Contractors in the tobacco marketing sector, who are also the leading tobacco buyers at the auction floors, are suspected of having colluded, over the years, to put a ceiling price on the auctioned crop forcing farmers to opt for contract farming, where prices were higher, at the expense of auction floors.
The contractors are also suspected to have had a long term systematic strategy to eliminate the auction marketing model, where competition is relatively intense.
For at least six years, the contractors are alleged to have put a ceiling price of US$4,99/kg at the auction floors whilst offering higher prices for contracted farmers.
With contractors historically offering farmers high prices relative to the auction price, most farmers switched to contract farming, rendering the auction system ineffective.
At least 95 percent of tobacco farmers are now under contract but interestingly merchants are no longer paying higher prices than those prevailing at the auction.
The sudden switch in 2020, where auction prices are now higher than contract prices, has raised suspicion that merchants are either not adhering to the Tobacco Industry and Marketing Board (TIMB’s) Price Matrix or are exercising their market power to supress prices.
In a review of competition in the tobacco marketing sector published in its May Newsletter, the Competition and Tariff Commission (the Commission), said there is need for further inquiry to understand why contractors are now paying lower than auction prices yet the quality of tobacco grown under contract is expected to be of better quality than that grown by uncontracted farmers.
The competition watchdog said given that one of the main reason for engaging contract farming is to ensure high quality tobacco is produced, contracted tobacco is expected to fetch higher prices.
“Using the percentage of bales rejected as a proxy for quality shows that in 2020 season, there was an improvement in the quality which saw a 49.7 percent decrease in rejected tobacco…
“This therefore shows that contract prices should have been much higher than auction prices, since quality is a major determinant of tobacco prices. Thus, the minimum price under contract must be the average auction price.”
Findings by the Commission revealed that both historical data shows that 95 percent of tobacco produced was marketed under contract and only 5 percent under auction.
In other words, the price of 95 percent of tobacco produced in the country dependent on the price of 5 percent produce.
Since the minimum price under contract must be the average auction price, merchants would have found it in their best interest to control price determination and eventually eliminate the auction system.
With the auction system almost dead, merchants can now use their power to pay low prices to the detriment of farmers.
The Commission suspects, there “might have been a deliberate long-term strategy by tobacco merchants to eliminate the auction-marketing model, where competition is relatively intense as merchants compete based on market forces”.
A 2015 Commission study revealed that the biggest contractors in the sector dictated tobacco prices.
The Commission highlighted that some of the big multinational importing companies also own some local merchants automatically making them market leaders in determining prices.
The majority of merchants, that sell to the multinational importing companies at global level, then find it difficult to buy above the globally multinational linked companies. According to the Commission, the immediate challenge arising from the switch to contract marketing model is the bargaining power that is now in the hands of merchants.
The majority of small scale farmers, constituting 89 percent of total farmers, do not have the capacity to negotiate contracts with large contractors.
And without capital to finance their own crop, the farmers are left with the only option of accepting the contract making them vulnerable to receiving excessively priced inputs and lower prices for produce.
Lack of bargaining power among smaller scale farmers is seen by the Commission, as one of the factors that exposes them to unfair contracts.
The majority of farmers are reported to be in tobacco related debt.
The Commission, however, warned that while the exercise of market power might be beneficial to merchants at the moment, it exposes them to great risk of side marketing by farmers as they seek better prices and selling terms.
Reports already indicate that there is now rampant side marketing in the sector.
Side marketing led to the almost total collapse of the cotton sector after Cargill incurred successive losses due to the practice.
“Given that tobacco is purchased using offshore funds, it affects future funding for the sector as merchants fail to honour their loans obligations,” the Commission explained.
The competition watchdog has since recommended that TIMB compel all merchants to purchase a certain percentage of their requirements from auction floors.
“This will enhance competition leading to increased prices at the floor as well as offering a counter checking mechanism on the contract system,” the Commission said.