Fulton and Zhao [2009]).
After years of reform and economic development, per capita income in China has increased significantly. An increasing amount of disposable income and urbanization have resulted in a class of richer domestic consumers that are more demanding. They expect quality controlled products with specific characteristics to be readily available. Furthermore, their demand for product diversity is increasing, and their diet is changing. Products in the marketplace are now differentiated based on what they do not contain, as well as what they do contain. Some attributes are achieved through processing, while others are achieved during production. Consumers in
Chapter 2. Sannong Challenges China are also specifying how they would like products to be produced, a pattern that has been noted in developed countries (Boehlje and Schrader [1998]).
To meet consumers’ demands for safe food products, the governing authorities have set and increased both safety and phytosanitary standards. These new standards are proving very difficult for traditional open spot markets to meet, since these markets are not set up to convey the information concerning produce attributes – quantity, quality, timing and safety – that consumers now demand.
It is also difficult to achieve the coordination among input suppliers, producers, processors, wholesalers and retailers that is necessary to meet these demands. Increasingly supermarkets have emerged as important players able to meet specific consumer demands related to production processing and quality, particularly for high-value products (Orden, Torero., and Gulati [2004]). Conforming to specific quality standards can be more easily accomplished in China, as elsewhere in the world, with a contract or ownership coordinated system. Compliance with food regulations on the use of drugs and chemicals also requires a greater degree of coordination throughout the food system (Boehlje and Schrader [1998]).
Thus, agricultural transactions that were traditionally made in spot markets are now in- creasingly made within vertically-coordinated markets (Saxowsky and Duncan [1998]; Reardon and Barret [2000]; Peterson, Wysocki, and Harsh [2001]). The rapid rise of supermarkets in the procurement system is institutionalizing contractual exchanges by demanding compliance with specific product and/or process requirements for procured produce (Reardon, Timmer, Bar- ret, and Berdegue [2003] and Berdegue, Balsevich, Flores, and Reardon [2005]). Supermarkets coordinate actions along the supply chain by standardizing product requirements across suppli- ers. Their standards specify and harmonize product and delivery attributes, thereby enhancing efficiency and lowering transaction costs (Reardon and Gulati [2008]).
The modernization of the procurement system by supermarkets poses major challenges for small farmers looking to enter the high-value market for agricultural products, or to capture more surplus from the supply chain. This stricter procurement system translates into increasingly demanding requirements from suppliers with respect to volumes, consistency, quality, costs and commercial practices (Henson and Reardon [2005], Reardon and Gulati [2008]).
The Chinese government directly supports the development of supermarkets, and supermar- ket chains, as part of their modernization strategy. In the 1990s the Chinese government invested heavily, using stock market financing, in its primary national supermarket chains to increase their competitiveness with multinational chains such as Carrefour and WalMart (Reardon and Gulati [2008]). At the same time, regulations were introduced to directly or indirectly constrain the development of traditional wet markets.
As a result, supermarkets flourished. Although they were virtually unknown only 20 years ago, there are now 23,000 supermarkets in China, with total annual sales of 303 billion RMB. In recent years the number of supermarkets has been growing 26 percent annually, and their sales are growing at 24 percent per year (China Statistics Bureau [2007]). To take advantage of new economies of scale, to increase the quality and safety of produce, and to deal with transaction costs, supermarket chains are becoming centralized. Supermarkets are shifting from a store-by- store procurement system that relied mainly on traditional wholesale markets and brokers to a centralized distribution centre model that uses specialized, dedicated wholesalers and large commercial producers (Berdegue et al. [2005]).
China’s agri-food sector is experiencing a trend toward closer vertical coordination driven by supermarket standards. Supermarkets are determining the conditions for procurement such as scale, volume, quality and safety standards, packing, packaging, and consistency. Buyer-driven chains, such as supermarkets, are characterized by high levels of governance, regulations, and long-term vertical coordination between producers, supply-integrators, processors and retailers (Vorley [2003]). This builds further momentum for the government’s rapid agricultural industri- alization strategy.
However, as Vorley [2003] points out, the high capital requirement needed from farmers in order to enter the buyer-driven supply chains is eliminating the traditional advantage of small-holder production. Farmers now require technology, financial capital, human capital, and organization in order to participate in the new vertically coordinated markets (Boselie and Kop [2004]).
In 1996, the National People’s Congress approved China’s ninth Five-Year Development Plan. Agricultural industrialization was one of its components. The following year the 15th
Chapter 2. Sannong Challenges Party Congress indicated that agricultural industrialization was a realistic method to reach the goal of agricultural modernization. In 2000 the Central Party Committee and the State Council made it clear that support for agricultural industrialization was equal to support for agriculture, and support for dragonhead enterprises was equal to support for farmers.
The need to generate tax revenues and create a source of local income pushed local leaders to initiate rural industrialization (World Bank [1998]) and to introduce various policies to attract investment. Dragonhead enterprises were attracted to areas by the market exclusivity, and the resulting lack of competition, that they were often granted by local governments.