CHAPTER TWO

2.0 LITERATURE REVIEW

2.1. Introduction
This chapter reviews literature relevant to the research problem under investigation. This chapter therefore
investigates what other authorities have written about the effects of quality standard on organizational
productivity.

2.2. The concept of new Kenya Cooperative Creameries

This section reviews literature on the effects of quality standards on organizational productivity in the dairy
sector in Kenya with particular reference to the Kenya Cooperative Creameries (KCC). In Kenya a new
government, formed by the National Rainbow Coalition or NARC, came to power following elections in
December 2002. It quickly produced an Economic Recovery Strategy for Wealth and Employment Creation
(ERS), then in early 2004 adopted a Strategy for Revitalization of Agriculture (SRA) as a way of
implementing the principles of the ERS within the agriculture sector (Smith and Karuga 2004). The SRA was
widely seen as a good document and was warmly welcomed by the donor community in particular, given its
emphasis on rationalizing and reducing the role of the state in Kenyan agriculture so as to give greater space
for private sector involvement and investment.

However, more than three years on. there has been disappointingly little progress in implementing the SRA
reform agenda. This case study considers one notable reform within the agriculture sector that has been
undertaken by the NARC government: the revitalization of Kenya Cooperative Creameries (KCC) in 2003.
The revival of KCC is widely perceived as a successful intervention in the country 's dairy sector, albeit one
that is somewhat at odds with the emphasis within the (subsequent) SRA of reducing the role of the state in
Kenyan agriculture (FAC 2007).

It is argued here that the political changes that followed the coming to power of the NARC government in
2003 presented an opportunity for political transformation. There were changes in policy making and
implementation. These were affected by the new government in its quest to make its mark and meet the
challenges of a political euphoria that accompanied its electoral victory. The intervention in the dairy sector,
through the revitalization of KCC had both political and developmental (economic) objectives. Policy
processes, therefore, reflect growing demand for change and transformation of the society.

Secondly, in agrarian societies, dynamics in agricultural development lead to a certain form of politics which
in turn drives policy processes. Because of the dominant role of agriculture in the economy, social forces and
political interests anchored in the agricultural sector give rise to policy processes that advance interests of
particular groups. Policies then become an outcome of processes of negotiations between various interests.
Some social forces win and others lose out depending on their social basis of support in the society. For this
reason, it may be argued that that policies and their implementation arc essentially negotiated outcomes,
requiring the involvement of multiple stakeholders with different interests (Scooncs. ct al.. 2005). Policy
processes involves a complex set of interactions with different players and interests as well as the political
environment. Within the context of policy making, a number of factors come into play to determine the
outcome. These include the constitution, powers of various social forces, the bureaucracy, as well as the
prevailing state of democracy (FAC 2007).

In Kenya, the nature of politics of state interaction with the society influences policy initiatives, with the
political elite and different interests being important in determining policy outcomes, lite concentration of
power among the ruling elite, political patronage, donor influence, the technocrats and the civil society have
all been important in the policy making process in the country. The political environment as well has been a
major factor in determining policy initiatives and their implementation (Smith and Karuga 2004). In Kenya the
interaction of political and economic interests and their joint influence on policy outcomes are not recent
phenomena. In the development of the colonial settler economy, economic interests influenced convictions as
to what institutions were appropriate for governance of political life.

Bates (1989) observes that material interests defined political preferences; institutions were created and
forged to advance economic interests of particular groups because of this, there evolved a coherent
pattern of interaction of politics and the economy: economic interests gave rise to a certain form of
politics, and political interests in turn evolved certain forms of economic institutions. However,
institutions that were put in place to enhance the growth of agriculture also furnished resources that
helped political elites to maintain themselves in power (Bates 1989), as well as providing die social bases
of regime support. Thus, economic institutions became the theatre for political struggles. The interaction
of economic and political interests is well illustrated by the story of the revitalization of KCC.

Kenya is one of the largest producers of dairy products in Africa, w ith the highest per capital
consumption of milk in Africa, estimated as being four times the Sub Saharan African average of 25 kg
(Republic of Kenya 2005). The dairy industry accounts for 14% of the agricultural GDP and 3.5% of the
total GDP. It is based predominantly on smallholder production, which accounts for about 70% of die
total annual milk production in the country (Kenya Dairy Board, 2007).

Estimates of the number of smallholder households depending on dairy for (part of) their livelihoods vary
between 625,000 and 800,000 (Leksmono ct al 2006, Kenya Dairy Board 2007). Dairy farming
contributes to poverty reduction and equity in gender distribution of incomes since it is easily undertaken
in small scale by women. Based on dairy farming experience accumulated over 90 years. Kenya has a
relatively large herd of improved dairy cattle compared to other countries in the region. (Ngigi 2005).
The traditional milk drinking culture and keeping of traditional cows have also helped in the development
of the sector. Dairy production in Kenya is largely for the domestic market. Occasional surpluses may be
exported to regional markets and shortfalls may be met through imports of milk powder. Most notably,
droughts in 1980 and 1984 led to increased imports.
 I lowevcr. the quantities are tiny compared to the production volumes dairy fanning in Kenya dates back
to the colonial period. Many settlers ventured into large dairy farming with the support of the colonial
administration. The first high yielding cattle breeds were introduced into the country' during the colonial
period, lhe period also led to die emergence of formalized institutional and organizational framework for
milk marketing as well as delivery of livestock breeding and health services (Ngigi 2005).

The interaction of the state and farming settlers meant that the sector would be politically regulated.
Although many creameries were in place, the post-WWl depression period occasioned a reduction in
prices forcing some of the creameries to merge. This led to the formation of Kenya Cooperative
Creameries (KCC) in 1925 to facilitate the production, processing and marketing of milk and to insulate
farmers from the impact of the depression. Later on demand for dairy was accelerated by prosperity
from coffee and tea. which generated an increase in demand for milk and therefore demand for grade
cattle (Bates 1989). It is noteworthy that the settlers urged for restricted competition to ensure they
monopolized the sector.

