The supply of raw materials to agribusinesses in Brazil: Development of a conceptual model

Author: Olivier François Vilpoux

Researcher at the Catholic University of Campo Grande (UCDB) – Center of Technology and Agribusiness Study (CETEAGRO), Mato Grosso do Sul State, Brazil.

E-mail: vilpoux@ucdb.br

Address:Ceteagro - UCDBAv. Tamandaré, 6000Jardim Seminário79117-900 Campo Grande – MSBrazil

1

The supply of raw materials to agribusinesses in Brazil: Development of a conceptual model

Abstract:Organization of raw material supply chains has a major role in reducing the effects of production seasonality and improves regularity of supply, quality and price. Companies must find institutional arrangements that ensure a supply with as much regularity as possible. The research starts with the hypothesis that Transaction Cost Economy does not explain transactions with informal warranties. The research assesses industries with different governance systems and explains the reasons for the choices made. Has been used a model that combines formal and informal institutions with the model of Williamson. Institutions serve as warrantees for adopted governances. The information was obtained from case studies. Two levels of specific assets have been identified, depending on the degree of perception of the actors. When unnoticed, the existence of specific assets leads to the adoption of transactions in the spot market. When participants perceive specific assets, there is difficulty finding the necessary guarantees. Formal contractual safeguards only work with larger producers and informal guarantees are difficult for companies transacting with many producers. The adopted solutions are transactions in the spot market and vertical integration. Following our model, this kind of governance represents an inefficient solution, explained by the malfunctioning of formal and informal institutions. Key-words: Transaction Cost Economy, Social Economy, Institutions, Social Capital

1. IntroductionThe Brazilian agribusiness accounts for about 30% of national GDP and is responsible for just over a third of national exports and jobs. Of the total of Brazilian agribusiness, a third comes from small family farms (Brazilian Agrarian Development Ministry - MDA, 2006).Working with agricultural products has always represented a major challenge for food primary processing. The seasonality of production, perishability of products, changes in the quality of raw materials and sensitivity to climate instabilities are difficult to administer. On the other hand, consumers need regularity of supply, quality and price. Those realities are difficult to conciliate and represent a challenge for many agribusiness companies.To ensure the stability of their productions, companies must find institutional arrangements that ensure a supply with as much regularity as is possible. The Transaction Cost Economy (TCE), developed by Williamson (1985, 1996) from the article of Coase (1937), presents a methodological tool to understanding these choices. On one side is the spot market, based on prices and marked by the absence of ongoing relationships between actors. At the other extreme we have the vertical integration, which facilitates coordination and minimizes uncertainty in the transaction. Between spot market and vertical integration are hybrid forms, in which cooperation is built by the mutual interest of those involved in economic exchanges, constituting relations of medium or long term, benefiting both parties.Although covering formal and informal contractual relations, TCE does not explain why, in many countries, relations between companies and small family farmers are difficult. For the Food and Agriculture Organization - FAO (2009a), most organizations of small producers in the world do not work satisfactorily. The FAO warned that contracts are more common with large than with small producers. The latter prefer informal arrangements where the existence of social capital has a major role. Small producers are unlikely to engage in contractual relations, preferring the spot market, with no compromise between sellers and buyers (FAO, 2009b).

2

The role of informal relationships, based on social capital and trust, is frequently reported by economic sociology, but is only superficially examined by TCE. Even when Ménard (2004) treats social networks as part of the hybrid institutional arrangements, TCE has difficulties in explaining some forms of hybrid transactions based on the existence of trust. TCE also has some difficulties in explaining the use of the spot market, while transaction characteristics indicate the need for relationships with higher levels of guarantees, such as contractual relations and integration, in the case of cassava (Vilpoux, 2011) and milk supply. Despite these limitations, TCE is often used to explain the transactional relationships that exist between producers and agribusiness companies. However, small businesses have a great importance in the agribusiness of Brazil. Thus, although they occupy only 24.3% of the agricultural area, in the Census of 2006, the Brazilian small family farms represented 84.4% of national agricultural establishments, or 4.4 million families (Brazilian Agrarian Development Ministry - MDA, 2006). These producers represent almost the entire production of tobacco and cassava, 70% of beans and more than 50% of milk and pigs (Guanziroli and Cardim, 2002; Brazilian Agrarian Development Ministry - MDA, 2010).On the side of industrialization, micro and small businesses, with fewer than 20 employees, represent the majority of processing plants in many industries, such as cassava, milk and beans. Even in the most concentrated industries, as in meat, tobacco, corn and coffee, companies have to negotiate with a significant amount of small family farmers, as they represent around 30% of coffee production, between 40 and 60% of poultry, swine and cattle meat production, between 40 and 50% of corn and 95% of tobacco (Guanziroli and Cardim, 2002; Brazilian Agrarian Development Ministry - MDA, 2010).Besides the importance of small enterprises in Brazilian agribusiness, many processing companies operate in the informal system, further increasing the difficulty of analyzing the institutional arrangements using TCE methodology. Thus, Mathias (2008) estimated between 30 and 50% the amount of Brazilian beef slaughtered in a clandestine way. This percentage is similar in the case of milk and superior for cassava.This introduction allowed for an understanding of the importance of small family agriculture and micro and small agro-processing companies in Brazil, the role of informal relationships in this kind of enterprise and the difficulties of approaching these issues with TCE methodology. From these assumptions, the research objective was the analysis of institutional arrangements found in several industries of Brazilian agribusiness, using TCE methodology in conjunction with an approach closer to economic sociology, which allows for a better consideration of issues related to social capital and trust.The information on the governance systems of companies and characteristics of transactions were obtained from case studies published in the literature (sugarcane, tobacco, commodities, pork and chicken, tomato) or realized by the author (sheep, cassava, grapes, milk).

