The growth challenges of small and medium enterprises (SMEs) in South Africa's food processing complex

Abstract

This article focuses on the growth challenges and opportunities of small and medium enterprises (SMEs) in South Africa's food processing complex and argues that the growth challenges of these enterprises must be seen in the context of restructuring in South Africa's agrifood system. Based on a 30-company sample of SME food processors, the article argues that supermarket sourcing practices represent the most significant obstacle to the growth of these companies. Paradoxically, the complexity of South Africa's food retail system also offers opportunities for growth. The article ends by considering policy options for assisting SMEs, given this growth opportunity.

1. Introduction

The agrifood system in many emerging market economies has been transformed in the last decade. This transformation is closely linked to concentration in the food supply system and restructuring in the food processing sector. There is now a growing body of research that has explored the implications of concentration in food retailing and processing for consumers, farmers and food processors (Reardon & Barrett, 2000; Cook et al., 2001; Faigenbaum et al., 2002; Reardon & Berdegue, 2002; Weatherspoon & Reardon, 2003; Codron et al., 2004: Dries et al., 2004; Hu et al., 2004; Reardon & Swinnen, 2004). The research suggests that urban-based consumers are likely to benefit from modern retail structures and an advanced processing sector. With access to modern retail outlets supplied by a sophisticated processing sector, consumers increasingly have access to a greater variety of better quality food products. Yet the implications of these changes may be less positive for small-scale farmers and small and medium enterprises (SMEs) involved in food processing. Much of the burgeoning research into these changes in emerging market countries in Latin America, Asia and Eastern Europe suggests, with a few exceptions, that small-scale enterprises are increasingly marginalised from supermarket-controlled food value chains (Barron & Rello, 2000; Farina, 2001; Gandhi et al., 2001; Ghezan et al., 2002; Gutman, 2002). Not surprisingly, this finding has caught the attention of a wide range of development agencies interested in supporting small-scale farmers and rural enterprises (Vorley, 2001; Fritschel, 2003; CTA, 2004; DfID, 2004).

This article explores the growth challenges of small- and medium-sized enterprises in South Africa's food processing complex. For three reasons, this is an important time to be considering the growth prospects of SMEs in this sector.

• First, changes in South Africa's food system have been in line with those transformations reported in other emerging market economies. Since the early 1990s the retail sector has become increasingly concentrated, with several large supermarket chains now controlling food sales (Thomas, 2003; Weatherspoon & Reardon, 2003; Fig, 2004). There has also been significant foreign direct investment by food processors in several important commodities (Vink & Kirsten, 2002). The implications of these changes for new and existing SME food processors have yet to be fully explored.

• Secondly, the deregulation of agricultural markets from the late 1980s and early 1990s (Vink & Kirsten, 2000) has opened many new opportunities for small- and medium-sized processors. While there is evidence that they are playing an important role in changing the competitive conditions in the processing sector (e.g. Yankelevich, 1999; Vink & Kirsten, 2002) we have few insights into the growth challenges facing these enterprises.

• Thirdly, there is considerable policy support for, and interest in, SME food processors, especially those owned by previously disadvantaged individuals (e.g. DTI, 2002). The Department of Agriculture's proposals for Black Economic Empowerment in the agricultural sector, also known as the AgriBEE (NDA, 2004), also recognise the potential for SMEs in the food sector. Although the document is still in draft form and has not been accepted by all stakeholders, it does point to the potential of ‘agri-enterprises’, which would include food processors.

This article is based on secondary sources on South Africa's food sector, interviews with several supermarket ‘category managers’, and a non-random sample of 30 SME food processors located mainly in Gauteng but also in other parts of the country. Rather than providing a quantitative analysis of processors in this sample, the focus is on the growth challenges and opportunities for SMEs in this sector, based on company case studies. The first section of the article reviews the international literature on agrifood restructuring in the developing world. This section emphasises the shift to buyer-driven food chains and the implications of this change for small- and medium-sized food processors. In Section 2 changes in South Africa's food processing and retailing structures are briefly reviewed. This section explores changes in the structure of food processing in the context of market liberalisation and it describes the nature of concentration in the retail sector. In Sections 3 and 4 the growth challenges facing food processing SMEs – based on the 30-company survey and other interviews – are assessed. The article confirms the international evidence on retailer-led food value chains: supermarket sourcing practices represent the most significant growth challenge facing SME processors in South Africa. The research also identifies growth opportunities for SME processors. Paradoxically, these may also be found in the complex and changing structure of South Africa's retail environment. For the purposes of this article, food processing is defined using the Standard Industrial Classification (SIC) codes 301 to 304.