They invested in creameries and commercial dairy herds. They also lobbied the state to enact enabling
policy legislation and specifically legislations that would facilitate their monopoly of the sector.
Domination of dairy farming by large-scale white settlers thus obtained until 1954 when the Swynncrton
Plan introduced changes that allowed Africans to engage in commercial farming. The Swynnerton Plan
marked a major policy turning point in the dairy sector, opening up commercial dairy farming to the
indigenous population. This was accompanied by government training of smallholders on better methods
of animal husbandry. There were also deliberate measures to strengthen the farm production of
smallholder farmers more generally, which saw the emergence of cooperatives and agencies for the
marketing of agricultural produce
• (Muriuki et al. 2003).
 I he Dairy Industries Act was enacted in 1958 to preserve the dominance of KCC in the market. KCC
became the sole agent in the marketing of dairy products in the main urban centers, which became
known as “scheduled areas’’. The Kenya Dairy Board (KDB) was also instituted under the act as the
state agent to regulate the industry . KCC was appointed the sole agent for the processing, packaging
and sale of milk in the scheduled urban areas by the KDB.

The act also established regulations that were interpreted as keeping raw milk out of the scheduled
urban areas, where consumers were to be served pasteurized milk through the formal market. I he
enactment of the Dairy Industries Act has been seen as resulting from fear among the settler farmers
brought about by the opening-up of commercial dairying to the indigenous people. This appeared to
weaken the ability to coordinate the dairy products markets through direct negotiation and voluntary
cooperation of farmers.

This increased the need for a legitimate authority to formulate the rules of the market and to monitor,
sanction, enforce compliance and facilitate problem-resolutions. The settler-dairy farmers by 1956
increased their demand for statutory control of the industry. The series of activities that followed
eventually resulted in the Act in 1958. The colonial situation laid an elaborate infrastructure for dairy
farming. This infrastructure tended to favour large-scale settler farmers, consistent with general state
policies that protected and promoted settler economic interests.

According to Leksmono et al. (2006). the 1958 Act did not make the sale of raw milk illegal. However,
the Public Health Act. which KDB became responsible for enforcing within the dairy sector, states that
traders in food products must have "acceptable premises" in order to be licensed. Most informal traders
don’t have premises, so their activities were widely understood to • be illegal. Al independence, the
government sought to increase the involvement of smallholder farmers in dairy production.

One of the country's broad development objectives was improving the welfare and the distribution of
resources as reflected in the Sessional Paper Number 10 of 1965 on African Socialism and its Application to
Kenya, which set out among the development objectives, the need to achieve high and growing per capita
incomes equitably distributed among the citizens (Muriuki ct al, 2003, Republic of Kenya 1965). I he
government regarded the state control of the dairy subsector as central to its development, as was the case
with other economic activities. Control of economic activities was considered central for the country’s

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social and economic development. The government appointed a commission of inquiry in 1964 primarily to
address the issue of the dismal market participation by smallholders.

The 1964 Commission on Dairy Development recommended increased access to the Kenya Cooperative
Creameries (KCC) by all farmers as long as they met the acceptable quality, through the abolition of
contracted milk quotas. This made KCC a guaranteed market for all raw milk as well as a buyer of last
resort. It also became an agent for the implementation of statutory controls in milk prices. Private dairies
dealing with raw milk were shut down, giving KCC all monopoly rights and mandate to accept all milk
delivered.

KCC embarked on a rapid expansion programme, with guaranteed loans from the government, and official
monopoly access to protected urban market. This expansion in capacity was necessary to achieve a national
network of chilling stations and processing plants and packaging commensurate with its new role. This
enabled it be a reliable outlet for all dairy farmers and since it cushioned the smallholder farmers from price
fluctuations it offered a stable marketing system (Ngigi 2005). This contributed greatly to the confidence
that farmers came to cultivate in KCC over the years. Government investment in the dairy industry during
this period took the form of highly subsidized inputs for breeding, animal health services and production, in
addition to intensified training for local staff.

In addition, the government supported widespread introduction of highly productive breeds of dairy cows.
There was also a major land transformation during this period involving the subdivision and redistribution
of former large farms owned by white farmers. The land transfer programme contributed significantly to the
increase in smallholder dairy production. By mid

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1970s, smallholder dairy farmers had overtaken the large-scale farmers as the major producers of milk in
Kenya (Lcksmono et al., 2006, Ngigi 2005). During this period, the dairy sector enjoyed various forms of
donor support. The development of cooperatives in the country also greatly befitted from donor support.
Furthermore, this period witnessed the rise of new economic-cum- political elites interested in pursuing
large-scale farming and dairy fanning in particular. Inspired by the success of some of the large-scale
colonial settlers, the new black elites bought settler land in the former white highlands through the land
purchase programmes. They also entrenched themselves in the agricultural economic institutions established
by the settlers, including KCC.

Whilst KCC provided valued services to new smallholder dairy producers, the cost of its operations was
high. By the 1970s, KCC started experiencing trading losses, which reduced the price that it could afford to
pay to farmers for their milk. According to Ngigi (2005), during the period 1971-92 the producer price for
raw milk declined at 1.36% p.a. in real terms. Since the KDB had to get funds from the beneficiaries of its
services to discharge its responsibilities, it was empowered by the 1958 act to levy cess on all commercially
handled milk. KCC became the agent to levy the cess on all those supplying it with milk on behalf of KDB.
In response to KCC’s trading losses, in the 1970s the government empowered it to retain 50% of the cess
that it collected on behalf of KDB. In the 1980s KCC was allowed to retain all the cess, instead of remitting
any to KDB. The retention of the cess heralded the start of a series of concessions that eventually led to the
limitation of KDB’s ability to carry out its regulatory responsibilities. At the same time. KCC’s privileges
and monopoly powers increased.

