Agro-holdings: Vertical integration in agri-food supply chains in Russia

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Agro-Holdings: Russian-Style Vertical Coordination in Agri-Food Supply Chains
Eu.Serova, Centre AFE,
Moscow, Gazetny 5, serova@iet.ru, F.+7(495 )629 6596
1. Background
In the middle of the 1990s the various researches of Russian agriculture began to register an emerging
of a new organizational form of farming which was quite different from the main type of agricultural
producers in all post-Soviet economies (Rylko, Jolly, Serova, Khramova, Uzun, Koester, etc). Especially
evident this process has become after the crisis of 1998 after which a recovery growth in agri-food sector has
started. There is no common name for this form in a literature: Rylko and Jolly (2005) call them New
Agricultural Operators (NAO), Serova and Khramova (2002)– vertically integrated companies, in Russian
official practice the name of agroholdings is already assigned for these forms. Regardless the name one uses to
identify this phenomenon it unites the number of quite different kind of agricultural companies, established in
different ways and motivated by different incentives. More over, sometimes the structure of these forms differs
dramatically. Not necessarily they are organized as the holding companies, not every case is coupled with
vertical integration along supply chain. In this respect the term “new operators” reflects the essence of the
phenomenon in the most adequate way – something new verse traditional form.
These are the big, much bigger than traditional Soviet farm enterprises and their current heirs, farm
operations, established with the capital arrived from outside of a primary sector. Sometimes capital comes
from downstream sector when processor invests into the raw supplying farms, sometimes it comes from
upstream sector when supplier tends to control buyer of inputs, very often capital originates from entirely
outside agri-food sector – mainly from the most profitable sectors of Russian economy such as energy, finance,
metallurgy. In some cases several farm enterprises are hold by one holding company, but it can be also sole
huge farm enterprise. Sometimes such companies are organized under control and with participation of the
regional and/or local administrations, however in majority of cases it is purely private initiative. Management
structure differs also tremendously from company to company. Land tenure issues can be arranged differently:
huge areas can be in ownership of a company, but most often it is rented land shares.
What distinguishes these new operators from the traditional farm enterprises is not only or
predominantly a scale of operation but a notable investment inflow to the primary sector, new type of
management, new technologies, commercial orientation of the business and aggressive behavior in the
markets.
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So, there is no still clear understanding and definition of this new phenomenon in Russian agriculture,
but it rapidly grows in the last decade and plays significant role in agri-food sector of the country. It is quite
opposite direction of Russia’s agricultural development than it was supposed to transit after a collapse of the
Soviet system: the former collective and state farms are not being split into individual farms but are united into
even bigger agricultural companies. Not pretending to develop the comprehensive theory of these new
operators in this paper we intend to discuss the preconditions of their emerging, motivations, scope and
possible consequences of their functioning.
In order to understand how the farmland and business are accumulated in these new operators we
should recall the way Russia’s agrarian reform was implemented in the early 1990s. As it is broadly known the
Russian land reform and farm restructuring was based on the procedure of so-called land sharing. The workers
of the kolkhozes and sovkhozes as well as pensioners and social service officers had got the equal conditional
shares in the land operation of the parent farms. The conditional shares were not marked on the ground and can
be considered as some kind of options: they gave the right for holder to withdraw with a physical plot anytime
without permission of the other land shareholders; and only location of the plot was to be agreed. These land
shares are transferable in all type of legal transactions. In the reform of 1992-1994 around 12 million such
shares were allotted to the rural dwellers. About 300,000 households utilized their right to withdraw from the
farm enterprises and set up their own family farms. The rest of rural dwellers prefer to stay in their original
status. In majority of cases they leased their land shares to the farm enterprises.
The current structure of agricultural production in Russia has an ambivalent nature. On one hand, farm
enterprises operate the absolute dominating area of farmlands (Figure 1). On the other hand, since 1991 the
total used for farming area has shrunk by 7.5% while the area in farm enterprises was reduced almost by 20%.