2. Agrifood restructuring in the developing world

The restructuring of agrifood markets–sometimes described as agroindustrialisation (Cook & Chaddad, 2000; Reardon & Barrett, 2000)–has been most intense in middle income or ‘emerging market’ countries. Population growth, political transformation, higher incomes and urbanisation in these countries have stimulated demand for processed food products (Farina, 2002; Farina & dos Santos Viega, 2003). This demand is increasingly met through large supermarket chains, which now dominate food sales in Latin America, Asia and Eastern Europe. Although these changes have been slower in Southern Africa, South Africa's retail structure is highly concentrated and has been expanding rapidly into the region (Weatherspoon & Reardon, 2003). The growing power of supermarket chains has led to a situation where most food value chains may be described as buyer-driven, with important implications for food processors and primary producers.

Buyer-driven food chains have three central characteristics:

• First, the relationship between agents in the chain is increasingly through contractual agreements and rarely involves open market transactions. Supermarkets now source larger volumes of processed food products from a limited number of preferred suppliers. These preferred suppliers are normally ‘listed’ as regular suppliers to retailers; listing often involves an audit of the processor's facilities to determine the company's capacity to supply large volumes of processed food of a high quality. The use of fewer preferred suppliers has the effect of reducing the retailer chain's transactions costs. These new contractual agreements also allow retailers to move towards a system of traceability, which allows them to trace quality and food safety problems back to individual suppliers. Given recent health scares associated with food contamination, guaranteeing traceability is becoming an important goal for retailers; it may also be used to gain a competitive edge over other retail chains. Preferred suppliers are under enormous pressure to supply a product consistently and of a high quality. Failure to meet these standards may lead to the food processor being ‘delisted’, with disastrous implications for the viability of the company.

• A second change associated with buyer-driven food chains is related to competition in the food processing sector. The growing concentration of power in the retailing node of the food value chain has placed significant pressure on food processors. These companies now compete for valuable shelf space in the major retail chains. Intense competition between processors has led to restructuring in this sector, often associated with mergers and acquisitions. Foreign direct investment in the food processing sector has intensified the competitive pressures in this node of the food value chain. The food processing sector in many emerging markets is, as a consequence of these changes, increasingly concentrated and dominated by a small number of large domestic and international companies.

• The third outcome of buyer food chains has been the emergence of private grades and standards (Dunn, 2003). Market liberalisation and structural adjustment programmes in emerging market countries have frequently resulted in the weakening of health and quality regulations for food products, where they existed (Reardon & Farina, 2002). Concerned to ensure that food products on their shelves are safe and meet high quality standards, some supermarket chains have established private grades and standards for commodities produced by food processors and primary producers. They may also require processors to meet internationally accepted standards such as Hazard Analysis and Critical Control Point (HACCP). Meeting these standards requires significant investments in terms of upgrading facilities, purchases of new monitoring systems and ongoing expenses associated with new technical staff.

The overall impact of these three changes has been to exclude small-scale processors from retail chains, and by implication from the most important outlet for food sales in emerging markets. Small- and medium-sized processors are usually unable to meet the volumes needed to become a listed supplier. These companies also find it difficult to upgrade to private or international grades and standards that may involve permanent in-house laboratories for testing food samples. In the ultra-competitive environment of food processing, small- and medium-sized processors are frequently taken over by larger processors in an effort to limit competition and increase their own capacity. On the basis of a number of case studies, Reardon & Barrett (2000, 203) argue that ‘too often the process of agroindustrialisation leads to industrial concentration, [and] exclusionary practices that crowd out undercapitalised indigenous firms and small farmers’.