The dairy sector experienced rapid production growth between 1981-1991 with an average annual growth
rate of 10% (Ngigi 2005). None of the secondary' sources consulted for this study fully explain this rapid
increase in growth rate as compared with the previous two decades. Producers continued to benefit from
subsidized support services until the mid-1980s, but subsidies were gradually removed in the latter part of
the decade. Meanwhile, as already noted, real producer prices were declining in real terms through die
1980s.
Moreover, growth in the Kenyan economy as a whole - an important determinant of dairy demand -
began to slow during this period, following annual growth of 6.6% between 1964-1973 and 5.2%
between 1974-79. What is clear is that the performance of KCC became an increasingly serious issue
during the 1980s.

By the late 1980s KCC was struggling to cope with demand to collect increasing volumes of milk from
smallholders. Two new dairy cooperative societies - the Meru Central Farmers Cooperatives Union
(1983) in Eastern Province and the Kitinda Dairy Farmers Cooperatives Society (1986) in Western
Province were registered as dairy processors to fill the gaps evolving from KCC’s declining capacity.
However, according to Ngigi (2005), these never accounted for more than 2% national milk intake.

At this time, some influential politicians anti fanners started pushing for an end to KCC’s monopoly.
More generally, donor agencies were also exerting growing pressure for economic reform. The Sessional
Paper Number One of 1986 on Economic Management for Renewed Growth, (Republic of Kenya 1986)
marked a major turning point in the policy environment that affected the dairy sector. Within the sector
itself, the first reforms were initiated in 1987. with the reduction of government’s role in provision of
breeding and health services. This was followed by liberalization of the manufacture and sale of feeds
and a reduction of the government’s role in the feed industry.

l hc marketing of milk itself was liberalized in 1992. (Ngigi 2005, Muriuki et al, 2003). Milk prices were
decontrolled and KCC’s monopoly on urban markets was revoked, ending 60 years of KCC dominance.
Following liberalization two groups of players entered the dairy sector to compete with KCC and
gradually take over its milk marketing and processing roles. The first group was small-scale milk traders,
who moved in large numbers to buy raw milk from farmers and sell it to consumers.

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The rise of these small-scale traders both contributed and responded to the collapse of marketing
cooperatives during the 1990s. I.eksmono et al. (2006) cite estimates that, by 2004, there were 40.000
such informal vendors accounting for 86% of total retail milk sales in Kenya. The shift to raw milk sales
was dramatic, contrary to the thrust of official policy since the colonial period and. therefore,
controversial. However, many poorer consumers preferred the option of cheaper raw milk, rather than
more expensive pasteurized milk, whilst some allegedly preferred the taste of raw milk (I.eksmono et al.
2006). Ngigi (2005) notes that in Kenya much milk is drunk in tea and coffee, and that Kenyans
habitually boil milk for these uses, hence reducing the need for pasteurization.

However, whilst many entered the market initially, not all were successful and some concentration in
activity took place after a few 1 years. The private processors, like KCC, found it hard to compete with
the informal milk vendors, given the preference of many consumers for cheaper raw milk. Through their
representation on the board of KDB (representation not extended to informal milk vendors) and through
advertising campaigns, they tried to restrict the activities of informal milk vendors, but so far without
success (Lcksmono cl al. 2006). There are mixed views and perspectives regarding the effect of
liberalization on the sector. Many donors and international organizations like ILRI, who had championed
the reforms, feel that it was a good thing, creating opportunities for small traders vending milk.

Others argue that policy reforms, including the liberalization of milk prices in 1992, produced mixed
outcomes at best. Competition in the milk market led to sharply higher farm-gate prices in nominal
terms. I lowcver, as shown by Ngigi (2005), these price rises were much more modest in real terms.
Indeed, real prices only rose during 1993-95. By 1999 the average farm-gate price in real terms was back
to prc-liberalization levels. Then, as shown in Figure 3. it fell even in nominal terms over the next couple
of years. Meanwhile, the introduction of cost sharing for inputs and services as a result of the reduction
in subsidies in the late 1980s meant that many farmers were not able to respond to higher prices due to
effects accessing inputs and other support services (Ngigi, 2005).
Whilst price increases as a result of liberalization were modest in real terms, liberalization also led to
increased price volatility for producers. This is in part the inevitable result of replacing an administered
pricing system with market competition. However, changes in the processing industry also contributed to
this increased volatility. According to Ngigi (2005, p41), the combined capacity of the private
processors rose steadily during the 1990s, reaching 500,000 liters per day by 1999. Higher figures for
private sector capacity are implied by Lcksmono ct al. (2006) and by Ngigi (2005, p51-52), which quote
KDB figures that show private processors handling 600,000 litres per day in 2000 at low capacity
utilization due to competition from informal vendors selling raw milk.

Ngigi (2005, p51) claims that KCC’s average daily milk intakes during 1986-1991. during which time
KCC averaged 77% capacity utilization, was 920.000 litres per day or around 360,000 tons p.a.4. If so. a
figure of 600.000 litres per day handled by private processors in 2000. combined with the 370.000 litres
per day handled by (New) KCC in that year, compares well with this figure. However, unlike KCC, none
of the private processors had the capability of turning excess milk into milk powder during times of glut.

