Quality Upgrading and Competition: Theory and Evidence from Uganda’s Coffee Sector (Uganda) This project studies how market structure affects incentives for quality upgrading along developing country supply chains via a field experiment in the coffee sector in Uganda.
In international coffee markets, there appear to be large returns to quality management. On world markets, higher quality coffee – ripe, undamaged, and washed– can receive premiums of over 90% compared to lower-quality coffee. However, farmers in developing country coffee production consistently fall short of these quality standards, resulting in an estimated $20-30 million per year in forgone revenue in Uganda's Rwenzori region alone (Morjaria & Sprott, 2018).
What prevents farmers from providing the high-quality coffee that international markets demand? One possibility is that, due to long supply chains of intermediation, farmers may not have access to the same quality premiums offered by the world market. If farmers receive a smaller portion of the world price for high-quality goods than they do for low-quality, this will depress the price-quality gradient they face (as compared to that prevailing on the world market) and will discourage production of high quality, relative to incentives under an undistorted quality premium.
Why might price-quality gradients diminish as they move upward through the supply chain? While there are many candidate explanations, we focus on the role played by market structure. Along the value chain, barriers to entry may be greater for intermediaries and processors of high-quality goods than for those serving low-quality markets.
Expensive equipment is often required to process goods to the standard required by high-quality international buyers or to test raw inputs to ensure they are up to snuff. Less tangible but potentially equally important factors like developing a reputation for quality may also serve as a hurdle for potential entrants into the high-quality market. For this reason, there may be fewer intermediaries (and final processors) in high-quality goods compared to low-quality.
The market power resulting from these barriers to entry may allow high-quality intermediaries to offer farmers a lower fraction of world price than do low-quality intermediaries, who – in the face of greater competition – may be forced to pass on a greater portion of the world price. These forces may depress the effective quality premium faced by farmers.
Partnering with a leading coffee procurement, processing, and marketing company in Uganda, we conduct a randomized control trial (RCT) aimed at generating exogenous variation in quality premiums at different points in the value chain. As part of the experiment, Uganda’s largest exporter of coffee has offered randomly-selected traders (i.e., intermediaries) different prices for high quality coffee beans and for low quality. This generates exogenous variation in quality premiums offered to traders. We are interested in examining how much of the quality premiums will get passed through to farmers and how the premiums will affect the traders and farmers' incentives to invest in quality. In order to examine the role of market structure, we generate exogenous variation in competition for high-quality products by randomizing the saturation of the quality premium offers to traders across geographic markets.