3.1 Impacts on Food Supply Chains
from Short-Term Climate Change
Short-term climate shocks increase climate vulnerability
and can be measured at various points along the supply chain
. Climate-shock vulnerability
points are called “hotspots” in the energy or food safety or phytosanitary literature (Giorgi 2006). Hotspots occur both in segments themselves (such as cold storage points, dry storage points, processing points, farming points, and input delivery paths to farms) as well as in sub-segments or individual operation points (such as mountain feeder roads to main highways) and input ingress points (such as water canals for farms or fuel, or electricity delivery interfaces). Vulnerability at each hotspot is dependent on the type of shock and attributes of a given segment. Further, the points need not be directly in the supply chain
, but rather in secondary supply chains
that feed into the product supply chain
Examples of short-term climate shocks are floods or hillside rock avalanches on highways, tidal wave or typhoon destruction of sea or river ports or disruption of energy or fuel sources. These changes can disrupt or stop the product or input flow, especially along longer supply chains
. For example, large poultry production and processing in Thailand by CP Foods relies on grain imports from the United States and imports chicken parts to China and Russia. A stoppage of operation in one of the facilities may disrupt production throughout the system, and may be very costly. Along a domestic supply chain
, poultry production for urban consumption in Bangladesh or Nigeria relies on feed ingredient shipments from grain and cassava zones to peri-urban feed and poultry production facilities, which are vulnerable to road flood-outs and political strife (Liverpool-Tasie et al. 2016 for Nigeria).
A key point is that vulnerability
of a supply chain
often increases with the number and nature of hotspots. Further, the number and nature of the hotspots are in turn functions of the structure, conduct, and performance of the supply chain
. We can categorize these conditioning factors, which are elements of the transformation of the supply chain
, as follows.
The first determinant of a hotspot in the supply chain
is the physical infrastructure affecting production risk in the supply area. The irrigation and drainage and flood control infrastructure upstream in the farming area is a crucial conditioner of the impact of drought and flooding shocks. This kind of private and public infrastructure is present far more in Asia, particularly East and Southeast Asia and in some zones of South Asia, and far less in Africa (Rosegrant et al. 2009). This discrepancy highlights the relative vulnerabilities by geography.
The second factor is the geographic distance along the supply chain
. Longer geographic distance to the farm zone, and/or longer “lead time” from the assemblage and first stage processing and the final processing and demand points, increase vulnerability
to climate shocks. There is however a trade-off
between the vulnerability
this implies and the diversification
of urban food supply sources that long supply chains
afford, which could reduce vulnerability
to some degree. Even so, the rapid urbanization in both Africa and Asia is resulting in longer supply chains
with increased climate vulnerability
The third factor is the degree of product perishability. The greater the perishability of the product, and thus the need for fast delivery and/or cold storage, the greater the vulnerability
to climate shock. This factor
again increases climate vulnerability
in Africa and Asia as the diet transformation has brought a huge surge in the demand for perishables.
A fourth factor is physical intensity in a given segment (e.g. irrigation, farm equipment, cold storage, delivery trucks). The robustness of physical capital is a key element in the vulnerability
of supply chains
to climate shocks. An example is the widespread damage to flimsy bamboo greenhouses on Java during unexpectedly virulent storms in the past few years. There is a general tendency for the capital/labor ratio to rise in food supply chains
as one moves from traditional to transitional to modern chains, which increases vulnerability
. That tendency is for three reasons: (1) the labor market tends to tighten with urbanization and physical capital substitutes for labor; (2) physical capital enables supply chain
managers to reduce vulnerability
by off-setting climate-imposed costs with economies of scale, and reducing transport times with larger vehicles and inter-modal facilities, and increased cost competition in commoditizing supply chains
further drives this investment; and (3) increased quality competition in modernizing supply chains
increases equipment needs to achieve quality and safety attributes from suppliers to meet buyer requirements and standards. Growing dependence of suppliers and buyers on “asset-specific investments” may increase incentives to protect these assets from climate shocks (such as by investments in flood control).
A fifth factor is the location specificity of production or intermediation. Vulnerability
to climate change
decreases with more interchangeable places to produce a crop or handle it logistically. Location specificity, as a special case, can be linked to asset-specificity in that buyers depend on, are perhaps “locked into,” sourcing from a farm zone or intermediation point due to specialized resources, firms or farms. This in a sense “holds hostage” the supply chain
to these locations and thus to climate shocks they undergo. The “lock in” may run both ways – suppliers may be dependent on specific buyers in order to make profitable the specific investments they have made for that relationship. Moreover, asset specificity tends to be correlated with the product being a “differentiated product” instead of a commodity competing only on cost.