The share of gross agricultural output originated from farm enterprises is less than a half (Figure 2). The
deepest point of recession in total Russia’s agriculture (1998) was gotten at the level of 56% of the GAO in
1991, the gross output on the farm enterprises counted in 1998 just 35% of the re-reform level.
On the first glance, it means that the farm enterprises maintain the major part of their lands, while
actual production is concentrated already in the individual farms. However, the data on household production
(Figure 3) show that this sector has not extent its output significantly; only potatoes, vegetables and fruits
make a certain exemption. In the pre-reform period household plots mainly produced for the self-consumption,
official data certified that only 13% of total output went for sale (Serova, 1999). Therefore, the remarkable fall
in share of farm enterprises in the GAO reflects just the same remarkable fall in food consumption in the
Russian Federation with the start of the reforms. Demand for agri-food products felt due to the drop in
purchasing power of population, and output of the commercial (market oriented farm enterprises) was reduced
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in the same extent; the household kept on producing for self-sufficiency purposes at the same extent as prior
reforms. Arithmetically the share of individual farms increased.
So, the reform process created a special agrarian structure in Russia characterized with a large-scale
farm structure dominance. In 1992-1994, the millions rural dwellers had got conditional shares. The custom
law of turnover of these shares was formed during last decade. More over in last 3-4 years, land market was
developing mostly in form of land shares transactions. More than a half of farmlands belong to land share
holders, major part of which do not work on farm enterprises (mainly they are pensioners). The land shares
rather often were given to the rent with life-long support: the aged rural dwellers use to pass their shares to the
new owners, which in return undertake some life-long services and payments to these people. It was a notable
social guarantee for rural aged people, which have much less social security services than urban dwellers.
Thus, this system of agriculture set up a base for integration we tend to explore in this paper. Large-scale
business make process of merging easier than in case of dispersed farming. Land shares market and
willingness of rural people to rent their shares created a base for land accumulation by outside investors.
However, before 1998 these options were not utilized because agriculture was loss-making sector, and
financial markets provided much better alternatives for investors in Russia than real sector and farming in
particular.
The situation radically changed in 1998 (Figure 4). Fourfold rouble devaluation in August 1998 was a
trigger for the significant agri-food import substitution started in Russia almost immediately after the default.
Already in September the agri-food imports were reduced drastically having opened the internal markets for
the domestic producers. Financial crisis of 1998 meant also a significant reduction of the financial speculative
markets. An after-crisis government imposed more severe control over capital exports. Therefore domestic
capitals were looking for the real sector for investments. And the projects with a short investment cycle and
small initial level of investments were the most attractive in the crisis environment. Food and later light
industry were such sectors, which met these two requirements. So already in the fall of 1998 there was an
evident flow of domestic investments to the food industries.
Boom in a food industry, at the same time, faced with the limited supply of raw due to fall in the
imports. The domestic primary sector demonstrated very high transaction costs. This inspired vertical
integration process and corresponding downward investment flow to farming sector.
At the same time the Russia’s huge businesses (mostly mineral oil holdings, some financial holdings,
etc.) had to look for options for business diversification in order to avert the financial risks. Agriculture
appeared to be one of the most attractive industries for such diversification: grain and oil net returned were
strongly negatively correlated by that time. In addition some agricultural sectors were very profitable by that
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time. Thus, the grain capital return reached up to 400% in a number of regions. Together with considerable tax
concession for agriculture it causes investment attractiveness. It has also inspired capital inflows to the sector.
So, in result of these trends agri-food sector had got an investment growth (Figure 5 &Figure 6). In
the after-crisis years a rate of growth in investments in agriculture have appeared above one in economy as a
whole.
Thus, after the crisis-1998 big and huge companies from various sectors of economy acquire
agricultural assets and farmland for agricultural production, establish the agricultural companies, invest quite
significantly to this business and become the important players on the agricultural markets.
2. Incentives for establishment of agroholdings
There are two major types of such “new” investors. Firstly, they are presented by the large variety of
downstream companies – traders, processors, storehouses, etc., and those upstream ones operating for
agriculture – feeds, fertilizer suppliers, for example. Under severe fall in raw imports after the crisis-1998
many of agribusiness companies became interested in the domestic supplies of primary agricultural products.