Thus, seasonal peaks in production post-liberalization have at times led to sharp falls in prices. Exposed
to market competition. KCC’s inefficiency and other internal effects led to its gradual demise in the
1990s. An initial symptom of its malaise was delayed payments for milk deliveries by farmers, which
eroded farmer confidence in KCC. thereby further reducing supplies received. KCC collapsed in 1999,
leaving many farmers unpaid for their milk deliveries. National milk production had already fallen from
its late 1980s peak prior to milk market liberalization. Ihe ending of subsidies on inputs and support
services contributed to this. For several years after 1992. production remained essentially static.

However, it began to pick up again from 1999 and has since passed the peak levels achieved prior to
liberalization. One final observation on the post-liberalization era is that official policy and. even more
so, legislation have lagged behind structural changes in the sector. As with many agricultural activities in
Kenya, a number of old laws remain on the statute books, but are either no longer enforced or are subject
to varying interpretations. Official attitudes towards informal

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milk vendors have been a particular area of uncertainty and cause for concern since 1992, although there
has recently been progress in this area (Leksmono et al, 2006). In 1993. the Kenya Dairy Development
Policy was formulated to guide the dairy industry through the liberalized market environment. This
policy document has since been revised a number of times into various drafts, but not yet implemented
or even finalized. It was updated in 1997 and revised in 2000 after wide stakeholder consultations. At
this point it was accompanied by a Draft Dairy Industry Bill. The policy was revised again in 2004 and
2005. It was presented for stakeholder consultation in April 2006 and has currently reached a draft
Sessional Paper stage awaiting presentation to the cabinet together with the Draft Dairy Bill.

From the discussions with stakeholders, there is a feeling that policy is not leading the sector. It is
lagging hehind the developments in the sector. Policy is also not seen as reflecting the reality of the
industry and is also not guided by evidence. The decisive intervention by the NARC government in re-
establishing control over KCC in 2003 and investing in the company to expand its operations stands in
some contrast to the protracted deliberations over wider sector policy. The remainder of this paper
investigates the events leading up to this decision and the reasons why it happened. In this section we
briefly discuss the outcomes of the revitalization of KCC. Much as with liberalization in 1992, the
outcomes of the revitalization of KCC can be debated. However, there is a widespread view that the
revitalization of KCC has had a positive impact on the Kenyan dairy sector. I.eksmono et al. (2006. pll)
note that, "The re-launch of KCC has broadened the competition in the formal market segment,
contributing to belter farm gate prices and the current relative exuberance in lhe dairy sector.

New KCC’s own milk intake has increased from 40,000 litres per day (or around 14.6 million litres p.a.)
in 2002 to 400.000 litres per day by end of 2006 (KDB 2007). Figure 4 shows that all KCC plants have
seen an increase in intake, but that the increase has been much more pronounced in some than others.
Other figures indicate that the total milk intake to processing plants in the country rose from 173 million
litres in 2002 to 274 million litres by 2004 and 332 million litres in 2005 (Republic of Kenya 2005 and
2006). I his suggests that, whilst most of the national increase in milk processing has been accounted for
by KCC. it has not crowded out the activities of the various private processors. Nevertheless, the private
processors do feel that KCC
is gening undue advantage in the form of protection and different forms of support from the government.
KCC sets what amounts to a benchmark price, in the range of Kshs 16-20 per litre, giving farmers some
price predictability. With its wide coverage over the country and capacity' it is able to purchase all the
milk delivered to it by fanners. KCC is, therefore, seen as a major stabilizing factor for milk prices. Il
remains to be seen whether this improved confidence was translated into increased milk production.
However, it is estimated that milk production in the country increased by 10% from 3.2 billion litres in
2005 to 3.5 billion litres in 2006 (KDB 2007, Daily Nation January 30. 2007).

Confidence that production was growing again comes from the entry of new players into the dairy sector
since the revival of KCC. The current vibrancy in the sector is thus associated with the development of
farmer support services like feeds suppliers, providers of artificial insemination services and other
services supporting the dairy industry. There has been an increase in those providing veterinary services
like agro vet enterprises, whilst non-governmental organizations and microfinance institutions (MFIs)
have seen dairy as a strategic activity for poverty reduction interventions. KCC is also collaborating with
traders and suppliers of dairy inputs to enable farmers to access such services on credit terms. Farmers
can take inputs on credit, with the payment being deducted by KCC from the milk deliveries.
Commercial banks have also introduced specific loans for dairy farmers, giving farmers loans for
purchase of dairy cows, repaid through the delivery of milk. The revival of dairy marketing
cooperatives, with active support from the government, has gone hand in hand with the revival of KCC
and the dairy sector.

23. Standards Implementation for Productivity (SIP)

A Standards Implementation for Productivity (SIP) project is intended to assist industry in the
implementation of standards for the improvement of productivity covering both the manufacturing and
services sectors. In SIP projects, the standards to be implemented can cither be developed or adopted
from existing international, national or widely accepted industrystandards. It brings together significant
players, SMEs and other stakeholders in local industries

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to participate in SIP pilot projects. Besides facilitating the project, we work closely with industry to
bring together relevant private and government parties to implement standards and assess the impact of
the SIP projects for industries. The benefit was encouraging other players in the industries to adopt the
standard for improvement of their competitiveness. SMEs which have participated in SIP pilot projects
have reaped tangible benefits such as cost reductions, better connectivity and improvements in
productivity, quality, safety and health. To date, the pilot projects have achieved 10 times the returns of
the grant amount of the projects. Some companies have reaped more than $20 million in savings. Co-
tunding of SIP pilots is available to encourage the adoption of standards for your industry, particularly
among SMEs. Pilot projects can involve both large and small companies.