2. Institutional arrangements Institutional arrangements can be defined broadly as ways of organizing transactions. In the 1970s, Williamson returned to the concepts of Coase (1937) and presented the basic proposal that markets and hierarchies are alternative ways of organizing capitalist production. From this period, TCE has become the most appropriate approach for studying the mechanisms used for the coordination of transactions, because it involves the analysis of contractual relations established between participants in a production system.According to TCE, on the one hand is the spot market, where the "invisible hand" of Adam Smith is present. In this type of arrangement, the economic agents follow their interests and short-term relationships are developed, taking the price as a barometer for the interactions. The spot market transactions are marked by the absence of continuous relations between the actors. At the other extreme is vertical integration, in which economic actors become part of

3

the same entity, which facilitates coordination and minimizes uncertainty in the transaction. For TCE, between spot market and vertical integration hybrid forms are found, in which cooperation is built by the mutual interest of those involved in economic exchanges, constituting medium or long term relations, benefiting both parties. According to Peterson, Wysocki and Stephen (2001), insofar as there is movement from the spot market to vertical integration, the invisible hand of Adam Smith makes room for coordination efforts, which take their maximum condition in vertical integration, looking to reduce transaction costs.In TCE, hybrid forms are made up of contractual relations. However, in the original approach of Williamson, little importance is given to this type of arrangement, considered of secondary importance.Furubotn and Richter (2005) separate the contractual relationships in two groups, protected and unprotected by law. The legal agreements are in turn ranked among the standard contracts (contracts without flexibility) and relational agreements (Macneil's inspired term) with continuous renegotiation of relations in light of certain events. In this case, personal relations between the participants of transactions are important. In the group of contractual relations not protected by law, the engagement between participants is even more important that in relational contracts (Furubotn and Richter, 2005). Ménard (2004) reinforces this position when he states that the effect of reputation is important in hybrid forms and this is facilitated by the repetition of transactions between actors. For the author, a key feature of the hybrid forms is a mix of mutual dependence and the need for continuity in relationships. The arrangements with these features work between the market and the hierarchy and can be formal or informal.

3. Choice of institutional arrangementsChapter 2 identified the different types of institutional arrangements, with the importance of formal and informal hybrid arrangements. However, with the large number of possible options, it is important to understand the process of selecting an arrangement for a particular transaction. TCE, developed by Williamson from the pioneering work of Coase (1937), proposed to solve exactly this problem.

3.1. Transaction Cost Economics (TCE)The theory of TCE may be considered an arm of the New Institutional Economics (NIE). Williamson (1985) differentiates it from other theories that study the economics of organizations by pointing its micro analytical character, incorporating behavioral assumptions in his analysis, considering relevant investments in specific assets and recognizing the firm as a governance structure and not as a simple production function. For the author, TCE puts economic issues in the organizations as a contractual problem.In continuation of Coase's famous paper in 1937, Williamson (1985) states that the neoclassical assumption of transaction costs equal to zero is a fiction. The institutional arrangements arise as a response to the need to minimize costs (transaction and production costs). For the author, the internalization of transactions is the result of the comparison between the hierarchical and bureaucratic costs in relation to the costs through the market.The understanding of TCE involves the acceptance of behavioral assumptions of bounded rationality and opportunism. As explained by Williamson (1985), bounded rationality is related to the incompleteness of contracts, to the extent that some elements of the transaction are not hired ex ante. On the other hand, the opportunistic behavior of agents leads to renegotiation and, possibly, disruptions and disputes ex post. This opportunistic behavior may be more or less harmful to the contractual relationship, resulting in transaction costs. It can be argued that bounded rationality and opportunism are the structural basis of TCE.

4

It is established, from a steady increase in transaction costs, a chain whose extremes are exemplified by relations in the market (spot market) and vertical integration, with the existence of intermediate, or hybrid, forms consisting of formal or informal contractual relations. For TCE, the choice of an institutional arrangement by those involved in the transaction is done in search of reducing transaction costs. However, as stated by Pondé (2002), the organization of transactions within a company does not eliminate opportunism; it merely attempts to control it through hierarchy. There are three transaction attributes considered by the TCE, which influence the institutional arrangements adopted: frequency, uncertainty and asset specificity (Figure 1). The frequency is related to the recurrence or regularity of the transaction. The second attribute is identified with the uncertainty of the transactions related to the availability of information and opportunistic behavior of individuals. The third is the specificity of assets, which represents the costs arising from the impossibility of alternative allocation for the asset in any other transaction. Specific assets are those that cannot be reemployed without a loss of value, making the investment risky and generating transaction costs.For Williamson (1985) asset specificity is the attribute of greatest importance for the study of governance structures.