However, they found that domestic markets are severely underdeveloped; collecting of raw is costly and
coupled with high business risks. Therefore, many of these companies started to expand their business control
over the farming.
Secondly, the huge nonagricultural holdings in banking, oil and gas business, metallurgy and so on
have started also invest to primary agriculture. They are attracted with extremely low initial investment rate,
high net value return and tax concessions for agriculture. Also primary agriculture was one of the least sector
of the national economy where secondary privatization has not taken place yet.
One more motivation factor for entering agriculture by non-agricultural business was extreme low
liquidity of farms by that time. More than half of farm enterprises were insolvent. It was easy to acquire the
farms by purchasing its debts and running formal bankruptcy process. Low profitability of agriculture as a
whole reduced value of major assets tremendously and it was easy to buy mills, elevators, storehouses etc. at
ridiculously low prices. In the transitional environment temporary cheapness of the assets is a weighty
motivation for their acquisition. And once acquired some agricultural assets, the companies started to expand
activity into this area (see Box 1).
Box 1. Vertical integration in grain company OGO
The evolution of the private grain company, OGO, was typical for a Russian business that emerged in
the years of perestroyka and was activated with the economic reforms of the 1990’s. By 1994, the company
became interested in privatization. In accordance with a led of company A. Zlochevsky’s words, they
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suddenly realized that “privatization is passing us by”. Since the company had free capital, it had started to
purchase grain storage and processing facilities. A knowledge of European and American grain markets led
them to estimate that the sale prices of the Russian elevators were fantastically low prices. Thus, the purchase
prices of an elevator with storage capacity of 100 thousand tons at the moment of actual purchase was
US$100-700 thousand in Russia and $3-10 million in the USA. At that time the company had no strategy
targeted at manufacturing activity; it only understood that the enterprises should be acquired because of the
company’s interest in the grain sector.
Initially the company intended to re-sell the purchased enterprise. It was in a dilapidated state from a
managerial point of view. However, replacement of a manager and technological changes (even without related
replacement of the equipment) transformed a loss-making enterprise into a profitable one. Through this
experience, awareness that manufacturing could be profitable was gained. The company started to expand its
purchases of storage and processing capacities
OGO was buying so-called grain products combines. In the Soviet Union grain products combine was
an enterprise, which includes elevators, milling facilities and those for production of compound feeds. Once
the feed capacities had been acquired, the company faced a series of problems. The feed producing plant,
which OGO bought in 1994, had an unfavorable geographical allocation. The competitors of the company
were assigned territories closer to the main regional feed consumers. To create competitive advantages, OGO
decided to direct its production toward high quality feeds. It was decided that the production of high quality
feeds would significantly increase the effect of their application and, thus, attract more customers.
The company shifted to the production of feeds for primarily poultry. High quality feeds, however, did
not meet market demand. The high quality of feeds and additional services with which the company supplied
the customers led to a growth in individual costs of the feeds. They were 15-20% higher compared to those of
the national average. In other words, the company did not take into consideration the restrictions of the feed
consumers. The poultry producing agricultural enterprises faced significant budget constraints. They were also
not sure of the return from using new feeds, so they preferred not to buy the higher price formulations.
Thus, the company faced a problem. It had spent capital to invest in acquisition of the feed producing
facilities, in overseeing their modernization, in elaboration of new technologies, and in generating new
balanced rations for feeding; finally it invested in training skilled personnel and in improving the managerial
structure of the company. Everything proved to be for naught.
The strategic solution was chosen via stimulating vertical integration towards the poultry sector. For
OGO, this choice was linked to answering the question of: “what is more profitable, production of cheap feeds
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or cheap meat?” According to A. Zlochevsky, “sales of feeds as a final product was not profitable”. With this
fact in mind, it was concluded that the company would produce a final product, i.e. poultry meat.