In a situation where there is a confluence of location and asset specificity and product differentiation, suppliers and buyers may have a strong incentive to invest in climate shock mitigation
to protect the mutually profitable linkage. However, climate shocks may reach a level that requires too high an investment in mitigation
for the linkage to be profitable, at which point the buyer or supplier would back away from this linkage. For example, a buyer who requires a high level of food safety (and thus low pesticide use), may break away from a given zone when climatic
changes increase insect density to the point where more pesticide use is required to have acceptable fruit cosmetic quality, and thus make it uneconomic to rely on that zone.
Further, supply chain
networks such as a supermarket chain source from several different zones (such as occurs in Mexico for tomatoes, see Reardon et al. 2007) over the year in order to smooth product supply inter-seasonally. While inter-season average vulnerability
may remain low, periodic shocks due to climate or violence may increase dependence (such as in the North-South maize supply to feed mills for chicken and fish in Southern Nigeria; see Liverpool-Tasie et al. 2016). Sixth, more concentrated (as defined by industrial organizational terms) segments of the supply chain
may either increase or decrease vulnerability
to climate shocks. On the one hand, concentrating a process in a single large firm rather than in many small firms could make the process more risky (such as happened in the US in 1993 when the beef supply of the large chain Jack in the Box was tainted by E. coli from a single source and then infected the many points of supply). However, large companies have the means to make the “threshold investments” needed to mitigate or cope with a climate shock, as discussed in the next sub-section.
Finally, a seventh factor is variation over time in one location and over locations in the exposure to climate risk, controlling for the nature and occurrence of the hotspots per se. This acts as a magnifier and complement to the above six determinants of whether a point in the supply chain
is a hotspot.
In sum, the determinants of hotspots described above, namely physical infrastructure to reduce production risk in supply zones, geographic length of the supply chain
, perishability of the product, intensity and robustness of physical capital, asset specificity cum location specificity, concentration, and exposure to climate risk) generate a large number of “hotspots” in developing country food supply chains
, before and after the farm gate. They also vary enormously over locations and products and the degree of transformation of supply chains
. That implies that solutions to climate risk for supply chains
will need to be highly differentiated and adapted to varying circumstances.
Moreover, these determinants are present in all directions of supply chains
, including rural-urban chains, urban-rural, and rural-rural. While research on this is still in its infancy, we surmise that rural-urban and urban-rural supply chains
, compared with rural-rural, will tend to have better infrastructure, be as long, involve more perishable products, and be more concentrated and asset-specific than rural-rural supply chains
. This difference likely arises because rural-rural chains move more grains and tubers and shelf-stable vegetables like potatoes, while rural-urban and urban-rural, which include cities as origins or destinations, are more varied in product terms and more transformed in industrial organization terms.
3.2 Impacts on Supply Chain
Structure/Conduct/Performance of Short-Term Climate Shocks from Strategic Responses of Supply Chain
Enterprises in any segment of the supply chain
, including input firms, farms, processors, and distributors, can be said to maximize utility under constraints. Utility derives from the level and stability of profits, which are a function of costs, product quality and safety (the latter two being in turn a function of requirements derived from the governance of the supply chain
, such as the degree to which standards are imposed). Constraints are a function of assets, including productive assets and human capital, which can be private, collective, or public.
Within the constrained optimization
framework, a firm (such as an urban retailer or processor, or an urban or rural wholesaler) has to decide on the design of the supply chain
used to source inputs and market outputs. Du et al. (forthcoming) decompose the “optimal supply chain
choice of the innovator” to six detailed choices: (1) production quantity given capital constraints and market conditions; (2) in-house versus purchased supplies (upstream this means deciding how much feedstock to grow vs. purchase from other farmers, midstream is inventory levels, and downstream is creation of marketing services in-house or outsourced); (3) for purchased supplies, whether to buy through contracts or spot market arrangements; (4) when using contracts, what terms and conditions to include; (5) for in-house production, what technology to use; and (6) how the degree of monopsony and monopoly, and government regulations that affect market power, change the choices made for these five considerations. These basic questions form the basis from which a supply chain
is designed. The vulnerability
to climate shocks are derived from the nature of the supply chain
(controlling for the climate shock) which in turn is formed by design decisions of firms using them.
All else equal, a short-term climate shock reduces profit for these firms. To attenuate profit loss, firms or farms need to innovate and make investments to manage risks ex ante or cope with shocks ex post, at a type and level appropriate for the nature of risk. We follow a long literature on investment and call these “threshold investments” (Hubbard 1994). Typically, a firm or farm would make the threshold investment itself to mitigate the effects of a shock. At times, a mitigation
measure taken by a single firm provides external economies to firms around it (or up or downstream from it). An example could be a firm constructing a culvert that diverts flood water not just from it but also from those physically downstream from it.
