Micro variable: DPIs

There were two occurrences that increased DPIs’ risk perception of imported supply of raw materials. First, the abolishment of Busep in 1998 has indeed resulted in the resurgence of raw material imports by DPIs to exploit their unused production capacity, but at that time Indone-sian currency depreciated heavily against foreign currencies due to the economic crisis: From IDR 2,500 per USD in the pre-crisis condition in mid 1997, USD/IDR exchange rate had peaked at 17,500 IDR per USD in mid 1998 (Aswicahyono et al. 2009) and levelled off at 8,000 – 10,000 IDR range ever since. Such situation caused immense increase in import costs for raw material. Second, the unexpected spurt in international milk price in 2008 gave DPIs a serious warning signal that import prices are not resistant to fluctuations caused by interna-tional policy and market changes or adverse climatic condition¹¹. Considering these occur-rences, DPIs perceived that they needed to hedge against risks of possible future price fluctua-tions by reducing reliance on imported supplies¹². This prompted DPIs to establish solid domestic supply base.

However, the performance of the local suppliers was low and stagnating¹³. DPIs, on the con-trary, require that locally produced fresh milk meets certain quality standards in order to be eligible for substituting the imported supplies. Lower-quality milk is only eligible for produc-ing SCM, but not for liquid milk or powdered milk (Meylinah 2008, p. 3; Meylinah 2007, p.

11 See Sub-chapter 6.4 and 6.5 for the causes of price surge on the world market.

12 Additionally, DPIs faced another, presumably less-pressing, issue of improving food safety that encouraged them to upgrade their local suppliers. Cf. Jöhr (2008).

13 See Sub-chapter 8.2 for the description of cooperatives’ low performance.

5). Apart from quality issue, the continuity and reliability – i.e. being free from chemical or antibiotic contamination – of the supply are to be guaranteed. But more importantly, high-quality milk is the basis for increasing the competitiveness of the whole value chain, because lower-quality milk requires higher technical efforts and thus higher costs in the processing. A spokesperson of the association of DPIs stated:

High-quality milk produced by Indonesian dairy farmers is competitive raw material for prod-ucts of dairy processing industries, not low-quality milk. (Stanton, Emms and Sia 2005, p. 22) In similar vein, representatives from the DPIs stated:

The task of our department is […] to ensure that the fresh milk supply from the dairy farmers is sustainable and meet our requirements. (DPI 3)

Our company concentrates on the production of powdered milk for babies and infants. There-fore, the quality of the raw material we need must be high and guaranteed. (DPI 2)

As a result, DPIs decided to give technical (TA) and financial assistance (FA) to the supply-ing cooperatives to upgrade their capability. With such decision, the quasi market relationship between cooperatives and DPIs that persisted until the late 1990s was transformed into a more hierarchical relationship¹⁴ where DPIs provided embedded service to their suppliers based on certain binding requirements. Nevertheless, the endeavour to upgrade suppliers did not result only in successful cases; the results of some cases have been discouraging. Reflecting on the lessons learnt drawn on their experiences in assisting their supplying cooperatives, DPIs then concluded that there are, at least, two conditions for a successful cooperation with the suppli-ers.

First, the partner cooperative must be led by leaders that are trustworthy and reliable. These leaders must show a strong willingness and commitment to progressively change the coopera-tive. Also, they must be orientated toward supporting their own cooperative members and not pursuing their own self-interest. DPIs’ representative explained:

What we need is an honest and simple cooperative leader, someone who has a true interest in developing the cooperative and its members and not making himself richer. Many coop leaders are not so trustworthy. It is very difficult to cooperate with such people. I think it is very impor-tant to identify and work with committed but simple people who are willing to work toward de-velopment. (DPI 1)

14 Cf. Sub-chapter 2.7.2

Actually it is not that we do not want to help our supplying cooperatives. We are open to coop-eration with them. The problem is whether our help will reach its intended goal and not be mis-used. Can you imagine, in a negotiation with a cooperative the director gave us a small note containing his account number and the amount he wants? We cannot play like that. We are al-ways audited and our transaction records must be clean and clear. (DPI 2)

These statements indicate the prevalence of malfeasance behaviour among cooperative lead-ers¹⁵ who misused DPIs’ supports. Being oriented toward self-interest, such cooperative lead-ers would seek and exploit any possible opportunity to bring benefits for themselves, thereby relegating the original goals of developing the cooperative and members to a minor agenda.

Also, since such cooperative leaders have vested interests; they are not transparent and usu-ally not willing to be subjected to scrutiny. Consequently, the monitoring of the upgrading progress through technical and financial assistances proved to be difficult.

Another aspect required from trustworthy leaders was their commitment to continuously and exclusively deliver the DPI in return for the assistances provided, because DPIs had to make sure that their assistance, or better said their investment, does give them proper return.