The psychological factor, which pushed the company for vertical integration, also existed. The
integration processes began in the domestic poultry sector. The fear to remain outside the integration wave, in
a situation where the feed consumers were vertically linked with the competitors, also affected the company’s
choice. However, A. Zlochevsky did not directly confirm this assumption.
OGO started the vertical integration processes in the poultry sector by leasing two large-scale broiler
farms in 1997. The company tried to organize demonstrations for the advantages of using its own feeds. It
used its own broilers’ feeding at these two broiler farms in order to demonstrate to the local poultry producers
all the advantages of using high quality feeds and new technologies. Because broiler feeding was extremely
sensitive to technologies, it was necessary to observe all stages of the technological cycle; results of the usage
of high productive feeds fell immediately if one was late with distributing the grain or water to the poultry.
However the poultry farms, which were leased by OGO, failed to follow rigorously the new technologies. As a
result this market strategy failed.
Even the application of a highly sophisticated ration of broilers feeding when the industrial as well as
the managerial culture proved to be low at the agricultural enterprise level (which at that moment was not at
the ownership of the company) often caused serious distortions in the technological cycle. It helped the leaders
of the company conclude that leasing of the farms was not enough of an effective form of investment in
general and of vertical integration in particular.
Step by step the company concluded that it was necessary to acquire the poultry farms. In 2000, OGO
became the owner of two broiler farms and then acquired two more farms. Thus, in 2000 the company became
the owner of four large-scale broiler farms in Smolensk, Tula, Kaluga and Astrakhan regions. This vertical
integration under full ownership permitted the company to completely realize the advantages of putting
together an application of their own feeds and the use of sophisticated technologies and management.
As a result, in a short period of time, the company managed to significantly increase both the
productivity and the profitability of broiler farms. The profitability of the broiler farms increased significantly
after acquisition by OGO.
Source: Nichols, J. et al.(2002)
In order to understand better the process in agri-food sector one should be aware that such vertical
integration is not a particularity of agri-food sector: now it is spread over all national economy. Such system of
business is a part of tax optimization policy of companies; also it helps to establish regional monopolies.
Moreover, the creation of vertical holdings is often urged by local administrations. This process can not be
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estimated as undoubtedly positive: its consequences can be negative both for the business involved and for
entire society, however, it is a reality, with which one should abide by. Agri-food sector was just lagging
behind in this general trend of Russia’s economy.
Apart of these general incentives for vertical integration and holding setting in Russia’s economy
there were two major incentives for this process in agriculture. Shortly mentioned above. One of them was real
vertical integration along supply chain as a reaction for the high transaction costs in food chain. Before the
crisis-1998 the companies of downstream sector (food got major raw materials and food products from abroad
with quite low transaction costs, but rouble devaluation made these deliveries extremely expensive. In this
circumstance downstream sector companies were enforced to turn to local suppliers, adjusting for that once set
up import infrastructure. However local suppliers demonstrated very opportunistic behavior what therefore
raised transaction costs dramatically. Vertical coordination in frame of regular contracts did not work due to
low level of law enforcement, low legal and business culture in economy in general and in agricultural sector
in particular. So the downstream companies had to expand their business to the primary sector to maintain their
main business. And this is a textbook situation of the vertical integration when the high transaction costs cause
vertical integration along food chain (Coase, 2001; Williamson, 1996).
Naturally in the vertically integrated company outsourcing should not be allowed and allowed in a big
extent: if the deliveries from (or supplies to) the agents outside the integrated company are coupled with the
low transactions costs than no need to expand business for the neighboring stages of food chain. However our
case study showed that such outsourcing is quite spread case in these agroholdings. Thus, mentioned in the
Box 1 company OGO did not insisted its poultry factories purchase compound feed necessarily form its feed
plant, however profits of these poultry factories as well as of all other divisions of the company were
centralized and redistributed from the mother company (holding company). So, it was more like risk aversion
activity than real vertical integration. Theory says that for risk aversion the firm tends to diversify its activities
in the way, when selected activities have independent or better negatively correlated net returns (Lee et al).
