Backward integration: One big step to beating FX crunch
Backward integration has become a popular topic in Nigeria in the last decade. Its popularity has been fuelled by crude oil lows, which have adversely affected foreign exchange (FX) inflows into the country, causing severe FX scarcity and disrupting production activities and supply chains.
Backward integration occurs when a company buys or merges with its suppliers, or internally produces segments of its inputs. A brewer, for example, can acquire part or whole of its sorghum supplier or sets up subsidiaries producing some of its sorghum, barley or hops.
“Companies often complete backward integration by acquiring or merging with these other businesses, but they can also establish their own subsidiary to accomplish the task,” Investopedia says.
A typical example of a backward integration success story is the Tyson Foods. In 2001, Tyson Foods based in the United States and China went into joint ventures (JVs) with Shandong Tyson Dalong Food Co Ltd, Jiangsu Tyson Foods Co Ltd and Tyson Shandong Food Co. According to a researcher Rajan Shah, the JVs propelled Tyson Foods into becoming a meat giant. During the outbreak of avian influenza in early 2013 in China, there was a big challenge for poultry products, but the food firm decided to win back the confidence of consumers by taking food safety seriously. Instead of sourcing birds from different farmers, it established its own poultry farm, controlling the entire value chain and production activities. As of the end of 2015, the food company had planned to set up 90 farms in China compared to 20 in 2013.
“To achieve this milieu, Tyson Foods had decided to control the complete production supply chain in China through the backward integration strategy,” Shah said in a research entitled, ‘Tyson Foods in China: Growth Plans Through Backward Integration.’
Backward integration is an important strategy that can help Nigerian manufacturers protect themselves against FX volatility. Depending on the sector, exposure to the FX market in the Nigerian manufacturing sector averages about 40 percent, according to the Manufacturers Association of Nigeria (MAN). But it differs from sector to sector. Food and beverages sector had an average of 64 percent local input or 36 percent FX exposure in 2019, according to MAN. Sectors like pharmaceuticals and chemicals would naturally have higher FX exposure because most of their inputs are imported owing to lack of functional petrochemical industry in Africa’s most populous nation.
Customs officials confirm that manufacturers are the biggest importers. Products from inputs to machineries are imported into the country on weekly basis by manufacturers. The fact that manufacturers are biggest importers is, however, ironical given that the sector should naturally be at the forefront of export and repatriating FX into the economy. Manufacturers’ reasons for not meeting up with these expectations are well-known, but the realities of the times say now is time to look inwardly.
Backward integration saves costs and reduces exposure to the FX, which has continued to stall production activities across board.
Today, many firms are struggling because they cannot find greenback needed to import inputs.
“We wanted $60,000, but we could only get $5,000 from one of our banks. It is now much worse than the 2016/17 situation, and some of our members are thinking of moving to ECOWAS in January when the continental free trade starts,” a director at a manufacturing firm told BusinessDay recently.
Nigeria’s monoproduct economy has become a punishing reality, which is now hurting the economy badly. For manufacturers, sourcing raw materials locally by way of backward integration is looking inevitable. Apart from saving costs and reducing FX exposure, it gives a competitive advantage and enables firms to control the value chain.
However, backward integration requires huge and expensive investments. Doing backward integration in the palm oil industry, for example, costs PZ Wilmar about $150 million. This cannot be afforded by most medium and small manufacturing outfits, which explains why experts are calling for more support from the CBN and other funding agencies to boost this segment of the economy. Apart from the benefits it brings to manufacturers, backward integration also boosts jobs, rural development and reduce pressure on the FX market. It can also lead to the springing up of millions of small businesses working with large firms.
Several backward integration projects in the country are hurt by land tenure system and community tussles. This is stalling investments in this sector.
A lot of companies have, however, done considerably well in this area. PZ Wilmar, a subsidiary of PZ Cussons, has bought 26,500 hectares of palm oil plantations in Cross River State. About 5,549 hectares (ha) of oil palm plantation are located in Calaro Estate, while 2,369 ha are in an area known as Calaro Extension. The firm also acquired Ibiae plantations with 5,595 ha; Ibad plantations in Akampa with 7,805 ha; Kwa Falls in Akampa Akpabuyo with 2,014 ha, and Oban plantations, also in Akampa, with 2,986 ha.
PZ Wilmar has likewise acquired palm oil mill (POM) and kernel crushing plant (KCP), investing around N20 billion in an oil palm refinery in Lagos.
“We are determined to continue with these investments and looking for opportunities to expand our plantations in the state. We have also invested around N20 billion in an oil palm refinery in Lagos,” Santosh Pillai, managing director of PZ Wilmar, told BusinessDay.
FrieslandCampina WAMCO, producer of Peak Milk and Crown Milk, currently has several locations in Oyo State and Niger State where it houses and supports local herdsmen who provide milk from local cows. The milk is used for the production of the popular Peak and Three Crown today.
There are several of Dangote Group’s backward integration projects in sugar, cement, and foods.
Apart from BUA’s nursery plantation in Kwara State, BUA’s Sokoto Cement is also doing a lot of backward integration work.
The ultramodern plant Kalambaina cement plant in Sokoto State, which gulped $350 million to build, is blessed with huge limestone deposits and the company has leveraged the opportunity.
Olam Nigeria is also doing a lot of backward integration projects in the country, including with its subsidiary Caraway Foods International Nigeria Limited, in the tomato industry.
To achieve the backward integration plan, Caraway started a pilot project in September 2019 on 20 hectares of farmland across three locations in Kano and Jigawa states, which are being expanded to 500 hectares. This is followed by the commencement of a larger out growers programme to engage 1,000 farmers to be trained and provided with seeds that will deliver the same kind of output the pilot farms are recording.
“This is complete end-to-end production and backward integration,” said Prashant Thakur, the regulatory head for Caraway Africa Nigeria limited, who is also heading the tomato backward integration project, recently. He explained that existing brands, Tasty Tom and De Rica, would continue to be produced except they would now be 100 percent local content.
Many other firms such as Flour Mills are also in this. Others like Unilever and Guinness are aggressively sourcing some of their inputs locally.
Guinness Nigeria is working with 30,000 farmers to realise this objective.
“We assure them of the market. As you are aware, African farmers have issues with predictable market. So, being able to assure them of the market gives them confidence. The other thing is diversification. This encourages manufacturers in Nigeria to take the Guinness example, source locally, involve the communities, and get the banks to access banking services,” Baker Magunda, chief executive officer of Guinness Nigeria, told BusinessDay earlier in the year.
As the FX scarcity continues to hit firms, backward integration promises to be a game changer. But it requires more funding support and the right environment to thrive.