Source: Zylbersztajn (1995).Figure 1. Analysis model of institutional arrangements in business transactions.

Williamson (1996) believes there are six types of asset specificity: a) site specificity, where proximity saves transportation costs and storage; b) physical assets, which refers to the specialization of assets needed to produce the product, c) human assets, which refers to the need for an investment in human capital to carry out the activity; d) dedicated assets, which are investments made for specific customers, e) brand, referring to investments in the brand of a company; f) temporal, in which the value of the transaction is related to the time that it is processed, intimately connected with perishable products.Transaction costs are directly linked to these factors and influence the institutional arrangements adopted. When firms adjust to the basic characteristics of transactions, they minimize transaction costs. This model is important for a better understanding of the mechanisms of choice of institutional arrangements. However, the analysis of TCE is incomplete and despite recognizing institutions as important, it considers them as static and constant for all parties involved, which limits their influence on the choice of arrangements. In countries like Brazil, where formal institutions are not always well defined and secure and where the influence of laws can vary between actors, TCE has difficulty explaining some of the arrangements found and new features need to be added to the analysis model.

3.2. Control of institutional arrangementsFor North (1990), rules, or institutions, allow for a defining of the limits within which institutional arrangements evolve. 3.2.1. InstitutionsNIE is dedicated to the study of institutions, or rules of the game, both formal and informal, that

5

structure social interaction and the role of economy and politic in the coordination of human actions (North, 1990). The role of institution is to reduce the cost of interactions between humans, constituting an important element of development and economic efficiency.There is a clear distinction between institutions and organizations. The first concerns the rules of the game, while the second refers to the agents. Organizations can be political (political parties, legislative assemblies, municipal governments), economic (companies, cooperatives, farms) and education (schools, universities). They are groups of individuals involved in the same way, seeking to reach a specific goal. Institutions are created and changed by human beings and organizations can be understood as agents of institutional change (North, 1990).Institutions affect the performance of the economy by affecting production and transaction costs. Both institutions and organizations provide structure to human interactions, the reduction of uncertainties being the main role played by institutions, which is achieved with the establishment of a stable structure (North, 1990 and 1991). To Theret (2003), institutions function as cooperative agreements, or as rules of coordination. North (1990) has investigated the role of institutions in the evolution of the economic context. The author describes them as being characterized by a) formal rules - the constitution, laws, property rights and b) informal aspects - taboos, customs, traditions and codes of behavior. For Nau (2005) institutions delineate the list of behavior expected and accepted in a particular context.Felipe (2008) states that informal institutions regulate and shape the behavior of the individual without the need for a legal apparatus. As informal institutions emphasize the relationships between actors, the penalties for non-standard institutional attitudes are also relational and consist mainly of the removal or exclusion of the group.In approaching the role of informal institutions, North allowed a link between the analysis of formal institutional mercantile arrangements, approached by the TCE, and informal arrangements, more common in small family agriculture and micro and small national agribusiness companies. This junction provides an important mechanism for analysis of interactions between parties involved.Informal institutions “refer to the complexity of values, norms, beliefs and meanings, symbols, customs and socially learned and shared standards, which outline the list of expected and accepted behavior in a particular context" (Nelson, 1995: 80). This definition is close to that of Nau (2005), for whom institutions limit the choices of the player and form a frame of reference. This frame sets the parameters according to which strategic action is taken.Institutions reduce uncertainty, because they allow the involved parties to predict the behavior of each other. This reduction of uncertainty facilitates the interaction between players and increases the levels of trust between partners, which, as they are working together, come to know each other better and therefore cooperate more easily. In this case, trust can be considered an efficient mechanism for controlling institutional arrangements.3.2.2. Trust RelationshipsTrust can be defined as the willingness to accept vulnerability to the actions of others, based on positive expectations of their behavior (Tillmar and Lindkvist, 2007). This attitude is due to two types of expectations:Depending on the judgment of a person about the tendency of another person to behave opportunistically;• Depending on the possibility of a person to behave opportunistically in accordance with

the local and global restrictions, norms and formal controls. This type of trust is defined by Williamson (1996) as institutional trust, linked to the existence of penalties that increase the cost of opportunistic behavior by encouraging the respect of agreements between parties.

For Baudry (1991), ancient relationships create a routine of personal links based on the notion of trust. In this case, as the relationships are only implicit, it is not necessary to formalize a written document. Mueller (1995) mentions three forms of trust:

6

a) Reputation, based on honesty and past experience. Ricketts (1987) emphasizes the importance of reputation, which allows for lower transaction costs. If a person acts opportunistically and if his actions are observable by others, the cost of his actions will quickly exceed his benefits. In a turbulent environment, the risk of opportunistic behavior increases and the actions of agents become inherently more difficult to measure (performance evaluation, from Milgrom and Roberts, 1992). That kind of trust can be assimilate to the calculative trust of Williamson (1996);

b) Possession of common characteristics, such as those in an ethnic group;c) Belonging to the same social organizations.