Thus in the case with OGO it was exactly the case. The company bought its poultry factories in 1997. In 1996-
1999 net returns in grain and meat poultry sector correlated with coefficient –0.997 (Calculated from Russian
Statistic Service data). So, in spite feed production and poultry production are the stages of the same supply
chain, their uniting in one company was not motivated by the factors of vertical integration but was the result
of risk aversion behavior.
This conclusion was even truer for the cases when mineral oil companies invest into grain production.
In Russia by that time 40% of grain production costs were made by fuel. Therefore a raise in fuel prices
reduces, ceteris paribus, profitability of grain, but on the other hand, increases profitability of fuel and vice
Chapter page 7

verse. In a such way a firm diversifying its business portfolio with fuel and grain business has high probability
to have stable net return regardless changes in grain and fuel prices.
The motivation of establishing the new agricultural operators has long-term consequences in the
company behavior. Those, which were established following the vertical integration pattern, would be more
stable, the integration between company divisions would be closer and more sustainable, it would be supported
by long-term investment and technological linkages. Those, which were driven by risk aversion portfolio
diversification, would tend to be more flexible in their reactions on economic situation. The main emphasis
will be done on the financial control of the divisions, on centralization of their profits. As it happened in other
sectors of Russia’s economy on the previous stages of development, they would tend to get rid of “non-
specialized assets”.
The official statistics does not distinguish these new forms of farming which are discussed in this
paper. Actually all farm enterprises in Russia are still a subject of obligatory reporting. These data is
aggregated by regions and nationally. So those farm enterprises what are included into bigger companies are
also reported but not identified by statistics. Therefore from the official data it is not possible to identify
agroholdings, their land use, sales, profitability and other parameters of functioning. So, only surveys
maintained by various groups of researchers provide some deeper information for analysis. For a moment we
are familiar with three major sources of data on agroholdings. One is a rating of 300 biggest farm enterprises
maintained by the Agrarian institute (Moscow), which since 2001 also includes data of the 33 agroholdings.
Data on these agroholdings are collected by postal survey and observe a very limited number of indicators.
Around 130 agroholdings are described by analytical center IKAR (Moscow), which contains much bigger set
of indicators. In 2002, we maintained our own survey in one of the major agricultural areas of Russia – in
Rostov area. This survey included 14 agroholdings and consisted of more than 20 questions, both quantitative
and qualitative.
These 14 companies make around 7-8% of total farmland and 21% of wheat area, 38% of wheat gross
wheat output of the region (Table 1). Average agroholding operation is more than 5 times bigger that average
farm enterprise of the area (though Rostov area is known for relatively big farms) and mostly specialized on
grain production (ibid).
Among 14 surveyed agroholdings 9 were established after the crisis-1998, however, those whish were
established prior this year their main land in use acquired also after 1998. The average size of operation is 32
thousand hectares (std. deviation – 39 thousands) (Table 2). These 14 companies make around 7-8% of total
farmland of the region and closer to 10% in terms of sales.
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IKAR database demonstrated the same distribution of agroholdings by period of establishing (Figure
7). So, the major part of agroholdings was set up after 1998 as it was stated in the beginning of the paper.
Due to the IKAR data, in 2001 average size of land in use of 115 surveyed agroholdings made 55
thousand hectares and in 2003 – 54 thousand (Rylko&Jolly, 2005). So the results of two surveys are quite
close to each other.
The surveyed Rostov agroholdings were asked about the motivation for expanding their business to
primary agriculture. Of course, the answers of the managers cannot be considered as the real explanation of
the firm incentives, but the answers allow understanding the feeling of the top managements regarding this
process. Table 3 shows that the major incentive was securing of raw deliveries and some intervention of the
regional authorities. Risk aversion was the least spread motivation by opinion of the managers. These results
are partially determined by the bias of the sample. Among 14 questioned agroholdings there was no one
established by non-agrifood sector company. Rostov is a huge grain and sunflower seed producing are of
Russia, and both of these crops are export-oriented cash crops. Agroholdings were mostly established by
exporters and/or processors, for which raw collecting was the main motivation to organize own farming
business to secure raw deliveries.
