By Kate Danaher
Rising demand for fair-trade products is creating an emerging need for growth in fair-trade supply chains. This is a fantastic opportunity to put more people to work under fair pay and labor standards — but the time and cost involved in scaling these supply chains while maintaining fair-trade standards poses a major challenge. To overcome it, we need new financing and business relationships that enable increased production while assuring benefits for supplier communities.
Chris Mann, CEO of the yerba mate beverage company Guayakí, boils the challenge down to its essence: If his suppliers grow 40,000 acres of mate, they can sell the leaves. If they have a drying facility to process those leaves, then they can generate three or four times the value from those leaves. That would raise their community’s standard of living and potentially expand their market, but where does the financing to build the facility come from?
Trade finance for international supply chains (credit lines and other instruments designed to bridge payment gaps between buyers and sellers) is well established. Capital expenditure (CapEx) finance, which funds facility and equipment needs, is not. Major funders such as the World Bank will do it, but only in major amounts — in the millions. Smaller-scale fair trade suppliers typically need much less than that, on the order of $100,000 to $500,000.
That capital gap exists because these are challenging loans. Many fair-trade suppliers don’t have access to local banks specializing in small and medium enterprises, which are best positioned to service CapEx lending to local businesses. The suppliers may also need technical assistance that local lenders can’t provide. And even when neither of these issues comes into play, the loans are often too costly.
Smaller loans are riskier but take as much time and expertise to underwrite as large loans — and sometimes even more. The result is that even when producers can find loans for projects like building facilities for drying mate leaves, the interest rates are unaffordably high — 12 percent or more. Suppliers can manage those rates for short-term trade financing, but CapEx loan terms are typically three to five years, and these businesses can’t pay double-digit interest rates for that long.
“The capital is maturing — there’s more in the marketplace than there used to be. But the right financial products at the right term are still being evolved,” noted Ben Schmerler, director of investor relations at Root Capital, during a recent panel discussion I moderated. “That, combined with businesses that have the skills and acumen to take [financing] on, is a gap.”
New thinking about filling the gap
Some brands are beginning to provide CapEx financing to their suppliers. In the same panel discussion, Les Szabo of Dr. Bronner’s talked about how the company got one of its suppliers in Sri Lanka off the ground. Social lenders turned the supplier down for CapEx funding, so Dr. Bronner’s put up the capital. With some operational history, the borrower was able to get a loan from Triodos Bank at 8 percent, and is now borrowing from a local commercial bank at under 5 percent. Now Dr. Bronner’s is working with Root Capital on a Ghana supplier’s $450,000 facility-expansion project.
Smaller brands, however, often face a choice between providing CapEx financing to suppliers and investing in other crucial aspects of their business. At RSF Social Finance, we’re working on a solution to this problem for Guayakí and other fair-trade companies in our Social Investment Fund portfolio. Since we don’t lend internationally, we’ve come up with the concept of trust underwriting: where we have a trust relationship with a fair-trade borrower, and that borrower has trust relationships with its suppliers; we will offer our borrower loans at reasonable rates (around 5 percent) to fund its suppliers’ CapEx needs.
We believe that by relying on trust and community, we can reduce transaction costs — one of the biggest barriers to supply chain financing for both the lender and the borrower. Our relationships with existing borrowers mean we don’t have to underwrite the life out of these loans. We’re piloting this concept with a philanthropic fund, which enables us to take more risk than we could with our main investment fund, and if we can prove that the model is sound, we hope others will replicate it in different sizes, regions and supply chains.
Strong relationships are the secret to success
If this strategy works, the impact could be huge — but the relationships have to be there. Scott Leonard, CEO of the ethical fashion company Indigenous (a former RSF borrower), made that point during the panel. “Are we as brands and investors willing to work within that community?” he asked. “How far are we willing to go to benefit that community? We often stop short.” He noted that Guayakí is trying to build the sustainable yerba mate market for everyone, not just for Guayakí. Similarly, Indigenous is working in Peru to help alpaca farmers do their own spinning, but when their product reaches the market, “Maybe 5 percent of it comes through Indigenous.” This kind of capacity-building “creates a unique opportunity for the community.”
Even at a company the size of Dr. Bronner’s, community relationships are key to achieving significant impact. “It’s all about connecting directly with farmers,” Szabo said, citing his company’s use of a fair-trade premium fund to support community-driven projects.
True partnership is the thread that ties together all the potential supply chain solutions I’ve seen. If we develop trusted relationships throughout the supply chain and extend ourselves to find solutions that work at the systemic level, we should start to see better opportunities for those who need them most.
For more information, check out the video below:
Image courtesy of RSF Social Finance
Kate Danaher is lending manager for sustainable food and agriculture at RSF Social Finance, a pioneering funder of social enterprises based in San Francisco.