Economies of scale ineffective in Lankan tea business

Dr N Yogaratnam, Chairman, Tree Crops Agro Consultants

Sri Lanka had an established reputation as a leading producer of the world's best teas. However, in recent years, there has been increasing discrepancies between reputation and performance.

The export-oriented industry is under increasing threat from within and without.

A range of complex domestic issues has negatively affected productivity and efficiency, while increasing international competition has had significant impacts on product price and profitability.

Tea is a natural beverage that competes with other natural and formulated beverages.

The five major players in world tea trade in the last ten years, {2000, actual and 2010, Forecasted (FAO) } demonstrate a variable but obvious trends for increasing supply (22.7 percent) and exports(1.72 percent) over the 10 year period (table 1 ).

The dominance of these five main producers is currently under challenge. Their contribution to world trade fell from about 80.7 percent of tea exports in 2000 to 72.6 percent in 2010.

This was largely due to the production from new market entrants including Vietnam, Cuba, Argentina, Brazil, Peru, Uganda, Bangladesh, Malawi and Malaysia.

As can be seen, Sri Lanka occupies second place in total production volume and is still the leading exporter, with 25.7 percent of the world total.

However, its declining importance is seen in the statistic that this share of world trade has dropped from 40 percent in 1970 to 27.9 percent in 2000 and to 25.7 percent in 2010.

Furthermore, its 7.87 percent production volume increase in the last 10 year period is far less than the impressive increases of competitors in Asia and Africa, such as India by 31.3 percent and Kenya by 28.8 percent.

Sri Lankan Tea

The key economic indicators of the Sri Lankan tea industry, namely the privatised large-scale plantation or estate sector, and the smallholdings sector,indicates in general the superior performance of the smallholder sector relative to the plantation sector (Table 2).

Despite a workforce only half the size of that in the estate sector, the smallholder sector contributes almost 2.5 times as much to national tea income, as a result of superior performance in both crop productivity and labour productivity.

This appears to directly contradict the theory of economies of scale, especially in this situation where plantation production has been established for almost 160 years, whereas smallholder production is a much more recent development, dating back only to the 1970s, and receiving Government policy support only in the 1990s.

The increasing trend in tea production since 1993, to a record level of 318 million kg in 2008 is attributable mainly to growth of the smallholding sector. In 2009, tea production in Sri Lanka declined by 9 percent to 290.89 million kg, being its worst performance since 1999, both plantations and smallholdings recording a reduction of 5.2 percent and 2.5 percent, respectively. Yet, the smallholding's share of 55 percent is remarkably higher than that of the plantation's share of 39 percent.

However, the industry is subject to complex issues, both domestically and internationally

Loosing market leadership

Comparative data for Sri Lanka, India and Kenya for a range of indices, show that whereas the private smallholder sector was very competitive with major competitors India and Kenya, the plantation sector was afflicted with low productivity and high cost of production.

Yield (Kg/ha); Sri Lanka- Plantations, 1275, Small holdings, 2450; India (North)- 2127; India(South)-2300 and Kenya, 2237. Intake per Plucker (Kg): Sri Lanka- Plantations 13.5, Small holdings, 24.5; India (North), 26.2; India (South),25.2 and Kenya, 48.0. Labour / ha (Persons): Sri Lanka- Plantations, 3.21; Small holdings, 2.78; India (North), 2.67, India (South), 2.50 and Kenya, 2.20. Cost of Production (US$ /Kg): Sri Lanka- Plantations 2.04, Small holdings, 1.54; India (North), 1.52; India (South), 1.39 and Kenya, 1.00.

Although these figures may need updating, yet they are indicative of the continuing gravity of the situation.

Production orientation

The Sri Lankan tea industry still concentrates on volume of production rather than market demand. It has failed to adequately exploit new market needs such as value-added teas.

In the past two decades, there had been some progress in this direction, yet it has been unimpressive with less than eight percent of the tea exported only, belonging to higher value-added categories (tea bags, instant and green tea).

Currently, only about 40 percent of the tea exported is packeted, while the rest is bulk tea. In reality, although Sri Lankan tea producers complain about volatile markets and low profit margins, the country has lost its market shares in several regions due to the higher prices and the poor quality of tea.

In addition to these issues, there are specific and critical issues in relation to both sectors, which are discussed below;

Issues in the tea plantation sector

1. Old Tea Bushes

More than 50 percent of tea fields are 100 years old and are still in seedling tea.

Replanting with VP tea has still not been done as desired.

2. Lack of Basic

Product Mix

Orthodox types of tea have been dominant, despite a growing demand for fast-infusing crush-tear-curl (CTC) tea in the Middle East, Pakistan and Russia. Only 3 percent of Sri Lanka's tea is CTC in contrast to India's 83 percent and Kenya's 98 percent.

3. 'Old' technology

The geography of most tea cultivation areas limits mechanization of harvesting and other field activities. Moreover, the majority of the tea factories that are in operation are small and use obsolete technologies.

The average area served by a factory is 308ha as opposed to 1,000ha in Kenya, where smallholdings dominate the tea sector. This creates higher processing costs for Sri Lankan tea.

4. High labour costs

Tea plantation activities are labour intensive. Rising labour cost is a major contributory cause to declining profitability. The political bargaining power of workers' unions, influences wage costs, for example through winning wage increases which also include the unusual guarantee of 300 days work per year, unjustifiable on productivity grounds.

5. Politicization of labour relations

Workers are used by politicians for their political agenda. Politicians strongly influence policy decision-making on plantations.

This is only a part of more complex reality which involves peculiar etho-politico, union- worker relationships, and workers security.

6. Paternalism

The trade union-worker relationship represents the paternalism which is in some ways reflects the old estate management-worker relationship from colonial times. The trade union is an institution that reproduces feudal bureaucratic social relations.