Authorities enforcement to establish agroholdings as a motivation is frequently mentioned in the
literature (for instance, Gataulina et al, 2004). However, it was not an original cause for establishing of such
companies. On the contrary, the authorities on the federal and regional level have started to talk about
agroholdings when they noticed their emerging in economy after the crisis-1998. They caught sight of
advantages of this form in attracting investment to severely under-invested sector. Also it was a good mean to
get rid from the chronically insolvent farm enterprises in the region. Thus, the administration has begun to
press local business, especially agribusiness, to affiliate farm enterprises; sometimes it is set as a precondition
for getting other assets the company looks for (such a kind of additional charge for desired assets). Sometime
regional authorities can recommend (insist on) the particular farm enterprises to join in case the investor looks
for such farms. This process can be implemented with more or less level of administrative pressure, but always
it is hidden process, which is difficult to register in surveys. However, even in Rostov area, known for its more
laissez-fair policy among other agricultural areas, our survey has showed that 8 agroholdings of surveyed 14
faced with government involvements in expanding of the business towards farming (Table 3). In such areas as
Belgorod and Oryel, which like Rostov area are characterized with the prevalence of agroholdings, but known
for the high extent of governors intervention into economy, the administration involvement into agroholding
establishment might be much higher (Box 2). However, IKAR data shows that only 5% among 133 surveyed
agroholdings belong to the state.
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Box 2. Oryel Niva: agroholding set up by regional administration
Currently Oryel Niva controls 337,000 hectares of land and employs 16,000 workers. It processes
200-300,000 tons of wheat. Its activities include 102 large farms, 28 processing plants, 100 trade
organizations, 32 service enterprises, etc. The company was established and run by the regional ministry of
agriculture. The main idea underlying its creation was the late Soviet pattern of agribusiness administration,
when all regional farm enterprises, processors and service enterprises were joint into one administrative unit.
The official target for such administrative uniting in the late 90s was control over the value added distribution
among value chain as far as administration was under strong impression of low market power of farms verse
processors and traders. In result Oryel Niva got a tremendous monopoly power joint with a regional policy
instruments. Thus, local farms could not deliver their output to any other than Niva purchasers even in case of
better terms because of menace to be deprived of the regional subsidies and privileges. Later several parallel
agroholdings (Oryel agroholding, Pshenitsa-2000) were set up in order to eliminate this monopoly. However
all these new establishments are under strong control of the administration and do not help much in this
respect.
Source: Gataulina et all, data of Centre AFE.
In some cases state-owned agribusiness companies transforms into private agroholdings (see Box 3).
Box 3. Tyumen Grain Company: state-owned agroholding tending to be privatized
Tyumen Grain Company was set up in 1999 as a state-owned machinery service company. For the
regional budget means a number of high quality harvesters were acquired which were supposed to serve local
farm enterprises. However farms did not pay properly for services, the company runs bankruptcy. In 2004 the
crisis manager was invited who re-established the company as a joint venture with 100% of state ownership.
This new company affiliated two farm enterprises with grain and poultry production (via land shares rent from
holders). Now its portfolio consists of three kinds of business: machinery services for regional farms, grain
trade and poultry production. In the nearest plans of the company to acquire grain storage facilities and grain
processing (mainly for compound feed) assets, establishing trading division. The company is preparing for
privatization.
Source: data of Centre AFE
3. Access to Land
Mostly land the new operators use for cultivation is acquired through the mechanism of land shares
transactions (Table 5). The new operators do not tend in the majority of cases to get lands into private
ownership because an ownership of the huge areas creates a high barrier for exit from the business: in case a
Chapter page 10

company would like to exit from farming it will be very difficult to get back invested into land capital by
selling it out – land prices would fall due to the huge supply of land in one region. In this situation rent of land
shares was a very appropriate for both sides way of land transactions: on one hand it lets a quick and quite
cheap access for land for new operators, on the other hand it provides a notable subsistence for rural dwellers,
mostly aged and low-income population.