The existence of trust facilitates relations between economic agents. Trusting someone means “bracketing the risk” (Tillmar and Lindkvist, 2007). For the authors, it requires a “leap of faith”.Trust should not be reduced only to a formal cooperative relationship, because it involves interactions with strong mutual learning. It is in these relations of trust that tacit knowledge is shared among agents. For Sabourin and Teixeira (2002) the principles of mutual trust allows for:

a) The minimization of the uncertainty associated with opportunistic behavioral practices;b) The minimization of the costs related to contractual arrangements that incorporate

defensive mechanisms for monitoring the conduct of agents;c) The optimization of the division of labor within the network, adjusting the scale of

production and avoiding a duplication of effort;d) The facilitation of the transfer of tacit information.

With many authors such as Putnam, Coleman and Fukuyama, trust is confused with the notion of social capital. However, for Lin (1999) and Reimer et al. (2008), although related, these two aspects cannot be confused.

3.2.3. Social capitalThe term social capital has been used with increasing frequency to explain social and economic development and cooperation between individuals. Family, neighborhood, friendship and professional relationships can be latent forms of social capital. These relationships go through a set of norms, beliefs and social values that are specific to a community and as such can be considered as local institutions. Bourdieu (1980) describes social capital as “a durable network of more or less institutionalized relationships of inter-knowledge and inter-recognition”. In the works of Coleman (1990) and Putnam (1996) social capital emerges from the characteristics of the social organization of which the authors emphasize the trust and norms. These characteristics contribute to an increase of the efficiency of society by facilitating coordinated actions.Fukuyama (1996) defines social capital as a set of informal norms that promote cooperation between two or more individuals. For the author, the norms that constitute social capital can range from simple rules of reciprocity between two friends to complex and elaborate doctrines like Christianity or Confucianism (informal institutions). It is from the existence and sharing of these standards that trust and networks between individuals arise. Coleman (1988) distinguishes four main sources of social capital:

• Type 1: strong links, through family, community and religion. It provides the security necessary to facilitate market transactions.

• Type 2: frequenting the same school, church, city, etc. • Type 3: same culture (existing standards). • Type 4: recurrent market relations.

7

Lin (1999) defines social capital as being linked to resources embedded in a social structure that can be accessed by individuals. For the author, the capital contains three elements, the resources embedded in social structure, accessibility to these resources and the use by individuals, or mobilization, of these resources. This definition is similar to that of Bourdieu (1980) for whom the volume of capital of an individual depends on the size of the social network that he can mobilize and the amount of capital tied to network members. Thus, the link with a lot of people without much power (financial, access to information,...) is not a relevant social capital.According to Albagli and Maciel (2004), social capital provides:

• Easier sharing of information and knowledge as well as lower costs due to the relations of trust, a cooperative spirit, common socio-cultural references and objectives;

• Better coordination of actions and organizational stability, due to collective processes of decision making;

• Greater mutual understanding, enhancing the predictability of behavior of agents, reducing the possibility of opportunistic behavior and providing a higher commitment to the group.

As defined by Lin (1999), social capital is based on social networks whose character is essentially non-mercantile, or non-financial, but once used can provide for individuals, or groups of individuals, a financial return, as they enable the realization of mercantile transactions.

4. Analysis model of institutional arrangementsIn selecting the characteristics of the transactions relevant to the choice of institutional arrangements, before the asset specificity, the main characteristic of the model developed by Williamson, the dependency between actors has been added (Figure 2).

Figure 2. Basic characteristics of transactions that influence the choice of formal and informal institutional arrangements.A dependency relationship consists in the capacity of an actor gaining more by interacting with other actors than by acting alone. As a result, the actor will seek to interact with others, avoiding spot market-type arrangements, arrangements typical of situations with no dependence.A simple dependence between actors is not sufficient to explain the types of institutional arrangements adopted by these ones. In the case of dependency, the finalization of the transaction means the loss of additional gains linked to the interaction, but is not synonymous with effective loss for the actors. It is possible to cite the example of producers, or companies, that join to make common purchases. In this case, the common purchases characterize a cooperative arrangement and allow for the increase of scale and lower prices. However, the completion of the arrangement does not imply costs for the involved parties, who return to their situation prior to the cooperation agreement.To complement the analysis it is necessary to introduce the notion of specific assets, as defined by Williamson. The occurrence of asset specificity means the impossibility, or difficulty, for an actor to change his partner after starting a transaction with other agents. To Fiani (2002), after investing in specific asset, the buyer and seller enter into an exclusive relationship, which increases the dependency ratio. In this case, the cost caused by the disruption from the transaction brings

