Deepening the Economy with Backward Integration

0

Jonathan Eze writes on Unilever Nigeria Plc’s ‘Partner to Win’ initiative, positing that greater use of local content and more extensive backward linkages could help Nigeria’s economic landscape

Backward integration refers to the process in which a company purchases or internally produces segments of its supply chain. In other words, it is the acquisition of controlled subsidiaries aimed at the creation or production of certain inputs that could be utilised in the production. This backward movement is initiated to ensure supply along with securing bargaining leverage on vendors.

Backward integration is a well-known competitive strategy. Through the control of more of its supply chain, an organisation can bring down the costs as well as guarantee access to key materials. Moreover, it can also manipulate competitors in an indirect manner through affecting how they access their raw materials. In certain cases, a number of companies might join hands for purchasing and controlling a supplier
Nigeria has experienced rapid but low-quality growth over the past decade. This has been accompanied by limited structural change and little economic transformation. The share of manufacturing in Nigeria’s gross domestic product (GDP) is low relative to that of other countries, and the country’s heavy reliance on oil and gas exports before now, meant that little attention had been paid to developing the manufacturing sector or diversifying into more complex products.

That is why there is a clearer need for greater diversification of the economy to promote quality growth, economic transformation and employment. This can be aided by the development of value chains that facilitate higher-value added processing and manufacturing activities within Nigeria and make greater use of locally produced inputs and services in production through the creation of backward linkages. The latter can have positive effects in terms of stimulating economic development; promoting the development of local industries; creating economic linkages; building local capacity, capabilities and technologies; developing skills within the workforce; boosting employment; and minimising capital flight. Greater use of local content and more extensive backward linkages can help Nigeria economic landscape.

There are benefits associated with backward integration. First is increased control. Through the process of integrating backward, companies can control their value chain in a more efficient manner. When retailers take the decision to develop or acquire a manufacturing business, they attain increased control over the production segment of the distribution phase.

Another is cost control. Through backward integration, costs can be considerably controlled all along the distribution process. In the conventional distribution process, each phase of product movement includes mark-ups to enable the reseller to earn profit.

By direct sale to end buyers, manufacturers are able to do away with the middle man through removal of one or more mark-up steps in the course. In other words, a single entity controlling the entire distribution process brings in enhanced capability leading to optimisation of resource utilisation.

However, some companies adopt backward integration in order to block competitors from gaining any access to important markets or scarce resources. For instance, a retailer might purchase a manufacturing company and have access to proprietary technology as well as resources or patents that are solely available in the local area of the firm.

Manufacturers Association of Nigeria (MAN) disclosed recently that investments in backward integration projects have boosted local content by 53.17 per cent. Investigation showed that companies like Unilever among others are taking the lead in backward integration especially with its support for the policy through its “Partner to Win” initiative.
Partner to Win is Unilever Nigeria’s initiative of investing in capabilities of intermediary companies to enable them convert farm produce to usable goods that will be sourced by the company as part of its raw materials locally. The organisation believes this will enable it achieve a significant reduction in the importation of raw materials by working with local partners.

According to Yaw Nsarkoh, the Executive Vice President, Unilever Ghana/ Nigeria, 90% of its brands in Nigeria are manufactured locally. The goal is to achieve 100%. In December, 2017 the Company inaugurated its Blue-Band Margarine factory with the aim of ending the importation of the product. Providing the motivation for this decision, Yaw said, “the backward integration programme of the federal government is a sound policy and as an organisation we are committed to this initiative. We have found strong connections between this policy and our business model. This has spurred us to enhance our local sourcing capabilities.”

Yaw cited examples of steps taken by Unilever to achieve this drive in packaging and agro-based materials. “Already, Unilever has achieved over 80% in local sourcing of packaging materials. The aim is to achieve 100% by the end of 2019 and overcome the current challenges of local vendor’s capacity to meet up with global best standard.” In agro-allied sector, Unilever is partnering with intermediary companies, for the supply of cassava and starch.