New land legislation, which comes to force in 2002-20031, have dramatically increased transaction
costs on land share market (Shagaida). Until these laws a land shareholder could rent out her share
individually, and it was the tenant's problem to consolidate rented shares into one land plot. A tenant wishing to
cultivate a certain land area could sign individual agreements with every shareholder and then require
parceling out the corresponding physical plot (or several large plots). Each owner in this case received rentals
individually (in theory the rentals could differ but in practice it happens rather seldom). Under the new Law
shareholders have first to come to an agreement on joint renting out of common land holding, to parcel it out
from mother farm lands and only then to rent it out on behalf of the whole collective. The latter becomes the
recipient of rental payments.
First of all, collective rent raises rentals, i.e. the cost of getting access to land for outsiders: reaching
an agreement with each individual shareholder is ceteris paribus less expensive than that with the entire
collective. This in turn results in smaller outside investments in farming: external investors have to pay more
for accessing land and respectively have less funds for investing in production. Besides, collective rent is most
likely to get under control of large farms' managers thus enhancing their power to dispose of land that they do
not own. Also the procedure of transaction registering and plot mapping is legally conditioned with a great lot
of administration steps and fees, which sometimes make the transaction unfeasible (ibid).
The process of land privatization and farm restructuring in the early 90s led to the situation when land
under farms belong to one people and business, generally speaking, to another people. Therefore, new
operators need not only accessing land but also acquire the business per ce. Our small survey in Rostov area
showed that bankruptcy procedure is most spread way for purchasing farming business, at least in this area
(Table 5). This fact also explains why percentage of sampled agroholdings established with a government
involvement was rather high in our survey: the investors for sure would like to get farm enterprises with better
1 In the end of 2001 new Russian Land Code was adopted. The issues of agricultural land turnover
were excluded from this Code in order to make its adoption easier politically. In spring 2002 a special law “On
Agricultural Land Turnover” was adopted.
Chapter page 11

financial status but due to the administrative pressure were to buy the insolvent farms with which regional
government did not know what to do.
4. Management structure
The next table gives an impression about internal management process in the agroholdings. All
holdings set the intra-firm transfer prices what allowed them to optimize tax burden: Russian legislation
release farms from profit tax therefore with well designed transfer prices companies can redistribute value
added from other levels of the supply chain towards farming divisions. As almost all agroholdings centralized
the profits from farming divisions these transfers of value added make sense in respect of tax reduction tactic.
Notable that centralized profits from farming divisions are mostly used for investment to farming but not used
for other purposes. Almost all sampled agroholdings keeps in their hands sales of output and supply of inputs.
The last means the control over technological policy in entire company. Also the central holding appoint
managers to the farms, which are very often are not local dwellers (which is important for our further
considerations). In the competence of the farm enterprises managers remain a set of negligible issues: labor
relations, minor technological decision making.
The structure of the biggest agroholdings can be very much diversified and agriculture can be only a
insignificant part of the portfolio (see Box 4). On the other hand, there many companies which are not
organized as the holdings and operate solely in farming, but by all other features they are similar to the
diversified companies: they have huge farmland areas in operation, they brought initial capital from outside the
sector and they are commercially oriented (e.g. a company Grain Industry in Saratov region, cultivating around
35 thousand hectares for grain in crop rotation)
Box 4: Business structure of some agroholdings
Company OGO
Nowadays the company OGO is one of the biggest Russian grain market operators. It is a large-scale
diversified company, involved not only in trade, handling and transportation of grain, but also in food and feed
processing. OGO produces a vast range of processed commodities, like flour, groats, vegetable oil, beer and
feeds. Vertical integration processes started by the company a few years ago turned it into one of the biggest
poultry market operators. OGO controls the whole vertical poultry chain from grain production, and feed
production up to the wholesale and retail marketing of poultry meat. (Figure 7&Figure 8
Company Agrico (2003)
A company was established as an affiliated division of one of the biggest mineral oil company of
Russia, but later was separated and now operates as an independent agroholding. It runs a little more than 50
Chapter page 12

thousand hectares, have around 10 farms, several grain elevators and processing facilities, sugar refinery,
assets in poultry and swine sectors, transport divisions, guard services, construction divisions, investment
division and some others. The key crop production of the company is grain and oil seeds. The company is
concerned with non-agribusiness assets and investigates the perspective of their sale.