There are important exceptions to the general finding that buyer-driven food chains lead to the marginalisation of small- and medium-sized food processing firms. In several transition economies in Europe and Latin America there is evidence that large retailers are playing an active role in assisting SME processors and primary producers. On the basis of research in Central and Eastern Europe, Dries et al. (2004: 552) found that ‘modern retailers assist their suppliers with credits, inputs, extension services and even bank loan guarantees to upgrade their capacities to produce and deliver products of high quality and, increasingly, food safety standards’ (also see McCormick & Atieno, 2002; Dries & Swinnen, 2004). This positive relationship is similar to the one observed between large agribusinesses and contract farmers (Kirsten & Sartorius, 2002). Dries et al. (2004) warn, however, that retailers are more likely to play this role where there is a dearth of high quality suppliers.

3. A brief profile of South Africa's agrifood sector

South Africa's food processing sector has characteristics similar to other emerging markets. It is highly concentrated, with several large listed companies controlling both production capacity and sales in most food categories (DTI, 1998; Hill, 2000; Fig, 2002). Concentration is a consequence of both apartheid agricultural marketing legislation and the technological barriers to food processing. The 1937 Marketing Act permitted agricultural control boards to implement restrictive licensing on food processors. The logic of restricting the number of processors was based on the argument that there was excess capacity of raw material, which could have a detrimental effect on the income of white farmers. By controlling the number of processors, the state and its various control boards hoped to achieve the broader goal of the Marketing Act, which was to stabilise white farmers' income (Vink & Kirsten 2002). Restrictions on the establishment of dairy processors, for instance, led to a situation where five very large processors were able to create regional monopolies on both the sourcing and supply of milk products. In sectors that were not controlled through marketing boards–most notably chicken production and some vegetable and fruit processing–technical barriers to entry appear to have played an important role in leading to a concentrated structure of ownership (e.g. Amin & Watkinson, 1998).

The effect of marketing legislation and technical barriers to entry is a sector characterised by extreme levels of concentration. There are, however, several qualifications that need to be made about the concentration of South Africa's food sector. First, there are variations in the level of concentration within the food sector. The level of concentration in the dairy sector is very high, whereas in grain and other food products it is lower. Similarly, concentration within the major food groups varies considerably – compare, for instance, bakery products with sugar and sugar products (Table 1).

Table 1: Concentration in the food sector, 1996

		Industry sales in percentage terms for largest
Food sector and sector	Number of companies	4 companies	10 companies
Meat, fish, fruit, vegetables, oils and fats	480	19,6	36,8
Vegetables and animal oils and fats	16	65,2	97,8
Canned and processed fruit and vegetables	157	35,0	55,0
Canned and processed fish	46	57,8	79,2
Dairy products	113	68,4	80,0
Fresh milk	46	70,8	83,5
Butter and cheese	17	82,0	97,4
Milk powder and other edible milk products	13	87,0	99,9
Grain mill products	283	36,0	56,4
Flour	209	42,6	64,8
Breakfast foods, starches and starch products	8	95,4	-
Prepared animal feeds	72	37,3	60,1
Other food products	821	26,1	53,3
Coffee, coffee substitutes and tea	15	80,4	95,8
Bakery products	522	45,3	62,6
Cocoa, chocolates and sugar confectionery	72	72,9	82,4
Source: Adapted from Vink & Kirsten (2002).

Secondly, the level of concentration by the food sector masks the extent to which individual firms are involved in a number of food groups. Tiger Brands, for instance, is involved in the production of milled products (wheat and maize), processed fruit and vegetables, confectionary items and dairy and meat products. Similarly, when Bokomo Foods merged with Sasko, the new enterprise – Pioneer Foods – became involved in the production or processing of dried fruit, fruit juice, vegetables, bread and other baked products, grain, animal feed, eggs and broilers and containers to transport fresh and processed food products. In other words, the use of SIC categories may underestimate the extent of concentration in the food sector.

Thirdly, there is evidence of both increasing concentration and market fragmentation in the period since 1996. The liberalisation of agricultural markets from the late 1980s opened up many new opportunities for small- and medium-sized processors, notably in baking, dairy, milling and meat production (e.g. NAMC, 1999). In several of the food groups the number of new processors has grown at an explosive rate. At the same time, however, restructuring in the food sector has led to mergers and takeovers, which are likely to have played a role in increasing concentration (Chabane et al., 2004). These seemingly contradictory processes have led to a situation where the market share of the largest companies remains high, but these companies now face considerable competition from many small- and medium-sized processors. Despite their limited market share, these new firms have played an important role in changing the competitive environment of food processing in South Africa.