Moreover, the needed threshold investments (and returns to these investments) will be conditioned by the sources of vulnerability
related to the seven determinants of hotspots discussed above. We surmise that there is a greater possibility for threshold investments to reduce risks on some determinants of hotspots (such as physical infrastructure to reduce production risks) than others (like intensity and robustness of physical capital). In addition, we expect the risk mitigation
strategy of a firm in an area of very low density of physical capital or non-robust physical capital to be different than that of one in area of high density of capital and high robustness. There are also mutual externalities of items of capital stock in a given area; for example, if a sea wall is fragile or flimsy a mitigation
investment in flood control canals next to it would be ineffective. By contrast, there could be a positive externality where pond lining reinforcement is undertaken in an aquaculture area bordering the sea where strong sea walls have been erected.
A key point is that not all zones, firms, and farms will be able to make the needed threshold investments. The challenge is exacerbated by the need for ex ante investments – implying an investment, credit, and planning horizon foreign to small firms and farms. This can create a kind of “poverty trap” (Carter and Barrett 2006) caused by climate shocks and accompanied by exclusion of certain zones, firms and farm strata. This can lead to a concentration of the segments of supply chains
, such as when large processing firms gain market share after a shock. It can lead either to concentration of zones where the product is produced, or a shift toward new zones (similar to what can happen in long-term climate change
The threshold investments cum strategies of managing risk from short-term climate shocks or coping fall into several categories. A major distinction is between large, transnational companies and smaller, domestic companies. For example, firms and farms may need to temporarily or permanently switch away from supplying zone or intermediate point. This of course is done constantly in international trade, such as the example of a US fruit processing firm recently shifting from Mexico to China to Argentina as costs changed. Some large companies do the same in large domestic markets, such as Charoen Pokhpand (CP) building compartmentalization of its supply chains
in Asia to allow switching from one source zone to another after a climate shock. International sourcing also diminishes climate shock risk by having a more diversified network of suppliers with low degree of correlated exposure to climatic risks.
Such investments are less easy for most domestic sourcing, which we noted is 90% of the food supply of Africa and Asia. The challenges can be substantial for several reasons. First, there may be no cost-effective sourcing alternative in the short run, either in terms of switching from long distance to “local” sourcing, or switching to another zone. This difficulty may be more acute for urban-rural and rural-rural supply chains
as the web of transport routes and the economic sourcing distances for rural consumers may be more limited for these supply chains
. By contrast, rural-urban supply chains
utilize a more extensive web of transport links including large highways, radiating from and to a large city.
Second, another zone might be available but lack prior requisite investments to meet the buyer’s requirements. An example is the requirement by most European retailers for perishables suppliers in developing countries
to have GLOBALGAP certification. This would involve “asset specificity” of investments, often substantial, by suppliers in a given zone (and typically by larger producers). If the buyer suddenly had to switch zones, it may well not be able to find the qualified suppliers. Again, this challenge might be more acute for the rural-rural and urban-rural supply chains
than for the urban-rural chains, but the issue is present for all three depending on the product and the degree of transformation of the market.
A similar challenge might go for a range of post-harvest transport and processing facilities that would be needed to source. Moreover, a large buyer with standards needs to provide an ongoing incentive for suppliers to make investments in the requisite quality and so on. If the buyer is seen to be risky as a client, farmers, processors, and distributors will shy away from making needed relation-specific investments for that client. The buyer would need to maintain a minimum of demand from that zone or set of suppliers to maintain the incentive.
Third, the business management literature references the need to reduce lead time and “increase agility” to avoid risks or cope with shocks (Ponomarov and Holcomb 2009). This involves investing in alternative arrangements to existing suppliers or supply routes and systems, all of which are costly. For example, CP built
“redundant ports” for rice supply from Thailand to its foreign markets, building several ports along rivers to provide alternatives in the case of a typhoon or tidal wave. With the growing need for these investments in the face of increased climate shocks, market concentration in larger firms will likely increase.
As a consequence of the above challenges, firms and farms may make induced innovations in “climate proofing” or “climate adapting” their equipment and processes. Firm-level investments might include energy saving or less energy dependent equipment (e.g. larger equipment), larger and more vehicles, and more rapid transport (to reduce inventories “held hostage” to climate shocks). Firms may also invest in enhanced storage through driers and dehumidifiers or stronger storage (for exampleFootnote 1 investment by a cocoa cooperative in typhoon-proofed cocoa containers in Vanuatu), and increased access to information flows for better “supply chain
intelligence” as well as purchase insurance policies
, where available. Finally, firm-level investments may seek to enhance supply chain
-level efficiencies. At the government- and community-level, investments could seek to reinforce and/or build deep-water/off-shore ports (as in Indonesia, Shanghai, Rabobank), increase resilience
in urban logistics, and seek to improve arrangements between governments for facilitation of shipping and supply (such as Hangzhou government did with Heilongjiang). Finally, an improved regulatory environment could further induce the private investments noted above, and create incentives and capacity for these investments.