8

the actors to seek institutional arrangements that offer some kind of guarantee before starting the transaction.To the traditional asset specificities described by Williamson, it is possible to add one, the social specificity, which is the time and effort spent by the participants in the functioning of the interaction. The construction of this investment, similar with the social capital necessary for the implementation of an ongoing relationship, has a cost similar to that described by Orstrom (2011) to establish and maintain a relationship with other individuals. In the event of termination of the interaction, this investment is lost, as with other types of specificity. Thus, the interaction between two or more actors can create some degree of asset specificity.In addition to the dependency between involved parties and the specificity of assets, the choice of institutional arrangements needs to consider the level of uncertainty that exists in the transactions. For Williamson (1985) the more risky the transactions, the more intermediate coordination modes are left out in favor of spot market transactions or vertical integration.The frequency and duration of transactions, discussed in the TCE, were not included in the model of Figure 2. It has been estimated that these features were directly linked to the level of uncertainty, because frequent and durable transactions favor the development of common rules and an implementation of trust relationships that reduce uncertainty.The model presented in Figure 2 indicates the characteristics relevant to the reduction of transaction costs and for the choice of institutional arrangements, but not the kind of influence of these characteristics. For this purpose has been elaborated the model presented in Figure 3.

Figure 3. Mechanisms responsible for the adoption of institutional arrangements.According to the assumptions of TCE, in the presence of bounded rationality and the possibility of opportunistic behavior, it is possible to consider that, with the exception of spot market, there is always uncertainty in the interactions established between actors. In this case, uncertainty can potentially influence all interactions.The model presented in Figure 3 identifies the existence of dependency between the actors as the most important feature of the transaction. The preliminary condition for the existence of an hybrid transaction is to generate positive

9

gains between participants, among which we can mention, in addition to direct financial gain, access to more developed technologies, to different markets, to information difficult to access, to acquisitions of larger quantities and lower prices, etc.Importantly, if there is a dependent relation between actors, it should be clear and accepted by the participants of the transaction. In Brazil, where the educational level of producers and in small agribusinesses is rather low, the lack of awareness in regards to the importance of better coordination among stakeholders can lead to the preference for less efficient arrangements, as in the spot market.The perceived dependence is a condition for the existence of a lasting interaction between actors. Once this happens, asset specificity comes to have great relevance. To Fiani (2002) asset specificity is required for the consideration of the risk connected to opportunistic attitudes. In a situation with dependence but without specific assets, completion of the interaction would not bring losses to the participants, it would only prevent them from benefitting from this interaction. In this case, guarantees are not necessary for the realization of the transaction.Lasting transactions between participants favor the emergence of social specificity. Consequently, in the case of interaction of actors who have some dependency between them, it is frequent to have some degree of assets specificity, with losses related to early termination of the interaction.The existence of asset specificity in the presence of uncertainty increases transaction costs and forces participants to seek guarantees that the relationship will occur without problems, until the end. The greater the assets specificity, the greater the necessity of guarantees. As shown in Figure 3, the first level of guarantee is provided by formal institutions or, as North (1990), by formal rules of the game. The existence of efficient contract laws reduces uncertainty and allows for formalizing the interaction between individuals with the adoption of contractual arrangements. However, the difficulties of contract enforcement (performance evaluation) and issues related to compliance with the laws, such as the cost and time related to legal proceedings, can harm contractual solutions. Britto (2002) identifies two types of flows between companies participating in one network:• Tangible flows, through which are transferred inputs and outputs that can be easily monitored, allowing the adoption of systems of formal contractual governance. These flows are found primarily in commercial transactions. • Intangible flows, for which there is no formal contractual framework that regulates the transmission and reception. In this category are introduced information flows and all flows whose outcome cannot be measured precisely.The fact that the result of intangible flows is not measurable prevents the functioning of formal guarantees, forcing the actors to seek alternatives safeguards. Even in the case of tangible flows, the adoption of formal arrangements is not always a solution. Besides the evaluation of activities, the use of legal guarantees involves the existence of penalties for lack of compliance to the agreed actions.Vilpoux (2010), after interviewing 37 companies processing cassava starch, found that 70% of them did not believe in justice for solving their business problems. Consequently, for a lack of belief in a judicial resolution, companies were seeking arrangements based on trust. In Brazil, the formal institutions offer mainly high levels of guarantees in transactions between large companies. For transactions with small businesses, such as those found in many commercial transactions of Brazilian agribusiness, the guarantee level drops considerably. In this type of business, transacted values are reduced and many businesses operate completely or partially in the informal sector, which complicates the judicial recourse in cases of dispute.In the case of a malfunction of formal institutions, the players need to seek alternative guarantees, such as informal institutions or social capital. The proximity of actors, with the existence of a common regional culture and sharing of the same rules, allows for the emergence of informal institutions. The fact that individuals belong to the same clubs and associations, and share the same norms, beliefs and values facilitates the presence of social capital. Informal institutions and social capital enable the conducting of transactions based on trust (Vilpoux and Oliveira, 2010).Formal institutions do not require the

10

establishment of trust relationships. Two actors who perform a transaction by signing a contract do not need to know each other. The proper functioning of such institutions, with the existence of effective enforcement and dissuasive penalties for opportunistic behavior, is a requirement to ensure the realization of the transaction.In the absence of formal and informal guarantees, even with the recognition by the actors of a dependency between them and the existence of specific assets, the establishment of a lasting relation is very difficult and individual arrangements predominate, such as vertical integration and spot market. With the existence of dependency between actors, such arrangements, although indicated by the absence of guarantees, are not efficient because they are the result of an institutional deficiency, formal and informal.5. Examples of institutional arrangements in the Brazilian agribusinessIn the transactions between businesses and small family farmers, contractual relations are difficult. This aspect is emphasized by FAO (2009 b). Figure 4 helps to explain these difficulties.