South Africa's food processors – both large and small – have had to face a rapidly changing retail sector. In the last 20 years South Africa's retail sector has changed dramatically, from a highly fragmented and diverse structure of small- and medium-sized shops, to the domination of large supermarket chains. There are approximately 70 000 outlets that can be broken down into three broad categories: large retail outlets (hypermarkets and supermarkets), medium retail stores (medium-sized stores) and small convenience stores (including spaza shops and ‘cafés’) [spaza shops are informal retail outlets located in former black residential townships]. Yet the large number of retail outlets masks the high level of concentration in the sector: a small number of very large, formal retail chains control around 70 per cent of turnover. Concentration is most apparent in the supermarket sector, where only 2 per cent of supermarkets are responsible for between 50 and 60 per cent of all food sales in South Africa. The large formal chains include the listed companies Pick 'n Pay, Shoprite-Checkers and Woolworths, and the recently listed Spar group. South Africa's retail sector is characterised by intense competition for market share (Weatherspoon & Reardon, 2003).

Given the concentration of food sales in South Africa, most food processors are dependent on formal retail chains for the sale of the products they manufacture. This concentration also means that the terms of trade are decidedly against processors who must supply large volumes and meet the increasingly strict specifications of retail buyers. They are also subject to a range of difficult ‘buying practices’, including long payment terms, rebates, discounts, returns and promotional discounts. Although large food processors can use popular and heavily promoted brands to improve their terms of trade, retailers have responded with ‘no name’ or house brands, which they use to pressure large processors to reduce prices. Recent data on food consumption patterns suggests that ‘no name’ and house brands are the fastest growing ‘branded’ processed food products (ACNielsen, 2003).

4. Food processing SMEs

The 30 food processing SMEs surveyed for this study were not selected randomly and the sample is thus not statistically representative. The survey did, however, include enterprises involved in all four of the SIC codes for food processing (Table 2). In addition, it included enterprises defined as small (i.e. between five and 50 employees) and enterprises defined as medium-sized (50–200 employees). Finally, the sample included four companies owned by previously disadvantaged individuals who were assisted through land reform and other government grants. In other words, although the sample may not be statistically representative of all SME food processors, the survey method ensured that the widest possible range of enterprises was sampled.

Table 2: Standard Industrial Classification code for firms in the 30-company survey

SIC Code and description	Number of firms in survey
301: Meat, fish, fruit, vegetables, oils and fats	8
302: Dairy products	10
303: Grain mill products, starches, starch products, prepared animal feeds	7
304: Other food products (e.g. honey, chilli sauce, etc.)	5
Total	30

The method of research involved open-ended interviews with the managers of the small- and medium-sized enterprises. A range of questions was asked, including the history of the business, sources of raw material supply, markets and the most important growth challenges facing these enterprises.

The following common characteristics of food processing SMEs emerged from the research:

• First, 26 of the food processing SMEs interviewed sold their product outside the formal retail structures that exist in South Africa. In other words, only four of the SME food processors interviewed supplied Pick 'n Pay, Shoprite, Woolworths or Spar. The enterprises not supplying supermarkets sold their products through smaller independent retail stores or other enterprises involved in a further stage of processing. The small-scale wheat millers that were interviewed supplied smaller independent and speciality bakeries. Similarly, the medium-sized poultry producers in the sample reported selling their product at the factory gates or through independent wholesalers. SMEs of all food categories also sold food products to private and public institutions, including banks, mines, prisons, hospitals, schools and feeding schemes. These results suggest a direct link between some SME food processors and other businesses that do not involve supermarket chains. A consequence of the market focus of the 26 SME food processors away from formal retailers is that they tend to be more involved in supplying black South Africans in townships through spaza shops, through networks of hawkers, or at commuter stations.

