Filling the Gap Between Farm and Fair Trade

October 25, 2010, 8:11 pm
Filling the Gap Between Farm and Fair Trade
By DAVID BORNSTEIN

Fixes looks at solutions to social problems and why they work.

We’ve all seen the ads for fair trade coffee with the beautiful photos of villagers hand picking coffee cherries in exotic regions around the globe. Fair trade is one of those ideas that’s always in the air, but we don’t often consider what it means. What does it really take to connect rural producers in the developing world with consumers in wealthy countries – so that everybody benefits?
While the global market for natural goods is booming, millions of small producers who dream of accessing it are shut out.

Willy Foote is an American banker who has spent the past decade answering this question. In the early 1990s, Foote worked for Lehman Brothers doing corporate finance in Latin America, where he fell in love with the culture and learned to play dozens of revolutionary songs on guitar. In 1996, he left Lehman to pursue a business journalism fellowship in Mexico, and he and his wife spent two years traveling around the country in an old pickup truck, interviewing villagers. What he found was that the missing link between small producers in the developing world and middle-class consumers who like to buy their morning coffee at Starbucks is a special kind of banker. That’s why, in 1999, Foote founded Root Capital, a not-for-profit organization that helps environmentally sustainable grassroots businesses gain access to capital, skills and markets.

Of the 2.6 billion people who live on $2 a day or less, three quarters live in rural areas, and many are small producers – which is why the World Bank says agricultural businesses are the most effective vehicles to reduce global poverty. The problem is that their businesses, even when they form associations, are too small and risky to be served by banks and too big for Grameen Bank-style microfinance. To succeed, they typically need access to loans between $10,000 and $1 million. This is a banking no-man’s land – often called the “missing middle.” While the global market for natural goods is booming, millions of small producers who dream of accessing it are shut out. Every day, we hear politicians trumpet free-market solutions as a cure for economic ills, but few have worked out the messy details to make the slogans real – especially for people in the countryside.
Root Capital Rolando Lazo works with SOPPEXCCA, a coffee cooperative that receives loans from Root Capital.

That’s what Root Capital does. Consider the example of Rolando Lazo, a coffee producer who lives in the Jinotega region of Nicaragua, in the densely forested mountains about 100 miles northeast of Managua, where the country’s best coffee is grown. Jinotega was the location of some of the worst violence during Nicaragua’s civil war in the late 1970s. When Lazo was a boy, his parents were killed and he grew up in extreme poverty, often sleeping under trees. He eked out a living as a migrant farm worker, barely earning enough to cover his basic needs, let alone save for the future.

Today, Lazo and his family have a small plot of land and a house – plus electricity, TV and access to potable water. How did this happen?

Lazo joined a coffee farmers’ cooperative that linked up with a larger association of 19 cooperatives called SOPPEXCCA. Over the past six years, after struggling financially, the association received nine loans from Root Capital ranging from $70,000 to $450,000 to build an export business that would benefit all its members.

Most of the credit went to cover costs between the time when the association’s 700 farmers harvest their coffee and the payments come in from buyers. This ensured that farmers wouldn’t be forced to sell at fire-sale prices to middlemen. Some of the loans were extended to Lazo and others to buy their own land. And $280,000 was used to purchase a warehouse and a dry mill with machines for hulling, sorting and packing, which ensure consistent quality coffee. The investments reduced processing and transportation costs and allowed SOPPEXCCA to earn profits that would otherwise have gone to private millers.

As a result, SOPPEXCCA now sells much of its coffee at specialty-grade prices to retailers in Germany, Italy, Ireland, the Netherlands and the United States, where Peet’s Coffee carries its beans. According to the association, sales have increased from $531,000 in 2003 to $1.7 million this year.

While traveling through Mexico, Foote had met hundreds of farmers who had good products to sell. “I came across leaders wherever I went,” Foote said. But hardly any could get access to credit. Without opportunities, many resorted to illegal logging or slash-and-burn agriculture, practices that eroded the soil, destroyed biodiversity, and made their communities vulnerable to flooding – all of which deepened poverty.

One day Foote found himself in the Chimalapas jungle surrounded by 100 vanilla farmers in cowboy hats. The farmers had organized themselves and taken back their land from narco-ganaderos (narco-ranchers) who grew marijuana and poppies for the drug trade. ” ‘We’re organized now,’ ” Foote recalled a young leader declare. “‘We have our cooperative. We will find markets for our vanilla and we will make money!'”