* Case reported by Zylbersztajn and Zuurbier (2009)Figure 4. Institutional arrangements between farmers and agribusiness companies in Brazil.There are situations where coordinated relations between producers and companies are not required, as in the case of commodities for which there are no dependency relationships between actors. In the sheep industry, for most producers of Mato Grosso do Sul, a state located in the Central-South of Brazil, sheep production is just an additional source of income, in parallel with cattle, which is the main activity. The producer is not concerned with the commercialization of his production, which is small. In this case, he does not need guarantees and prefers to remain independent and sell in the spot market. A similar case can be identified with honey producers in the state. In other cases, there are relations of dependence between producers and companies, but these relationships are not perceived by at least one of the actors, often the producer. This is the case with cassava, where producers sell to the company with the best offer (Vilpoux, 2010)

11

and with small tomato growers in the Vale do São Francisco (Zylbersztajn and Zuurbier, 2009). In both cases, contracts with companies may be signed, but the lack of perception of future earnings related to the transaction encourages producers to break their agreements. Contracts are established on the initiative of companies, which see clearly the dependence between the actors. The producers do not realize this dependence and sign, fully aware that the contracts will not have influence on their future behaviors. This situation clearly shows the lack of engagement by producers, as indicated in Figure 4.In the cassava industry temporal and site specificities exists, requiring guarantees of delivery. Formal guarantees do not work and companies do not maintain contact with producers, which cause informal guarantees to become inefficient. A similar situation happens with tomato companies in the São Francisco region, North-East of Brazil, in their transactions with small producers, encouraging companies to look for alternative sources of supply, such as the importation of processed products (Zylbersztajn and Zuurbier, 2009).In the case of slaughterhouses specialized in the processing of sheep, there are physical assets and site specificities. As producers are small, formal contracts are difficult, leaving only the possibility of informal contacts as mechanisms of guarantee. As an example, we can mention a slaughterhouse in Campo Grande, capital of Mato Grosso do Sul State, Center-South region of Brazil, which requires stability in the delivery of its product, but does not maintain contact with producers and faces very large supply difficulties.According to the criteria of specific assets, there are restrictions on transportation and storage in the industry of milk, generating dependency with specific assets between the actors. However, the lack of formal and informal institutions precludes the establishment of guarantees, forcing companies to work in the spot market. Dotto et al. (2010) describe a small dairy company in a settlement of Mato Grosso do Sul, whose supply was carried out by settlers who have proved themselves loyal to the company despite fierce competition. The authors conclude that the fidelity was due to the personality of the owner of the enterprise, which had a large social capital in the settlement (was director of the local association, participated to the church, used her political contacts to improve the infrastructure of the settlement and to help producers with financial difficulties,…) and managed to establish trust relationships with suppliers. The production of sugarcane is an industry where the plants work with formal guarantees, through contracts or without interaction, through vertical integration. There is asset specificity in the industry similar to that found in the cassava sector, but with different arrangements. The production of sugarcane is carried out by larger producers than those working with cassava, which improves the security offered by formal institutions. A similar situation can be found in the tomato sector of the São Francisco, North-East region of Brazil, with the arrival of large producers and the establishment of formal contracts with processing industries, which offers a solution that is not possible with small producers (Zylbersztajn and Zuurbier, 2009).Transaction costs, which include the cost of running out of raw materials, are higher in the sugarcane industry, which has a large export market, than for cassava, with a mainly domestic market, which explains the preference of the first for vertical integration, unlike the cassava industry focused on the spot market. The industries of tobacco, poultry and pig adopt solutions called quasi-integration that mix formal contractual guarantees and securities based on informal relations, which explains the presence of these productions in both types of arrangements, in Figure 4. The existence of dependence between the parties and of specific assets requires the adoption of some kind of guarantee, both for companies and suppliers. The signing of contracts does not represent an adequate security and needs to be complemented by other mechanisms, such as delivering supplies and animals in the case of poultry and pork, and funding, technical advice and input delivery in the case of tobacco. These investments relieve the actions of producers and increase confidence in future commercialization.6. Concluding remarksIn the absence of dependency between actors, each agent acts individually in the spot market. This

