Value Chain Glossary: Incentives
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Incentives
Any factor that encourages enables or motivates a particular course of action. This includes monetary (a higher price, lower financing risk) and non-monetary incentives (such as stability, learning, opportunity for future contracts). Incentives exist along all levels of the value chain. Incentives are directly related to governance structure and the nature of the firms along the chain. Development programs can be more effectively designed and implemented, by understanding incentives and risks early on.
The importance of identifying incentives along a value chain is illustrated by the following examples:
Transactions in the Indonesian Sulawesi cocoa-bean market are driven largely by price and volume. Conformance to quality specifications is not important since a market exists for almost all levels of quality. While international buyers express frustration with the inconsistent quality of the Sulawesi bean, most continue to source from Indonesia. Unless market signals change, there is little incentive for suppliers to upgrade. Attempts by buyers to improve Sulawesi bean quality has so far, proved futile.
Mali is the world’s second-largest producer of shea fruit,a naturally occurring, uncultivated crop. Despite its endowment of shea trees, Mali is a poor competitor on the global market for kernels and butter. The kernels, sought by international vegetable oil firms, are of generally poor quality and yield less oil than kernels from other West African countries. Gaps in the competitiveness of Mali’s shea kernels are found at the production and trading levels. Traders, whose networks are led by exporters, comprise 3-4 layers of intermediaries buying and selling multiple rural products. They generally purchase kernels indiscriminately and seldom control for quality. Producers, rural women gather shea fruit and process it to remove and sell its kernels or transform them into shea butter. Traditional processing practices are the main source of quality degradation.
The international vegetable oil firms have strong incentives to develop Mali as a reliable source of good quality kernels. They are investing in direct relations and greater cooperation with Malian exporters. Exporters and traders are also investing in improvements to the value chain, but to a lesser degree as they fear allocating too many resources to only one of their product areas, preferring to spread their resources, and risks, more broadly. Producers have few incentives to upgrade their processing practices as they currently perceive little benefit. Increased inter-firm cooperation between vegetable oil firms and exporters, especially the learning flows it engendered, had a dramatic effect on amplifying exporters’ incentives to invest in the shea kernel value chain. Sensitized to the international demand and its quality requirements, exporters sought to educate producers through radio and other means, and organized themselves to control quality. A local development project helped facilitate buyer-exporter relations by fostering market actors’ incentives and mitigating their risks. [1]
Accessing finance is a common challenge for many MSEs. Financial institutions are often reluctant to lend to businesses with little or no collateral. Purchase order finance (POF) is effectively an advance by the lender to the borrower for working capital secured by a verified purchase order or sales contract. POF is a transaction-based form of working capital finance that allows MSEs to fill more frequent and/or larger orders and thereby grow and become more profitable. It is also an attractive, low risk incentive for financial institutions to engage with MSEs in profitable transactions. In Bolivia's Chapare and Yungas regions, POF has helped small-scale farmers access working capital to fill purchase orders. The introduction of the POF instrument into the Bolivian financial market has created an incentive for FIs to work with MSEs and has helped farmers meet production demand.[2]
Related Articles
- microREPORT: Mali Shea Kernel Value Chain Case Study. Derks, Eric; Lusby, Frank. March 2006.
- microREPORT: Indonesia Cocoa Bean Value Chain Case Study. Panlibuton, Henry; Frank Lusby,Frank. June 2006.
- microREPORT: Purchase Order Finance in Bolivia: Innovations in Financing Value Chains. Schiff, Hannah; Stallard, Janice. May 2009.
- In Discussion Forum: Value Chain Finance Increasing Incentives and Reducing Risk
- Book Reference: Value Chain Development for Decent Work: A guide for development practitioners, government and private sector initiatives. Herr, Matthias; Muzira, Tapera. 2009.
Footnotes
- ↑ [1] microREPORT: Mali Shea Kernel Value Chain Case Study. Derks, Eric; Lusby, Frank. March 2006.
- ↑ [2] Purchase Order Finance in Bolivia: Innovations in Financing Value Chains. Schiff, Hannah; Stallard, Janice. May 2009.