They didn’t. The cooperative failed. Foote returned to the United States. He had planned to attend business school, but he never went. Instead, he started EcoLogic Finance (later renamed Root Capital). If farmers were courageous enough to resist the drug trade, he said, the least the world owed them was a decent shot at building honest businesses.

His timing was good. At the time, high profile companies like Starbucks, Whole Foods, and The Body Shop were looking to source more of their products from small producers, a trend that has accelerated – and will continue to accelerate the more customers pay attention to ethical and environmental considerations.

But a big bottleneck is the banking sector, which has yet to adjust its business practices to make markets work the way they could – and should. Only a quarter of the world’s bank branches are located in rural areas. “Nobody has figured out how to get commercial banks to focus on these rural markets,” said Foote. Even when they do, traditional banks are uncomfortable lending to people who lack hard collateral. The rural poor often have no land, buildings or legal titles. And government rural credit schemes have been riddled with corruption and waste.
Root Capital Maraba, a coffee cooperative in Rwanda, has been a Root Capital client since 2005.

Against this backdrop, Root Capital has lent $235 million to 305 rural businesses in 35 countries, with a 99 percent repayment rate, and it is poised to triple its annual lending by 2013. The businesses that Root Capital has financed – producers of such things as coffee, cocoa, nuts, cotton, fruit, timber and artisan goods -support 400,000 households, or well over a million people.

How has it achieved such success? Root Capital’s investment officers spend a third to half their time visiting clients, walking along dirt roads, discussing harvests, inquiring about whether farmers’ kids are attending school. Their intimate knowledge of their clients allows them to approve new loan applications in four to six weeks and renewals often in days. The organization raises money from investors at 2.5 percent interest – Starbucks is one of its biggest investors – and lends it out at 9.5 to 12 percent interest. This year, it expects to cover 73 percent of lending costs with interest income. Foote says the lending business will break even in three years.

Typically, in agricultural trade, small producers bear most of the risk while export companies and retailers reap most of the profits. What is most innovative about Root Capital is the way it has “derisked” an inherently risky business while shifting some of the profits from the big guys in the supply chain to the little guys. In addition to helping small producers add value, which boosts their revenues, the organization secures its loans by arranging fixed-price forward contracts from buyers. This insulates small farmers from the risk of price drops. And to further stabilize its borrowers, the organization works with companies like Green Mountain Coffee Roasters which provides grants to train leaders of rural associations in things like managing cash flow, account reconciliation, and financial decision making.

Root Capital also gets paid back directly from importers and retailers, rather than from its borrowers. “We think we have a very compelling risk mitigation strategy,” Foote said. “As long as product ships we get paid back. So we get very good at asking ‘Why wouldn’t product ship?'”

There are lots of reasons: droughts, frosts, labor strikes at port, civil wars. But that’s not usually what goes wrong in rural credit. What usually goes wrong is what caused the mortgage crisis in the United States: bankers make loans without getting to know their borrowers.

Root Capital can’t afford to make that mistake; it is trying to prove that rural producers represent a serious “asset class” for lenders. “If we lose a lot of money in the early days then the whole thing is over,” Foote said. So they have gotten good at finding bankers who are motivated to redeploy their skills to attack poverty. And they have no shortage of applicants.
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Root Capital is now expanding into new market segments – seed companies, agricultural processors, staple foods, like sorghum, beans, and maize, and high-nutrient foods like plumpy’nut. It is helping farmers invest in “leap frog” technologies like drip irrigation, which can multiply crop yields and efficiencies.

In the coming years, Foote plans to standardize Root Capital’s work – to turn it into a “plug and play business” so other lenders can adopt its model. Some of its borrowers have already “graduated” to mainstream banks, a mark of success. But Foote is not expecting commercial banks to dive in anytime soon. Rather, he envisions something similar to what occurred in micro-finance over the past 15 years.

“I think we’re going to see the catalyzing of an entirely new industry of specialized financial institutions that are 100 percent dedicated to this market,” he said. “Because it’s such a massive opportunity – and it’s so grossly underserved right now.”

David Bornstein is the author of “How to Change the World,” which has been published in 20 languages, and “The Price of a Dream: The Story of the Grameen Bank,” and is co-author of “Social Entrepreneurship: What Everyone Needs to Know.” He is the founder of dowser.org, a media site that reports on social innovation.

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