• The second finding is that the majority of food processors in the survey supply local markets. Only one of the SMEs in the sample supplied a processed food product nationally (through two supermarket chains). Three other food processors supplied food products to regional markets or large urban markets. These four firms supplying national or regional markets were also, not surprisingly, the same firms supplying supermarket chains. The other 26 firms supplied local markets only.

• A third finding of the survey relates to the competitive position of SME food processors. SMEs in this survey were competitive on the basis of price or quality. Wheat millers who supply small bakeries with flour said that their product was suitable for speciality baking, and superior to the flour produced by large wheat millers. Similarly, medium-sized broiler producers claimed to produce a better quality chicken than larger integrated producers. In the dairy sector the competitive position depends on the product: fresh milk processors tend to compete on price whereas SME cheese producers compete on the basis of quality.

• Finally, as is the case for other manufacturing SMEs (cf. Rogerson, 2001, 2004), the food processing SMEs surveyed were rarely involved in promotional efforts and much of their marketing was conducted through word-of-mouth or through the active efforts of company owners. In the same way as other SMEs in the rest of the economy, the owners of small and medium food processing companies are usually involved in all aspects of the business, including production, repair, financing and marketing. As was the case with the other broad findings, there is a difference between firms supplying supermarkets and those supplying informal markets. The four companies supplying supermarkets were already involved in formal marketing campaigns through the print media or radio or were under increasing pressure from supermarket category managers to establish some formal marketing structures for their brands.

A key finding of this section is the difference between SMEs supplying supermarkets and those selling their products through other ‘informal’ market channels. The results of this survey show that the majority of SMEs are not involved in supplying supermarkets. The next section explores why this is the case in the context of the growth challenges facing SME food processors in South Africa.

5. Growth challenges

In discussing the competitive challenges they faced, all of the food processors interviewed cited the structure of processing in South Africa as a significant problem. These difficulties were related to the impact of large and vertically integrated food processing companies on their businesses. The six poultry producers interviewed voiced the concern that they were not paying ‘true market prices’ for their feed because the largest broiler companies in this sector were also involved in the feed manufacturing sector (cf. Enslin, 2003a,b). SMEs in the dairy sector complained that it was difficult to source small volumes of raw material (cf. Frost, 1993; Hanival, 1996); when they were able to secure smaller volumes, it was often at high unit prices or the supplies were of a poor quality (cf. Wynne & Lyne, 2004).

Although the structure of processing was cited as a factor contributing to a difficult operating environment, it was not the most important growth challenge facing the 30 companies interviewed. Instead, all the SMEs identified retailer supply demands and the system of listing with a supermarket chain as their key growth obstacle. As noted earlier, only four firms in the 30-company survey of SME food processors had been or were currently supplying a supermarket chain. One company had recently been delisted as a regular supplier owing to quality problems; a second had very recently met the requirements for listing with a supermarket chain; and two others had been successfully supplying a processed food product to several retail chains. The other 26 companies in the sample were not considering ‘upgrading’ to the level of supermarket supplier. The survey information from all 30 companies provides insights into the significance of this growth obstacle and the challenges facing a supplier once this has been achieved.

Despite the fact that very few of the SMEs in the 30-company survey were supplying supermarkets, all the companies interviewed knew what was required to begin the process: it begins with an approach to one of the supermarket's ‘category managers’. Category managers are, as the title implies, responsible for a particular food category. A key part of their job involves assessing the capacity of new suppliers by evaluating the company's capacity and suitability as a supplier of processed food products. This process varies considerably between retail chains and is also changing rapidly in South Africa. One of South Africa's large retail chains requires a ‘facility audit’ that can cost up to R15 000 without any guarantee of becoming a listed supplier. Once listed as a supplier, regular six-month or annual audits are usually required to ensure that the supplier maintains a facility of the highest standards. Although the system of retailer-led auditing is relatively new in South Africa it seems likely to become an industry standard, given the intense competition between supermarket chains. Where a formal audit is not required, category managers are more likely to consider processing companies that have undergone an internationally accepted quality control audit, such as HACCP. All category managers will want to be certain that the company can supply sufficient and consistent volumes of high quality processed food to the retailer's distribution depot. Interruptions in supply and problems in quality are not tolerated and may be disastrous for food processors supplying formal retailers. While the SME processors in the 30-company sample recognised the need for a system of quality control, the companies not supplying supermarkets felt that the conditions were too difficult or too costly. The four companies supplying supermarkets felt that the auditing process was becoming increasingly onerous.