2.3.0. Benefits of Standards Implementation for Productivity

Competency. Improve productivity, quality and enhance customer satisfaction; Increase efficiency;
Reduce human errors through automation; Savings in product and production costs. Business
Opportunities, Standards are increasingly being used as a benchmark and qualifier for identifying
competent and reliable suppliers who comply with local regulations, international practices and industry
requirements. Suppliers who comply with standards stand to secure a foothold in the marketplace
through the legitimacy standards give and develop closer collaborations and relationships with trading
partners. Market Access. Standards help to promote trade by lowering technical barriers to trade.
Businesses which adopt national and international standards gain better access to both local and global
markets. Cost Savings, time savings - improved product time to market, product cycle lime and
manpower lime; quality - Improved product quality, reliability and shelf life and; Improved consumer
satisfaction and company branding (Jarillo 1988).

2.3.1. Standards Implementation for Productivity Highlights

• Over S50 million in savings and benefits have been gained from SIP projects
 • Recognition and publicity through seminars showcasing companies in successful SIP projects

• Financial support of up to 70% of applicable project costs, subject to applicable terms and
conditions. Assistance may be provided for manpower-related costs, equipment & materials,
professional services, consumables cost and other project-related expenses (Jarillo 1988).

2.3.2. Phase process for SIP implementation

Phase 1 Phase 2 Phase 3 Phase 4 Phase 5

IDENTIFY ASSESS DEPLOY VERIFY • PROMO1E

Identity need for . Engage stakeholders . Refine scope ’ Phase 4 is Showcase

Standardisation to assess identified only applicable successes
need for . Plan for for pilot
Conduct industry implementation implementation projects Collate and
outreaento identify promote
gaps Ensure commitment. . Monitor & assist in Verify actual projects
participation & support implementation benefits
identity standards of stakeholders realised Archival of results
to be utilised m . Confirm cost & for tracking and
SIP (to be Determine if pilot is funding needs . Monitor returns future reference
developed or required of benefits
revised where . Evaluate
necessary) . Propose scope expansion of
project and
. Project expected newfspin-off
benefits and funding projects
needs

Source: Jarillo 1988

2.4. What does the ‘new quality’ mean?

There were several severe food crises in the years prior to the BSE- and FMD- crises in the winter of
2000/01, e.g. the Coke-scandal in Belgium, the BSE-crisis in the UK, and the winescandal in Austria
and Germany. However, the crisis in the winter of 2000/01 can be regarded as the straw that broke the
camel’s back (Hanf/l lanf 2005). The growing concerns of consumers, producers and governments
worldwide have influenced the political debate on food safety. In the European Union (ELI) a variety of
new standards have been set in order to ensure the demanded minimum level of food quality. The result
of these developments is that legal quality requirements are becoming more stringent and
comprehensive (i.c., covering more safety attributes), and food policy is becoming increasingly
integrated across various sectors (Ugland /Vcggeland, 2006). With increasing knowledge and perception
of risk, consumer demand for safety and a willingness to pay for it increases (Antic. 2001).

At the same time, as incomes rise, consumers demand even more quality, including, besides safely, such
attributes as nutritional value, product diversity and tightness of product specification. Providing
credence attributes is becoming an integral and ubiquitous issue for business operators. Indeed, trust-
based attributes arc expanding and include, besides food safety and nutritional properties, different
contextual product properties related to certain public goods or values, such as environmental justice or
cultural (traditional) values, etc. (Allaire, 2004). Consumer arc. however, not able or willing to
intensively and fully ascertain the credence characteristics of food products. Thus, they look for signals
to facilitate their buying decisions, e.g. a well-known brand or a certificate of quality, thereby
motivating the participants of the food chain to take the appropriate measures and to meet the ‘new
quality' demand (Hanfi'Pieniadz. 2006).

Through the expansion and deepening integration of the EU. the quality-based competition among
business operators has intensified. On the one hand, the minimum quality standards of the EU force low-
quality producers to raise their quality or drop out of the market (Hockmann/Picniadz. 2006). On the
other hand, the increasing demand for quality signals especially allows supermarkets and manufacturers
of branded products to benefit from imposing voluntary, private quality and safety standards, some of
which are even more stringent than

19
similar governmental regulations. Hence, the use of private voluntary standards across food categories
has been increasing in both long-standing EU members, as well as in transition countries (Swinnen,
2006; Spencer/Reardon. 2005). Fulponi (2006) argues that private standards was become even more
prominent in upcoming years as we observe increased market concentration and buying power in the
retail sector, as well as its integration with financial markets. Unncvchr et al. (1999) assert that since
food safety and quality can be successfully managed using private standards, their diffusion was
henceforth even reduce the need for direct legal regulations. Thus, in order to meet the demanded new
quality, food processors and retailers was have to enact additional mechanisms and redesign their food
chains to induce the incentivecompatible behaviour of upstream business operators.

Hanf/Hanf (2005) concluded that these demands on quality lead to the conceptualization of chain quality
management concepts by combining these ‘new quality’ demands with general chain management
concepts.

2.4. 0. Verticalization and chain quality management

Food supply chains can be characterized as pyramidal-hierarchical networks. Such networks have a
strategic character, with the focal company being the core element. The focal company is the centralized
decision-making unit and may be cither die manufacturer or retailer (Jarillo 1988). Thus, the focal
company determines the decisions of all network members, including the choice of measures to ensure
the achievement of the super-ordinate network aims (Wildemann 1997).

Efficiency gains, higher profits, and cost reductions are important reasons for building such networks -
which can be called supply chain networks - with food quality being regarded as one of the most
important. Allaire (2004) mentioned the “quality turn” as a main reason for the tendencies towards
vcrticalisation in food chains worldwide. Ihe consultancy KPMG (2000) characterizes verticalisation as
the building of vertically coordinated systems resulting in changing markets for ‘fast moving consumer
goods' (FMCG). Thus, vertically coordinated systems are understood as the exchange of goods not
primary conducted by market transactions.