12

situation is the one described by TCE as the absence of specific assets. In this case, this type of arrangement minimizes transaction costs and is more efficient. The purchase of commodities in the spot market is an efficient arrangement, which minimizes transaction costs.The existence of unnoticed dependencies leads to institutional arrangements similar to the previous example. In this case, there is no minimization of transaction costs and the situation is inefficient. The lack of more continuous interaction between actors is due to the lack of information and is not the most efficient choice of arrangement. The move to more suitable institutional arrangements, the hybrid arrangements of TCE, involves actions of information and explanation to clarify to individuals, or companies, the importance of this kind of interaction. It does not help to promote the adoption of relational arrangements if people are not clearly aware of the importance of interaction with each other. This is the main difference with the TCE approach, which considers that actors are fully aware of the specific assets that may exist in the transactions.The limit in the perception of agents of the dependence between them introduces two new concepts, the projection into the future and that of tangible and intangible costs. Any gain from a lasting interaction between two or more actors is linked to future return, and should be more important than the present earnings in spot market. The perception of this return requires an ability of projection into the future, ability related to the level of education of the individual. Further research should be conducted to prove this statement, research that may be useful to understand the behavior of many small family farmers and small Brazilian agribusiness companies. The distinction between tangible and intangible costs is also needed to explain the lack of perception of many farmers and small entrepreneurs. According to the theory developed in this paper, the interaction between individuals, or companies, is beneficial when the gains from the interaction outweigh the costs. However, the difficulty for someone to project himself in the future decreases the perception of his future earnings. In parallel, there are many intangible costs that increase the costs of transaction, such as the need to attend meetings, and especially the loss of freedom, with the necessity to respect the decisions of other participants in the transaction. These are costs judged as important by many small producers. In this case, the subtraction of tangible and intangible costs, together with underestimated gains, turns lasting agreements with little or no interest. These are aspects that must be worked out with the actors before encouraging any kind of transaction. Once aware of the importance of an extended relation, parties involved will seek guarantees in order to protect themselves from opportunistic actions. The formal guarantees do not require relations of trust between individuals, and thus are more comprehensive. In order to function, they need only effective formal institutions.Trust relationships, based on social capital and informal institutions, are the main type used in transactions with small farmers and micro and small companies in Brazil. These guarantees depend on common norms between the actors, norms facilitated by the existence of a common culture, participation in the same organizations and similar experiences, among others. Informal guarantees are useful with small businesses, but are more restrictive and should work as a complement to formal institutions and not as a substitution, as is occurring in Brazil. ReferencesAlbagli, S. & Maciel, M.L. (2004) ‘Informação e conhecimento na inovação e no desenvolvimento local’, Ci.Inf., vol. 33, n°.3, Sept./Dec.Baudry, B. (1991) ‘Une analyse économique des contrats de partenariat industriel: L’apport de l’économie des coûts de transaction’, Revue d’Economie Industrielle, n°.56, pp. 46 – 57.Bourdieu, P. (1980) ‘Le capital social: notes provisoires’, Actes de la Recherche en Sciences Sociales, Vol. 31. pp. 2-3.Brazilian Agrarian Development Ministry (MDA), (2006) Estatísticas do meio rural. Department of Statistics and Socioeconomic Studies, 2nd edition, Brasília: MDA – DIEESE publications.Brazilian Agrarian Development Ministry (MDA), (2010) Agricultura familiar no Brasil e o censo agropecuário de 2006, Brasília: MDA publications. Available: http://portal.mda.gov.br/portal/saf/arquivos/view/arquivos-destaque/censo_2006.pdf 22 April