The experience of one of the companies that had very recently become a listed supplier illustrates the significant changes required to ‘step up’, in the words of the owner, to this new level. This food processor was typical of the profile of SMEs supplying informal markets: the company had previously sold dairy and ice cream products to independent stores, restaurants and, most importantly, to township residents through a network of hawkers. While the company had grown quickly in the recent past, its growth path had reached a limit; further growth was only possible by breaking into the formal retail market. As the owner explained:

Making the step up from being a small to a large supplier means moving into the formal retail trade. The implications have been enormous: volumes are much larger than we were used to and there is also more price squeezing and rebates. The requirements in terms of infrastructure and quality are huge. (Company interviews)

The experience of this food processor in making the ‘step up’ is highly revealing of the requirements for upgrading in this particular sector of South Africa's economy. While the increased volume requirements involved in shifting to the formal retail sector may seem obvious, the owner expressed surprise at the scale of the increase, which required new investments in processing machinery and storage facilities. Additional investments were also required to meet food safety standards: according to the owner, although he had not received a formal request from the retailer for a ‘facility audit’, he was nonetheless in the process of improving the infrastructure and monitoring systems for HACCP accreditation. The costs of upgrading will, of course, vary between the various food sectors. This company's investment of between R500 000 and R600 000 in new infrastructure for storage and processing and to meet the requirements of HACCP accreditation is, nevertheless, an indication of the large investment required to upgrade to retail supplier. According to this food processor, achieving HACCP accreditation would smooth the way for preferred supplier status.

Adjusting to new volume and process requirements is not the only change food processors need to make when becoming a listed supplier to a retail chain; these companies must also adapt to a range of purchasing practices that are specific to retailers. SME food processors not involved in supplying retail chains usually have a small operating budget and rarely need to carry the costs of storing either raw materials or the final product. Payment is normally based on cash-on-delivery terms. When SME companies upgrade to retail supplier, they are often required to bear additional costs associated with longer payment terms and also various ‘rebates’ and ‘discounts’. For instance, the terms of payment for retail suppliers vary between 60 and 90 days. For SME food processors this delay is very difficult to manage given that their raw material suppliers usually expect cash on delivery. The food processor with some experience as a retail supplier felt that although volumes had increased dramatically he had ‘less money’ than before:

When you're small and tight, it is much easier. You seem to have more money and there is generally less hassle. Once you become medium-sized things become more complicated. (Company interviews)

An extended payment term is not the only retailer buying practice processors must endure. Retail buyers often require standard rebates and discounts, they will charge processors for promotional costs and they will bargain very hard over price increases. In some cases supermarket chains will ask processors to supply a consignment ‘for free’ to celebrate the opening of a new retail outlet. According to the processor with several years experience as a supermarket supplier,

Every year you need to negotiate a price increase. If you get the increase, you are lucky – lots of times they will refuse to increase prices. If they do agree on an increase, they will cut you in half. So you end up going high. Buyers – they are nasty people; hard people; I don't think that even their families love them. (Company interviews)

Becoming a listed supplier rarely involves a contractual obligation from a retailer, and failure to meet the retailer's supply standards can be disastrous. One of the dairy producers surveyed had become a supplier of ‘no name’ branded milk to a major retail chain. When the retailer received numerous complaints about the milk going sour before the ‘sell-by date’, the quality of the milk was tested. The results showed that the milk had high levels of bacteria, the result of poor quality raw material rather than any problem in the pasteurisation process. This explains why the milk was going sour before its sell-by date. On the basis of the results of the tests, the dairy processor was immediately ‘delisted’, with disastrous results for its production volumes. In an effort to re-establish its status as a listed supplier, this dairy processor is now undergoing a retailer audit. This audit will require additional investments in laboratory facilities and new technical staff to monitor the quality of both the raw material and the final product.

The survey of SME food processors suggests that enterprises intending to grow beyond local markets and institutions such as banks, restaurants and other merchants of processed food must meet the increasingly stringent requirements of supermarket chains. Significantly, this shift requires both resources and new business strategies.