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In other words. verticalisation means intensifying vertical relationships, which can take different forms of
bilateral commitment between partnering firms based on implicit and explicit contracts.

Generally, we can distinguish between two partnering types: strategic and operational partnering:
Strategic partnering is defined as an “on-going, long-term, inter-firm relationship for achieving strategic
goals, which deliver value to customers and profitability to partners” (Mentzer ct al., 2000, p.550). The
aim of strategic partnering is to improve or entirely alter a company’s competitive position through
developing new products and technologies and by creating new markets (Webster 1992). Additionally,
strategic partnering should also include exclusivity and non-imitability (Mentzer et al., 2000). Operational
partnering is defined as a “needed, short-term relationship for obtaining parity with competitors” (ibid,
p.550).

Thus, an operational partnering strategy seeks to improve operational efficiency and effectiveness.
especially by reducing transaction costs. Such orientation involves shorter time spans and less
organizational resources. Therefore, operational partnership is much easier to implement (and also to
reverse) than strategic partnership. In addition to such aspects of aligning interests, chain management has
to consider aspects of coordination (Gulati et al., 2005).

In their framework on chain management Hanf/Dautzcnbcrg (2006) combined these considerations with
the thought that networks consist of different levels, namely firm, dyadic, and network levels. They point
out that these three aspects have to be mirrored in the collective strategy! of a supply chain network.
Thus, if quality is the leading idea or strategy to be coordinated along the SCN, all members must share a
homogeneous understanding of quality management, which provides the preconditions for the emergence
of a collective strategy, and thus collective actions that address the chosen strategy. In this ease, we
expect a correlation between the chosen quality strategy and the design of the partnership.
Therefore, the following assumption can be made in order to test it empirically in the second part of the
study: If a firm chooses a pure cost leadership strategy, we expect that this firm was produce products that
solely meet the minimum quality requirements (EU/ governmental regulations). In this ease, we expect
that vertical exchange was take place by arm's-length transactions, meaning that vertical co-ordination is
more or less done via the (spot) market. Thus, it was be sufficient for a cost-optimizing firm to develop
operational partnerships in both upstream and downstream stages. If a firm chooses the opposite strategy

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of product differentiation and quality attributes (especially trust elements) arc chosen as the means of
differentiation, we expect the firm to develop more sophisticated relationships. Yet we expect that the
differentiated firms are more likely to develop strategic partnerships. In this ease, vertical co-ordination
can be regarded as highly cooperative or even vertically integrated.

2.4. 1. Quality effects in co-operatives

food quality is no longer the matter of a single firm, but instead the whole food chain has to work together
in order to deliver the new quality'. However. Hanf/Schweickert (2003) as well as llanf zK(ihl (2005)
mentions that due to their organizational form, co-operatives face effects integrating themselves in supply
chain networks.

Major reasons tor this are the co-op’s internal institutions governing the behavior of the co-op’s members
and affecting the co-op's ability to manage the quality of its products. Arguments for this arc the
following: In the context of increasing vertically coordinated agri-food systems, Sykuta/Cook (2001)
showed that at the producer level, the most practical co-ordination mechanism is contracting. Because of
their very own property rights structure, producer co-ops have some advantage compared to investor-
owned firms.

However, in addition to these benefits, they also face some effects. By using a property rights approach.
Cook (1995) pointed out five general sets of effects: Free Riding Effects, Horizon Effects. Portfolio
Effects. Control Effects and Influence Cost Effects. As Cook (1995) showed, these sets of effects
constrict the various types of cooperatives (Sapiro l-Nourse 11) differently. Combining a principal-agent
approach with the concepts of opportunistic behaviour, conflicts of interest, asymmetric information and
stochastic conditions, Eilers. Hanf (1999) show that it is not clear who is the principal and who is the
agent, i.c., both the co-operatives and the members can be principals and agents. For this reason, neither
leadership mechanisms nor selective terms of delivery can be enforced by the co-operatives, i.c.. the
members can deliver all the commodities which alternative dealers do not accept. Co-operatives that are
to accept these commodities face the problem of adverse selection.

Additionally. Fulton/Giannakas (2001) show that the cross-subsidization and member heterogeneity in
large centralized, multipurpose co-ops may lead to substantial financial pressures for the co-opcrativc
because members of such co-operatives do not see a strong connection between the success of the co-op

22
and their own business.

Furthermore, Karantininis'Zago (2001) showed, by applying a game theory model, that instead of selling
their commodities to open co-ops, farmers would rather sell 1 In general, collective strategies are defined
as systematic approaches by collaborating organizations that arc jointly- developed and implemented
them to investor-owned firms if they had the choice (Astley/Fombrun 1983. Astlcy 1984, Bresser 1988.
Brcsscr/Harl 1986, Carney 1987. Edstrom et al., 1984, Sjurts 2000). Fulton (1995) concludes that if
markets disappear as a result of an increased vertical co-ordination, co-operatives may also begin to
disappear.

1 lendriksc'Bijman (2002) shares this assessment if investment on the side of the processor or retailer
becomes more important for the total chain value than the investments by the farmers. In an empirical
survey, Schramm et al. (2006) evaluated German dairy co-ops' brands. Using institutional economic and
behaviour approaches, they showed the strengths and weaknesses of co-ops' branding strategies. Even
though they were able to locate different factors exerting influence on branding strategies, quality issues
were of major importance - negatively as well as positively. Besides these disadvantages, Briscoc'Ward
(2006) name some managerial advantages of co-ops. as far as small and medium-sized co-ops are
considered: These include better communications with farmers, staff flexibility, easier (more efficient)
control, hands-on management, greater motivation, and identification.