Speaking on the economic benefits of aligning with the government on this strategy, Yaw said, “by working with the intermediary companies to source these materials, we are contributing to up-scaling the technical skills required for sustainable commercial farming in Nigeria. We are also investing in the production of palm oil for use in Blue-Band spreads and soaps, and exploring local production of herbs and spice for our seasoning cubes. We believe that our partnership with these investors will not only create jobs within the agriculture sector but also provide support that will enhance their technical know-how and skills.”

The ability of the local suppliers to meet international standards for such materials and the possibility of locally produced goods being more expensive than imported goods are key challenges the company is facing. However, this is not a deterrent factor but an opportunity to help them scale up their skills and compete at the international level. The Procurement Director-Markets, Unilever West Africa, Supply Chain, Mwanza Thomas, stated that “Our motivation and commitment to operate sustainably is far superior to these challenges. We are working with relevant authorities and local investors to ensure their produce meet the required standard for our products.”
The federal government designed the backward integration policy to deepen the economy and achieve robust growth. As it currently stands, imports are still the dominant source of inputs into food, beverages and tobacco in Nigeria, accounting for more than 70% of all raw materials. The Economic Recovery and Growth Plan (ERGP) blueprint anticipates a strong backward-integration led growth in the agro-processing, food and manufacturing sector.

However, industry players believe that there are some sectors where it makes a lot of sense to deepen backward integration. There are others where it is not appropriate. Having a blanket policy that applies to all is not sensible. Backward integration policies must be nuanced by the circumstances of the sector. In particular, backward integration is appropriate where it is ‘comparative advantage following’ rather than ‘comparative advantage denying’. In practical terms, this means that, after the various investments have been made, the level of costs should be lower than the cost of importing. If they are not, it does not make sense to do backward integration.
According to a report presented by SET Nigeria at the 23rd Nigeria Economic Summit, it stated that government appears to evaluate backward integration on the basis of whether it creates jobs and boosts investment and value added in the sector. “These measures are important, but this approach is incomplete because it does not take into account the impact of local content policies on consumers. It is perfectly possible to find policies that boost investment and create jobs and that are value-subtracting at the national level because of their impact on consumers. These calculations can be done – and the government should avoid forms of backward integration policy that provide long-term benefits for a sector or a handful of firms while imposing much higher costs on consumers.

“What is clear is that government has, to date, struggled to implement some local content policies effectively. This may reflect a lack of capacity and resources, particularly given Nigeria’s current difficult economic circumstances. Moreover, the high levels of informality in the Nigerian economy constitute an implementation challenge. The high protection and cumbersome procedures at borders, making cross-border smuggling a profitable activity, challenge the effectiveness of many of these policies.

“Thus, while government-appointed councils and boards in different sectors have endeavoured to play a coordination and facilitation role, much of the focus has been on tariff policy (and, to an extent, concessionary finance); the practical implementation of local content investments has been left to the private sector. This may be entirely appropriate: as the economics of local content suggests, one of the key market failures during the process of industrialisation are ‘coordination failures’. The private sector often has far greater capacity and resources than the public sector to coordinate the various investments and activities needed to create an effective supply chain.
“However, leaving the bulk of the work to the private sector is risky. Such coordination is generally only possible when the number of private sector actors is very small: firm-led coordination of local content investments runs the risk of firms proposing policies to enhance their market power. There is therefore a trade-off between the greater capacity for policy implementation of lead firms and their interests in inclusive and competitive policies.”

This also helps explain the wide variety of views expressed by firms about local content policies. While almost all were in favour of the principle, firms able to exercise control of the manner of implementation were strongly in favour of local content policies that bolstered their competitive position, whereas those with less access to the policy-making apparatus feared policies may be applied in an arbitrary or unnuanced way to the detriment of their businesses.

In principle, the trade-off between capacity and interests can be addressed through careful policy analysis, transparency in implementation and independent performance monitoring linked to the support that government provides. However, as noted above, outside of the oil and gas sector, these elements are the weakest components of the current local content policy environment.