Figure 1 represents the growth obstacle for food processing SMEs as well as required to become a supermarket supplier. On the left-hand side of the diagram, the situation for 26 of the 30 SMEs surveyed is represented. They operate according to cash purchases and cash sales and have low volumes and limited capacity for storage. These companies are not normally audited nor have they implemented an internationally accredited facility audit. This is not to say that the commodity produced by this category of food processor is inferior; on the contrary, many SME food processors produce goods of a higher quality than is the case for mass produced goods found on the shelves of supermarket chains. These 26 SME food processors were not considering making the ‘step up’ to supermarket supplier.

Figure 1: Operating environments for SME and large food processors

The four companies that did upgrade to supermarket suppliers had been forced to shift their business model to the one represented on the right hand of the diagram. They now had to manage longer payment terms and produce food in larger volumes. Owing to changing supply demands from supermarkets they were also required to invest in storage facilities to maintain inventories of their food product. In addition, they had undergone a retailer-audit or had independently decided to meet the requirements of an external, but internationally recognised, audit system (HACCP).

There is an important exception to this framework, and it may provide scope for turning the growth constraint of retailing into a potential growth opportunity for small- and medium-sized food processors. Although large retail chains require listed food processors to meet their demands for volume and quality, franchise stores – such Pick ’n Pay's ‘Family Supermarket’ and many Spar outlets – have some flexibility in selecting their food suppliers. These outlets use this flexibility to source commodities that are either price competitive or of a higher quality, as can be illustrated through the case of dairy products. Small- and medium-sized milk processors have overhead costs that are significantly lower than the larger, retailer-listed, dairy processors who source and supply fresh milk nationally. As a result, they can supply smaller volumes of fresh milk to retailer outlets at a significantly lower price. Franchise stores, which are often in competition with cafes and other independent food stores, use these cheaper fresh milk suppliers to avoid being undercut by their competitors. Sourcing from cheaper suppliers has the overall effect of creating price competition for this particular dairy commodity. For other dairy commodities where quality may be a significant factor, notably cheese and yoghurt, retailers are willing to stock small volumes of processed dairy products from small suppliers. One example within the yoghurt category would be organically produced yoghurt and other speciality yoghurt products. Individual retailers are also willing to consider stocking a range of cheeses as long as they can be convinced of their ‘speciality appeal’. These speciality products are usually priced higher than those supplied by the large processors and are therefore targeted at customers willing to pay more for dairy products that claim a higher quality.

The experience of one small dairy enterprise illustrates the opportunities that are available through independent retailers. This small specialised cheese and yoghurt processor approached an individual franchise store and requested shelf space for his cheese product, which he claimed was of a superior quality. The owner of the franchise store agreed to make ‘shelf space’ for his product in both the cheese and the yoghurt shelves of the store. In return, the retailer required a minimum of eight yoghurt varieties and several types of cheese. Because the dairy processor's brand was unknown, and his prices were higher than those of other large cheese and yoghurt suppliers, he decided to set up a ‘tasting table’ so that customers could sample his cheese. As he explained in an interview:

My problem with the consumer is that I need them to taste the cheese. The market is very price driven and they need to taste the difference. It also makes a difference that I am there – they want to be able to ask the cheese maker all sorts of questions. (Company interviews)

This dairy processor now supplies several individual franchise stores and also sells cheese and yoghurt directly from the farm. He is not, however, considering becoming a listed supplier as he cannot yet ‘carry the four months payment or the rebates’.

Supplying franchise stores thus offers an important outlet for small- and medium-sized food processors. It may provide the opportunity for enterprises to develop a ‘brand following’ and perhaps eventually upgrade to becoming listed suppliers. This is precisely the route followed by a successful processor of chilli sauce and other condiments. The company's history begins in a home kitchen where chilli sauce was manufactured and then bottled with hand drawn labels. The sauce was initially sold at flea markets and through independent restaurant outlets. With demand for the product growing, the owner approached several individual franchise stores, which agreed to stock the sauce on cash-on-delivery payment terms. The success of the product at this scale led eventually to the company being listed as a preferred and national supplier in all of South Africa's retail chains.