2.4. 2. The Quality Framework

According to Eilers/Hanf (1999) The Quality Framework forms the basis of the quality assurance system.
It comprises four interconnected building blocks which include: 1. Quality Standards; 2. Centre
Development Planning; 3. Internal Centre Evaluation; 4. External Centre Evaluation. The quality
framework provides an opportunity for stakeholders to examine the value of the work that takes place in
centres and acknowledge the achievements of trainees, Co-Ordinator/ Director, staff and management.
Areas for improvement are identified and actions are planned. Actions arising from the evaluation process
arc generally implemented in the short-term and some arc referred for inclusion in the centre development
plan. An important aspect of annual centre evaluation is the collation of evidence.

The guidelines for centre evaluation outline the various forms of evidence that may be gathered in

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relation to each quality area. External evaluation involves the evaluation of centre performance by the
Department of Education and Science Inspectorate. This allows for an external and unbiased view to be
expressed and provides an opportunity for the recognition and affirmation of good practice. The cyclical
process of planning, evaluation, implementation of actions and monitoring as informed by the quality
standards form the basis of the quality assurance.

Quality Standards are at the core, as they inform the other key aspects of the framework. Stakeholders are
encouraged to work towards continuous improvement through engagement in the processes of planning
and evaluation. Centres should carry out an Internal Centre Evaluation annually and should engage in the
Centre Development Planning process every 3-5 years where appropriate. External Centre Evaluation is
to become an essential part of the overall approach to quality assurance. The Department of Education
and Science Inspectorate has responsibility for die quality of education provided in Centres for Education
under the 1998 Education Act and therefore was be responsible for the External Evaluation of centres
(Mentzer et al., 20(H)).

2.4.3. The Quality Assurance Process

According to Jarillo (1988) implementing a quality assurance system involves a process of continually
working towards improvement in order to meet the needs of learners, staff and management. The Quality
Standards clarify what should be in place in centres while allowing for local flexibility in the way
stakeholders chose to achieve standards. The centre development planning process provides stakeholders
with an opportunity to review centre practice, identify gaps, highlight priorities and select areas for
improvement.

The plan is implemented over a period of three to five years and progress towards the achievement of
goals is monitored and evaluated, lhe centre development planning process involves a focus on the key
elements of the programme that arc not yet in place, or the areas of work which require a high degree of
redevelopment. On an annual basis key aspects of the programme are evaluated. The Internal Evaluation
Process involves the participation of various stakeholder groups. The quality standards outline 27 quality
areas and the guidelines for centre evaluation recommend that a centre would evaluate 9-12 quality areas
each year to include an evaluation of the implementation of the centre development plan. Annual centre
evaluation should involve a two-day session where stakeholders compare centre performance against the

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quality standard using the evaluation criteria outlined in this document.

2.4.4. Planning of quality management

The task of quality management can be daunting and the chief executive faced with this may draw little
comfort from the ‘quality gurus'. The first decision is where to begin and this can be so difficult that many
organizations never get started. This has been called TQP (Total Quality- Paralysis). The preliminary
stages of understanding and commitment are vital first steps which also form the foundation of the whole
quality management structure. Too many organizations skip these phases, believing that they have the
right attitude and awareness, when in fact there are some fundamental gaps in their ‘quality credibility’.

This was soon leading to insurmountable difficulties and collapse of the edifice. While the intellectual
understanding of quality provides a good basis, it is clearly only die planting of the seed. The
understanding must be translated into commitment, policies, plans and actions for full germination.
Making this happen requires not only commitment, but a competence in leadership and in making
changes. Without a strategy to address quality through process management, capability, and control, the
expended effort was lead to frustration. Poor quality management can become like poor gardening- a few
weed leaves are pulled off only for others to appear in their place days later, plus additional weeds
elsewhere. Problem solving is very much like weeding; tackling the root causes, often by digging deep, is
essential for better control (Oakland, 2004).

Individuals working on their own. even with plan, was never generate optimum results. The individual
efforts are required in improvement but it must be coordinated and become involved with the efforts of
others to be effective. The implementation begins with the drawing up of a quality policy statement, and
the establishment of the appropriate organizational structure, both for managing and encouraging
involvement in quality through teamwork. Collecting information on how the organization operates,
including the costs of quality, helps to identify- the prime areas in which improvement involves all
managers but a crucial early stage involves putting quality management systems in place to drive the
improvement process and make sure that the effects remains solved forever, using structured corrective
action procedures (Oakland, 2004).

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Once the plans and systems have been put into place, the need for continued education, training, and
communication becomes paramount. Organizations that try to change the culture operate systems,
procedures, or control methods without effective, honest two way communication was experience the
frustration of being a ‘cloned’ type of organization which can function but inspires no confidence in being
able to survive the changing environment bin which it lives. An organization may of course have already
taken several steps on the road to "total quality', if good understanding of quality and how it should be
managed already exists, there is top management commitment, a written quality policy, and a satisfactory
organizational structure, then the planning stage may begin straight away . When implementation is
contemplated, priorities among the various projects must be identified (Oakland. 2004).

2.5. Critical Review of Major Issues

Despite the fact that organizational capabilities in Polish agriculture remain relatively low. producers’
cooperatives continue to be a significant part of Polish dairy processing. To some degree all cooperatives
draw on the long history of cooperative thinking. Most of them were grounded in the 1920s and 1960s.
According to the statements of the interviewed persons, cooperative values are coming increasingly under
pressure. Additionally, some major investor- owned dairies were interviewed as well. In this case, only
the quality managers were asked for their analytic expertise, allowing relative statements regarding
various quality management issues in co-ops and investor-owned firms. Challenges of maintaining a
coherent socio-economic environment have been amplified by ongoing liberalization, globalization and
standardization, all of which change trade patterns for agricultural and food commodities and influence
production costs and commodity prices.