Besides, we also want a commitment that if they receive our supports they will commit to de-liver us their milk. If not, that is a loss for our investment. (DPI 2)

We are ready to help our suppliers to meet our requirements. But they have to commit to supply us continuously. Otherwise it does not make any sense. (DPI 3)

The conviction that successful cooperation is only possible with clean leaders is also a result of the weak law enforcement in Indonesia. Law enforcement in Indonesia is generally per-ceived to be ineffective by the VC-operators. Although the protection of property rights is more or less predictable, larger companies – like DPIs – have traditionally little faith in re-solving disputes through legal mechanism¹⁶. Using legal contractual arrangements to bind suppliers is not a viable option, because although the contract conditions and consequences of infraction of the agreed terms are stipulated in the legal contract, its enforcement is still not easy: Ex-post problem settlement should follow intransparent, complex procedures and thus is time-consuming, costly, and not always effective. Hence, in this context preventing or

15 See Sub-chapter 10.2.1.6 for the prevalence and acceptance of opportunistic behaviour.

16 See Aswicahyono et al. (2009) for more elaborate analysis of the contemporary economic policy in Indonesia and its enforcement.

ing the risk of malfeasance behaviour through cooperating exclusively with trustworthy and transparent cooperative leaders offers a better strategy.

The second requirement is that cooperative leaders must be willing to introduce reform into the organisation of the cooperative itself. One DPI stated:

Learning from previous experiences, we changed our approach. The support is not given di-rectly to the dairy farmers, but to the cooperatives, because basically it is the responsibility of the cooperatives to organise and help their members to improve their dairy business. It is not ours. So, we constantly liaise with the cooperatives and provide them support if they need. (DPI 1)

The statement was made against following background: In the early 2000 the DPI launched a massive supplier upgrading programme with considerable budget amount. From around 12 coops supported, only 3-4 exhibited considerable success, 2 totally failed, while the others showed moderate outcomes. The programme objective was to sustainably increase the welfare of dairy farmers by improving their management skill, in particular in hygiene aspect. As such, the programme was delivered directly to the dairy farmers. However, the programme was not considered to be successful, since the progressive changes were not sustainable: The technical know-how given was only practiced by the dairy farmers when supervised and given incentive. As soon as the programme ended and thus the supervision and incentive stopped, they returned to their former practices, because the programme did not create a sustainable structure. With the new strategy the DPI aimed at building the structure of the system where the cooperative leaders and dairy farmers embedded into: the broader institutional framework of their interaction system, including the organisational aspect of the cooperative. The effort to improve of dairy farmers’ management skill was changed from temporary capacity build-ing activities into a permanent trainbuild-ing service provided by the cooperatives. Similarly, the provisional incentive-giving was institutionalised into a reward and punishment system¹⁷. Another DPI also emphasised that their task in providing assistances focused on the empow-erment of the cooperatives so that they were enabled to provide services for their own mem-bers. For example, the quality regulations delineated by the DPI were to be socialised by the cooperatives. The capacity building required to change dairy farmers’ practices as well as the

17 See Sub-chapter 10.3 for further elaboration on the improvement of the institutional framework.

monitoring of the compliance was also to be performed by the cooperatives. Such approach reflects the strategy of empowering the institution of the cooperative.

Based on these perceptions, DPIs offered their TA and FA only to selected suppliers which satisfy their conditions. To access the supplier upgrading programme the cooperatives should follow the procedure as described by a DPI representative:

 The cooperative leader should express the commitment to supply the DPI continuously.

Important is also the willingness to accept the quality regulations (quality/price mecha-nism and SOPs) defined by the DPI as well as the recommendations given by the DPI.

This necessitates the readiness from the cooperative side to change the existing practices.

 The DPI then conducts field visit examining the conditions and practices at dairy farms and MCCs. A gap assessment is made to analyse the discrepancy between the existing and desired practices and conditions as required in the quality regulations.

 From the results of the gap assessment the DPI derives technical recommendations on how to improve the existing practices and conditions in gradual steps toward the ideal ones. Since the improvement measures also entail investment in equipment and infrastruc-ture, the DPI provides several loan alternatives.

 After discussing and negotiating the loan alternatives the cooperative leader can decide on the most suitable alternative with the specification of the credit volume, interest rate, and tenor. The repayment is made through deduction from the milk sale to the DPI.

The technical assistance (TA) provided by DPIs covers aspects required for building the ca-pacity of the cooperatives to meet the quality regulations. Technical guidelines specifying step-by-step improvement measures are given to the suppliers. For TA purposes DPIs assign field officers that regularly visit supplying cooperatives, discuss the progress of improvement measures, provide technical inputs and collect feedbacks for the DPIs. Through this embed-ded service the flow of technical information – including the introduction of new technology and innovation such as improved variety of fodder grass, silage production, and applicable milk test methods – from DPIs to cooperatives was significantly improved. Capacity building is also provided for extension workers and cooperative staff working at the MCCs. A com-prehensive quality audit on product and process parameters is conducted every 6 months.

The financial assistance (FA) aims at the upgrading of inappropriate equipment and infra-structure. The delivery mechanism of FA is different among DPIs: While some DPIs use the

own fund and provide the loan directly to the cooperatives. For the case that the loan was pro-vided directly by the DPI (2006), no interest rate was applied for the purchase of equipment dealing directly with milk quality, such as cooling machine and food-grade piping system. As Indonesia is not a typical milk-producing country and thus the dairy technology is underde-veloped, the DPI also helped with the sourcing and import of such equipment, usually second-hand equipment from typical milk-producing countries. For the improvement of infrastruc-ture, such as renovating or building new MCCs, the DPI charged an interest rate of 6% which was half of the interest rate for commercial loans at that time.