This opportunity to ‘break into’ the retail environment is different from what has been reported in other emerging markets. As noted earlier, Dries et al. (2004) found that in Eastern Europe retailer chains are actively involved in supporting smaller suppliers, but in an environment where there are significant supply constraints. In South Africa – where these supply constraints do not appear to exist – the opportunities for upgrading may be found in the complexities of the country's retail structure.

6. Concluding remarks: Supporting the growth of food processing SMEs

This research suggests that the growth challenges facing SME food processors in South Africa must be seen in the context of agri-food restructuring linked to the expansion and concentration of supermarket chains. The sourcing practices of these large retail chains has led to a situation favouring large and well-resourced food processors that can meet a set of increasingly strict demands for volume, quality and food safety. These developments have important implications for the growth trajectory of SME food processors. A key finding of the research is that the ‘step up’ from SME to supermarket supplier cannot normally be achieved through incremental growth and requires instead significant investment in infrastructure to meet the volume and process requirements of supermarket buyers. In addition, it also requires adaptation to a set of new business practices including longer payment terms, rebates and discounts. Given the scale of the investment required, only a small proportion of the SMEs in this survey were supplying supermarkets. Those not supplying supermarkets cited their inability to meet the volume requirements and the problems they would face in dealing with longer payment terms and difficult buying practices. The four companies that had recently made the ‘step up’ remarked on how this had transformed their operating environment in ways that were surprising and difficult to manage. The ‘step up’ is also clearly not without risk, as the experience of the fresh milk supplier that was ‘delisted’ illustrates.

Paradoxically, the growth prospects for SME food processors with ambitions to make the ‘step up’ may also be found in the structure of retailing. The existence of franchise stores, which have some flexibility in sourcing practices, means that there are opportunities for smaller food processors in South Africa's concentrated food retail environment. Several of the food processors interviewed were supplying speciality products to one or more individual franchise stores. The growth trajectory through this strategy could be incremental and is likely to be most successful through the development of a brand following and customer recognition. Once a sufficient following has been established, supermarket buyers could then play a role in helping these processors make the step up to listed suppliers. This growth route is unlike what has been reported in Central and Eastern Europe (Dries et al., 2004). In this particular emerging market a shortage of high quality suppliers encouraged supermarket chains to actively help smaller- and medium-sized enterprises become listed suppliers. The different growth opportunities for SME food processors in South Africa and emerging market countries in Eastern and Central Europe is significant: while both might be classified as emerging markets, with broadly similar processes of agrifood restructuring, this research suggests that the route to growth for SME food processors cannot be generalised across all emerging market economies.

This research also has implications for government support mechanisms for SME food processors. Support mechanisms need to be adapted to the specific needs of food processing SMEs. The Department of Trade and Industry has a wide range of programmes supporting SME development (Rogerson, 2004). In one of the programmes – the Sector Partnership Fund – almost 30 per cent of the successful applicants are in the agro-processing sector (Suzaki, 2003). This survey of SME food processors suggests that support mechanisms need to confront the key growth challenge facing small enterprises in this sector. Support structures should be geared to assisting these enterprises in overcoming the financial and technical obstacles involved in becoming listed suppliers to supermarkets. This means assisting businesses that are growing and attempting to break into the formal retail environment, which could be achieved by providing funds for technical assistance to improve the quality of the product and ensure that the facilities meet the standards of retailers. This form of assistance – which would facilitate ‘upgrading’ in the value-chain sense of the word (Schmitz, 2004; Humphrey & Schmitz, 2004) – would build on the important intervention provided by the AgriBEE. While this empowerment proposal correctly identifies preferred suppliers as a way of transforming South Africa's food processing sector, retailers are more likely to meet these goals when emerging SMEs have already broken into the retail environment, if only at the franchise level. An important question is whether the existing support structures can be adapted to the needs of existing and new food processors.

The author would like to thank two referees for their helpful comments on an earlier draft, and Wendy Job for preparing the diagram.

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Notes on contributors

Charles Mather

Charles Mather is Associate Professor in the School of Geography, Archaeology and Environmental Studies, University of the Witwatersrand. An earlier version of this article was prepared for Trade and Industrial Policy Strategies (TIPS).