Issues in the Smallholdings sector

1. Quality, Unity and Identity

The main issues stem from the large number and diversity in size and location of the 500,000 smallholdings. Quality of product is reduced by damage to an estimated 30-40% of tea leaves during transport. There is no politically free institution to facilitate market unity. As a consequence, processing efficiencies and market brand identity are elusive or unavailable.

2. Politicizing

This peasant sector is attractive to politicians and they form co-operative type of societies to achieve their political objectives.

3. Exploitation

Agents such as collectors, transport providers, and brokers may exploit smallholders through low payments, wrong weight measurements, and unreasonable deductions.

4.Growth

Land scarcity limits expansion of smallholdings.

5. Labour

Most tea smallholders employ family labour, but problems of labour supply are emerging because the young generation is resistant to this work as it has low dignity in Sri Lankan society. In this social structure, parents also encourage children to be educated and find a socially accepted job. This issue is common for tea plantations as well-From one of surplus to deficit with an annual decline at the rate of 10-20 percent of the workforce.

Tea Small holdings; small scale, large contribution

Within the last two decades, the smallholding sector, comprised 500,000 holdings of 0.5 to 20 ha, has shown remarkable improvement in productivity, land consumption, employment and income generation to the industry.

This sector, accounting for 61 per sent of total output, recorded a significant growth over the last 10-year period, compared with a 2 to 3 per cent growth in the production under regional plantation companies.

The average yield in the smallholdings sector, at 2216 kg/ha is almost close to double that in the larger scale plantation sector.

Despite its superiority in numerous ways to the plantation sector, the smallholding sector is not free from problems.

As illustrated above, these include political interventions, a lack of proper institutional and policy frameworks, and the nature of peasant type of production, characterized by lack of information and knowledge of farmers, lack of market orientation, and reliance on traditional technology, family labour and management.

Reasons for the sector's apparent success, despite such problems, include lean structure, family ownership and control, low transaction cost, clear property rights, and the state's subsidiary mechanism.

Therefore, the smallholdings enjoy high productivity and low cost of production.

There are also clear socio-cultural heritage reasons for the sector's success. There exists a clear preference for small-scale cash crop production over other forms.

This preference is rooted in religious values and beliefs, which embrace the simple life and low expectations, and provide neither confidence nor experience in 'managing' in the industrial capitalist sense. Their main value is to be satisfied with what they have.

Low productivity

It is not easy to provide prescription for such a complex industry. Any measures aimed at improving commercial performance must be able to be aligned with socio-cultural forces including state political machinations, trade union power, security of land tenure, and workforce attributes such as values, religious beliefs, ethnicity and class structure.

One area needing urgent attention if plantation production is to become more viable is to address the labour-intensive nature and high cost of production. Efforts need to be focused on lifting land and labour productivity substantially.

If major competitors are able to profitably sell their tea for half the price of Sri Lankan product , Sri Lanka must strive to do the same.

Total mechanization is not possible, but partial mechanization of field operations has the potential to reduce cost, improve land and worker productivity, and also boost the morale and status of workers as skilled machine operators. In addition, time-and motion and ergonomic studies could be initiated for devising ways to improve field and factory operations.

Research on product improvement and development, and promotion of Sri Lankan tea is two other key areas to be dealt with.

Revision of policy frameworks and institutional arrangements are necessary to address these areas without opportunistic political agendas.

Workforce issues

Other major challenges for the plantation sector are related to the workforce. Chronic absenteeism has major impact on labour productivity and cost, while workforce continuity and industry viability are threatened by out-migration for better conditions and a more fulfilling life outside the tea sector.

Raising the living, housing and working conditions for tea workers could address these issues.

Related to this is the need to redress the low cultural esteem for tea industry employment.

Both Sri Lankan and Indian workers have similar cultural origins, and are similarly attuned to accept paternalism, collectivism, respect for authority and existing class structures, and dependency.

Bureaucratic systems in the plantation section in Sri Lanka do not fully acknowledge such socio-cultural complications, and conflict is the common result. Therefore, a socio-cultural approach to the management system has to be incorporated in order to increase worker commitment. This is now being attempted by some of the RPCs.

Smallholder sector development

The smallholding sector has potential for further development as a competitive force.

This needs a central organising body more stronger than the TSHDA, to co-ordinate activities, which should include an effective extension system. Community-based programmes can be implemented to enhance collective bargaining power and find possible solutions for labour problems.

Collective power can be utilised to gain economic advantages available through wholesale buying of resources, transportation and sharing of knowledge.

To summarize

The continuity of the plantation holdings depends on raising productivity of land and labour through innovative agricultural technology and professionalism in management Raising profitability can be achieved through raising productivity and consequently lowering the cost of production and enhancing value addition.

This is a major challenge for policy makers and plantation management.

The smallholdings sector had been showing attractive growth and internationally competitive performance during the last 10 years, and has clearly overtaken the large plantations in terms of efficient use of resources, profitability and productivity.

However, this sector is challenged by problems of shortage of labour and land, inconsistent product quality, exploitation by intermediates, and marketability of tea leaves. Yet their survival and domination is assured due to their lean structure, family ownership and control, and family labour.

Historically, the large size of plantations has not conferred any inherent economies of scale that were not internal but external to it.

Even today, in the cultivation of tea, the large plantation does not enjoy any inherent economics of scale over smallholdings, as indivisible technologies are conspicuously absent.

Furthermore, external diseconomies can result if the individual estates belonging to the same company do not generate sufficient profit margins to cover overheads.

As cultural-political-production relations are dominant, the theory of economics of scale has no meaning in Sri Lankan tea business.

Will "small is beautiful" philosophy help?