Bearing fruit: Policy changes create new difficulties for small-scale cocoa grinders

Côte d’Ivoire is the world’s second-largest cocoa grinding hub after the Netherlands, and it produced 520,000 tonnes of processed cocoa in the 2013/14 growing year, or 12% of world cocoa processing. With a current grinding capacity of 550,000-600,000 tonnes, the government and the newly created sector regulator, the Coffee-Cocoa Council (Conseil du Café-Cacao, CCC) are seeking to boost local processing output from 30% of production to 50% by 2015.

Policy Change

In the early 1990s the government introduced a number of financial incentives to encourage investors to establish processing plants in Côte d’Ivoire. Designed to create a local industry that could compete with American and European processors, a tax break was granted whereby grinders were taxed on the weight of exported products rather than on the weight of the beans utilised to create the products. Known as the Droit Unique de Sortie (DUS), this system effectively decreased processors’ tax rate by 25%, and was only meant to enable processors to regain their capital investment costs over a period of five years, but sector mismanagement perpetuated the policy for 20 years. Processors also benefitted from an “indicative” farm gate price that was not respected, enabling firms to purchase beans at inexpensive rates.

Low bean prices and the tax break created fierce competition between raw bean exporters and processors in the purchase of cocoa. Additionally, under the DUS system, processors can use their export benefits to overpay at the source, which creates unfair competition for raw bean exporters by paying CFA15-25 (€0. 02-0.04) more per kg than exporters can afford to pay.

As part of sector reforms, the CCC revised the DUS system to apply to the weight of raw bean purchases to create a level playing field between exporters and processors. However, unlike exporters who are able to sell their cocoa with relatively low infrastructure costs, grinders lose an estimated 23% of their beans during processing while having to pay for expensive machinery. In theory, given Côte d’Ivoire’s processing capacity of over 500,000 tonnes, the country could process all of the cocoa produced locally. It could even become a cocoa importer and process more than is local production. However, without incentives, processors are not currently willing to expand their capacities because they have determined it is not economically viable.

Another reason cited by processors for a tax incentive is the lack of a local market for chocolate, necessitating a heavy reliance on the export industry. “In West Africa there is a low level of consumption for chocolate because it is a luxury. There needs to be research and development into cocoa products that fit African tastes, the climate and incomes. Once Côte d’Ivoire starts to develop domestic demand for cocoa, it will have a more viable sector that will not be as dependent on tax incentives,” Edward George, head of research at Ecobank, told OBG.

New Versus Old

The recalculation of the DUS has particularly disadvantaged newly established processors. Grinders that constructed processing units in the 1990s and 2000s enjoyed several years of the DUS tax break that enabled them to earn back their capital investments. However, processors that opened factories in the last couple of years no longer have the means to recoup costs in an environment increasingly competitive in terms of bean prices and operating costs. Newly established units include Olam International’s new factory in San Pedro with a capacity of 70,000 tonnes.

Large Versus Small

Several aspects of the reforms specifically disadvantage large grinders. One issue is the new way in which the CCC calculates the DUS on products, where a multiplier of 1.25 is used to evaluate the equivalent bean weight used to make different cocoa products. The multiplier is based on what the CCC considers as the industry standard ratio of 80 tonnes of cocoa products to 100 tonnes of beans; however, this ratio does not necessarily reflect the ratio used by all domestic grinders. Due to different processing techniques, bean qualities and productivity gains, many grinders’ ratios often vary between 82-84 tonnes of cocoa products to 100 tonnes of beans, and processors are able to produce more product with their cocoa beans than calculated by the CCC. Although processors have already paid export taxes on these beans, the current system obliges them to purchase more export rights for the “extra products”.

This results in a situation in which processors that are more efficient than the CCC’s calculations effectively have to pay taxes twice on the extra product, even though they are not technically exporting more beans. This has the potential to cost large grinders a significant amount of money. The government is still working on finding a solution to this problem.

Large processors are also experiencing difficulties due to the mid-crop bean prices, which grinders argue are too high due to the lower quality and smaller size of the beans. In 2011/12 mid-crop beans were priced at CFA400-500 (€0.6-0.75) per kg. The following year the mid-crop price jumped to CFA700 (€1.05) per kg, or only CFA25 (€0.04) less than the main crop, despite significantly lower volumes.

According to a 2014 Ecobank report, the CCC is considering the provision of a rebate for bean count purchases of 116-140 beans per 100g, although a final decision has not yet been made.

In addition to the challenges faced by large players, the viability of small domestic grinders has also been damaged by sector changes. Most local small-scale processors established operations during the last six years, and were therefore unable to earn back their capital investment costs under the DUS system and face high debt obligations and dwindling returns.

As is also the case with small-scale exporters of raw beans (see analysis), small processors are also at a particular disadvantage relative to large processors in procuring enough capital to purchase export contracts in the forward selling auction. Grinders are obliged to provide a bank guarantee worth 2.5% of the contract value, an off-taker agreement and a counter party to cover risks, all in three days of bidding on beans.

Accessing credit is another difficulty faced by small players, which demands a 50% down-payment with interest rates of 10-13%, while large processors pay only 2-3%. Unlike larger processors that can make up their losses in other trading arms, smaller grinders are unable to benefit from economies of scale due to the limited size of their operations, which have come under growing pressure due to expensive energy bills, high costs and taxes on machinery imports, and rising bean prices. Smaller players that have regular, long-term contracts with large multinational exporters and processors are at an advantage in the market, but without the prospect of a financial incentive such as the DUS, local grinders will be hard-pressed to compete.

This is particularly true for small to medium-sized processors, that may have difficulty operating without a tax cut or similar financial support. For example, Olam’s new processing facility cost over €20m, which is an investment that is beyond the capacity of many small and medium-sized players.

However, with the implementation of a subsidy, smaller processors would be more inclined to pursue the expansion of processing facilities. Creating an environment conducive to small and medium-sized players could have a positive impact on job creation, as well as the geographical distribution of processing activities.

Contradictory Policies

The cocoa reforms have succeeded in fulfilling several major objectives on the part of the government. With the introduction of a minimum reference price, farmers were given necessary assurances for profitable prices and consumer demand, and incentivised both cocoa production and improvements in bean quality.

However, higher bean prices, the removal of the DUS tax break and other reforms have created difficulties for processors, making it increasingly unlikely that the sector will achieve its goal of processing around half of national production by 2015.

“The only way for the government’s objective to be realised is if production dropped dramatically, and this is not likely to happen. The CCC’s goals are currently incompatible: they can either increase production or boost processing. The reforms have undermined the commercial case for having a processing sector in Côte d’Ivoire,” George told OBG.

Growing International Competition

Côte d’Ivoire’s cocoa processing industry is at a crossroads, but not solely because of its sector reforms. According to a 2014 Ecobank report, the volume of global cocoa processing has expanded 14.8% in the last five seasons to approximately 4.1m tonnes in 2012/13.

Although Côte d’Ivoire remains the second-largest processing hub in the world, its competitors are expanding at an impressive rate. During the last five seasons Indonesia’s grind grew by 112.5% and is projected to become a net cocoa importer in 2015, despite being the world’s third-largest producer, while Ghana’s processing activities have increased 69.1% to 225,000 tonnes during the same period. However, Côte d’Ivoire’s output grew by only 9.9%, and the reform is expected to lead to a plateau of processing volumes at best.