Similarly, the continuing expansion and deepening integration of the European Union, as well as the
current reforms of the common market organization for milk and milk products are redefining the
challenges for operators in the European dairy market. Thus, for milk processors that decide to stay in the
market, the issue is whether or not to adapt the current business strategy to the changing operating
environment. The success of an enterprise not only depends on its ability to reconfigure the production
system (technology, management) within the firm and improve the quality of inputs, but also to redesign
its food chains, so as to efficiently produce the demanded quality and variety of milk products.

In this context, co-ops face additional organizational effects that hamper their flexibility to make the

26
needed adjustments. The complexity rises since the co-ops must meet the interest of their members while
also satisfying the consumer. The member-driven orientation makes co-ops fundamentally different from
investor-owned corporations in that they are compelled to look for quite stable markets, since they are not
able to compete with more flexible and strictly profit- oriented private enterprises.

The interviews showed that on the one hand, all co-operatives recognize the changing market
requirements (demanded new quality) and understand quality to be an important action parameter for
reaching the needs and wants of the consumers. This indicates that even for the Polish co-operatives, food
quality is more than plain food safety and the ability to continuously reproduce an ex ante defined set of
attributes. On the other hand, the co-ops are also aware of the strong competition on the product
(consumer) market and of being confronted by multiple effects with regard to their 'inherent
characteristics’.

One of the largest constrains seems to be the conflict between the co-ops’ status (co-operative principles)
and economic goals: For most of the investigated co-ops, ‘success’ means the degree to which the
enterprise has achieved the targeted goals. Since co-ops target different social and economic goals and the
decisions arc made mostly on a consensus-driven basis, there arc plenty of potential conflicts of interest
and hold-ups in the decision-making process. For example, with regard to the quality issue, there are
significant inherent frictions when selecting small dairy producers-mcmbers that deliver low quality raw
materials.

The co-ops fee), generally, to be disadvantaged by the organizational and management structure, as well
as by the limited financial and qualified human resources that would significantly improve both the
process and product quality. Some co-ops also mentioned restricted access to foreign capital and know-
how as being their main competitive disadvantage in qualityimprovement. Indeed, investor-owned firms
with foreign investments benefit from having better access to approved business concepts and quality
assurance systems, as well as capital from the main company. In interviews, the representatives of the two
firms with FDI mentioned that they had not noticed any additional costs regarding implementation of
higher quality standards in the plant.

The implementation of QMS was monitored by representatives of the main company, and the staff in the
domestic sub-company was well advised and supported by special training with regard to quality issues.

27
One of the co-op leaders mentioned that “the domestic dairies w ith FDI have just to copy the approved
business concept and educate their staff on the costs of the mother company, whereas the co-ops have to
be very 'innovative' while meeting the current market challenges and dealing with co-op specific
constrains”. The ‘innovative- thinking refers, however, to finding a creative solution under the given
circumstances, while imitating the marketing strategies of private and prospering companies. The above-
mentioned considerations reveal that the lack of investment is one of the crucial hurdles for those
investigated co-ops that wish to adopt additional quality improvement instruments.

Surveyed co-op representatives reported being sceptical regarding the benefits of the quality assurance
systems prior to their implementation. In some cases, these doubts had postponed the decision to adopt.
Once introduced (i.c.. I1ACCAP prior to EU accession) the co-ops acknowledged many advantages, i.e.,
less variation in quality outputs, better harmonization of operational sequences, and less variability of
staff skills w hile managing the quality.

Further, co-operatives recognize some advantages as far as the relationship with their suppliers are
considered: Producers tend to trust a cooperative more than (foreign) investor-owned companies. I’he
surveyed representatives pointed out that a farmer is typically risk-averse and seeks stable, trust-based
relationships and social acceptance, both of which he can enjoy as a member of a co-op. In most cases,
these utilities outweigh pecuniary disadvantages, since most of the co-ops bid lower prices for raw milk.

Additionally, their support as ‘service providers’ enables them to supply some services to the farmers
independent of the government or other private services. Besides information transfers between the co-op
and the farmers (consulting, choice of production techniques), co-operatives offer their members credits
or access to credits for investments in the growth and specializations of the farms. These instruments
increase producer loyalty and assure, at least, continuous access to raw materials.

However, co-operatives still face multiple conflicts when selecting quality suppliers (supplier member). 1
he organizational ‘stickiness’ in the selection process of quality producers impedes the manufacturing
process and quality output and compels the co-operatives to target markets for lower quality.
Nevertheless, the co-ops strive to adjust to the market requirements and utilize various instruments to
induce the incentive-compatible behavior of upstream business operators. For example, cooperatives use
quality-dependent payment schemes to remunerate better raw milk quality. Additional provisions exist as

28
well, including a price premium for extraordinary quality (super extra) and direct delivery for farms either
approved by the veterinary bureau or which possess certain breeds of milk cows. All cooperatives pay a
price premium on membership. Thus, payment schemes differ greatly between dairies.

However, in all pricing mechanisms, the price increases as compliance with quality requirements set by
the purchaser increases. Cooperative representatives mentioned that the El. quality regulations have an
immense “educative’ influence on the farmers with regard to quality improvements. On the other side,
mandatory regulations take away a coop's ability to select (passive selection). The cooperatives expect
some competitive advantages at the procurement stage due to the better “accesses to their local
communities, in the middle-term.

2.6. Summary

This section consists of the following parts: the concept of new Kenya Cooperative Cremerics. standards
implementation for productivity, benefits of standards implementation for productivity, standards
implementation for productivity highlights, phase process for SIP implementation, what the “new quality
mean’, verticalization and quality management, quality effects in cooperatives, the quality framework, the
quality assurance process, planning of quality management and the critical review of major issues.

2.7. Conceptual framework

The main variable of study was

i. Production Cost

ii. Infrastructure
iii. Planning
Sales

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