13

2010. Britto, J. (2002) ‘Cooperação interindustrial e redes de empresas’, in Kupfer, D. and Hasenclever, L. (ed.) Economia industrial: fundamentos teóricos e práticos no Brasil, Rio de Janeiro: Elsevier.Coase, R. H. (1937) ‘The Nature of the Firm’, Economica, New Series, Vol. 4, No. 16, pp. 386-405. Available: http://links.jstor.org/sici?sici=0013-0427%28193711%292%3A4%3A16%3C386%3ATNOTF%3E2.0.CO%3B2-B 12 Jan. 2010.Coleman, J.S. (1988) ‘Social Capital in the Creation of Human Capital’, The American Journal of Sociology, Vol. 94, Supplement: Organizations and Institutions: Sociological and Economic Approaches to the Analysis of Social Structure, pp. S95-S120. Coleman, J.S. (1990) The Foundations of Social Theory, Cambridge: Harvard University Press.Dotto, F., Fernandes, C.De M., Silva, H.G. and Vilpoux, O. F. (2010) ‘Relações de confiança entre produtores rurais e a empreendedora do laticínio Dona Élia no assentamento conquista, Campo Grande – MS’, SOBER Congress – Conference Proceedings, 48th Brazilian Society for Rural Management, Economics and Sociology (SOBER) Congress, Campo Grande.Food and Agriculture Organization (FAO), (2009a) The State of Agricultural Commodity Markets 2009: High food prices and the food crisis – experiences and lessons learned, Rome: FAO publications. Available: www.fao.org/docrep/012/i0854e/i0854e00.htm 12 Jan. 2010.Food and Agriculture Organization (FAO), (2009b) The state of food and agriculture: Livestock in the balance, Rome: FAO publications. Available: www.fao.org/publications/sofa/en/ 12 Jan. 2010. Felipe, E. S. (2008) ‘Instituições e mudanças institucionais: uma visão a partir dos principais conceitos neo-schumpeterianos’, Economia, vol. 9, n° 2, pp. 245-263.Fiani, R. (2002) ‘Teoria dos custos de transação’, in Kupfer, D. and Hasenclever, L. (ed.) Economia industrial: fundamentos teóricos e práticos no Brasil, Rio de Janeiro: Elsevier.Fukuyama, F. (1996) Confiança – as virtudes sociais e a criação da prosperidade, Rio de Janeiro: Ed. Rocco.Furubotn, E.G.F and Richter, R. (2005) Institutions e economic theory. The contribution of the New Institutional Economics, 2nd edition, The University of Michigan Press.Guanziroli, C.E and Cardim, S.E. De C.S. (2002) Novo Retrato da Agricultura Familiar: O Brasil Redescoberto, Brasília: INCRA - FAO.Lin, N. (1999) ‘Building a Network Theory of Social Capital’, Connections, Vol. 1, n° 22, pp. 28-51.Mathias, J.F.C.M. (2008) ‘A clandestinidade na produção de carne bovina no Brasil’, Revista de Politica Agrícola, Vol. XVII, nº 1.Ménard, C. (2004) ‘The economics of hybrid organizations’, Journal of Institutional and Theoretical Economics, vol. 160, n° 3, pp. 345-376.Milgron, P. and Roberts, R. (1992) Economics, organization and management, New York: Prentice-Hall.Mueller, F. (1995) ‘Organizational governance and employee cooperation: can we learn from economists?’, Human Relations, vol. 48, n°. 10, pp.1217-1235.Nau, H. (1995) ‘Institutional, evolutionary and cultural aspects in Max Weber’s social economics’, Cahiers d’économie politique, vol. 49, n° 2, pp. 127-142.Nelson, R. (1995) An Evolutionary Theory of Economic Change, Cambridge: Harvard University Press.North, D. (1990) Institutions, institutional change and economic performance, Cambridge: Cambridge University Press.North, D.C. (1991) ‘Institutions’, The Journal of Economic Perspectives, vol. 5, n°. 1, pp. 97-112.Orstrom, E. (2011) ‘Background on the institutional analysis and development framework’, The Policy Studies Journal, vol. 39, n°. 1, pp. 7-27.Peterson, H. C., Wysocki, A. and Stephen, B. H. (2001) ‘Strategic choice along the vertical coordination continuum’, International Food and Agribusiness Management Review, vol. 4, n°. 2, pp.149-166.Kupfer, D. and Hasenclever, L. (2002) Economia industrial: fundamentos teóricos e práticos no Brasil, Rio de Janeiro: Elsevier.Putnam, R. (1996) Comunidade e democracia: a experiência da Itália, Rio de Janeiro: FGV.Reimer, B., Lyons, T., Ferguson, N and Polanco, G. (2008) ‘Social capital as social relations: the contribution of normative structures’, The Sociological Review, vol. 2, n°. 56, pp. 256-274.Ricketts, M. (1987) The economics of business enterprise. New approaches to the theory of the firm, Brighton: The Harvester Press Publishing Group.Sabourin, E. and Teixeira, O.A. (2002) Planejamento e desenvolvimento dos

14

territórios rurais – conceitos, controvérsias e experiências. Brasília: EMPRABA/CIRAD/UFPB. Theret B. (2003) ‘Institutionnalismes et struçturalismes : oppositions, substitutions ou affinités électives?’, Cahiers d’économie politique, vol. 1, n°. 44, pp. 51-78.Tillmar, M and Lindkvist, L. (2007) ‘Cooperation Against all odds: Finding reasons for trust where formal institutions Fail’, International Sociology, Vol. 22, n°. 3, pp. 343–366.Vilpoux, O.F. (2010) ‘Arranjos institucionais nas transações entre produtores e fecularias de mandioca: abordagem pela economia dos custos de transação’, Informe GEPEC, vol. 14, n°. 1, pp. 127-146.Vilpoux, O. F. and Oliveira, E. J. De. (2010) ‘Instituições Informais e Governanças’, Rev. Econ. contemp., vol. 14, n°. 1, pp. 85-111.Vilpoux, O.F. (2011) ‘Desempenho dos arranjos institucionais e minimização dos custos de transação: transações entre produtores e fecularias de mandioca’, Rev. Econ. Sociol. Rural, vol. 49, n°. 2, pp. 271-294.Williamson, O. (1985) The economic institutions of capitalism, New York: The Free Press.Williamson, O. (1996) The mechanisms of governance, Oxford: Oxford University Press.Zylbersztajn, D. (1995) Estruturas de governança e coordenação do agribusiness: uma aplicação da nova economia das instituições, São Paulo: University of Sao Paulo, Department of Economics, Management and Accounting. Zylbersztajn, D. and Zuurbier, P. (2009) ‘A non-naïve explanation of trust’ in Zylbersztajn, D. and Omta, O. (ed.) Advances in supply chain analysis in agri-food systems, São Paulo: Singular.

15