Source Data of Centre AFE
5. Agroholdings impact on input markets
The emerging of the agroholdings has significantly changed the demand for farm inputs in Russia in
the last several years. Such the holdings have become new and the most massive purchasers of farm inputs in
the recent years. Vertically integrated companies purchase inputs directly form the manufacturers, but most
often they by from the dealers. They tend to develop financial leasing although in accordance with the experts
estimate it is not profitable under the current conditions. These holdings are the major importers of agricultural
machinery. So, this group of demander for farm inputs is the mostly rapidly growing and presenting the major
part of demand on the input markets.
Another specific feature of farm inputs demand in Russia today is a notable development of
customary farming. On the contrary with a paradigm of the Soviet time when farms tent to possess all
necessary machinery which could be used during a very limited period of seasonal works, today the sphere of
machinery services is fairly quick emerging (see Box 3).
So, the demand for farm inputs is changing: it is not only reduced due to the fall in GAO, but due to
an alteration of inputs use, due to an emerging of the new purchasers in downstream sector in addition to the
conventional farms.
In the recent years there was a remarkable growth in use of vertical contracting schemes in deliveries
of inputs to farms. There are two types of the contracts of vertical coordination: production contracts and
vertical integration. In the first case buyers of the agricultural raw (traders and more often processors) supply
inputs to the contracted farms, which are to grow and deliver agreed volume of agreed quality agricultural
product. Quite often the technology of growing and way of delivered inputs use are also under agreement.
However under these contracts farms remain legally independent and rather often behave opportunistically,
using delivered inputs for non—contracted crops and breaking the obligations of contract. Therefore the
second type of vertical contracts is being fairly spread when downstream companies acquire a full control over
farming process. Then input deliveries to the farms (the branches of the big agribusiness holdings) are
conducted as a internal transactions of the vertically integrated company.
In the 3-year Russian-USA research project BASIS (Lerman) 144 farm enterprises were surveyed in 3
Russian regions. In sum the sampled farms acquired the significant part of their inputs under such vertical
Chapter page 13

contracts. Thus, in Rostov region vertical integration in agriculture is especially widely spread and
correspondingly the share of vertical contracts make a bigger share in total input purchasing contracts of the
farms than in entire sample (Figure 10&Figure 11).
6. Conclusion
So, agroholdings bring a lot of changes to the Russia’s agriculture and agribusiness. The consequences
of their emerging and functioning are still not clear. Below we discuss some of the positive and negative sides
of that process, which are already evident.
Firstly let us dwell on a positive influence of the agroholdings.
Without doubts their emerging and development brought a notable flow of capital investment to the
sector, which was deprived them for almost a decade. The investment allows modernizing of primary
agriculture as well as downstream sector and market infrastructure. The small survey in Rostov area showed
that the profits are not extracted from agribusiness but re-invested back to farming. The agroholdings are the
major purchasers of the modern machinery and equipment for farms; they introduce the most advanced
technology. More over, farm operation spatially extended from south to north direction allows increasing of
use intension of the field machinery: the companies move the tractors and harvesters from their southern farms
to the northern in accordance with local season of corresponding field works. That decreases productions costs
ceteris paribus.
Agroholdings bring to the framing sector new management skills; they train farm personal, send
people for training to the main educational centers in Russian and abroad (see Box 5). Six of 14 sampled
agroholdings in Rostov area sent their laborers for short-term training courses, one – paid for university
education, five – provided housing in rural area in order to attract skilled laborers to their farms.
Box 5. Introduction of the new technologies and training of the personal
Company OGO has bought a compound feed plant in Vologda area together with grain storage facility.
There was a choice to neglect this “makeweight” or to develope own feed business. The company choose the
second option
Two employees of the company within two years studied (mainly in the US) high technologies in feed
production. After this, the company started to produce high quality ready for consumption feeds for poultry;
these feeds did not need any additional processing at the place of consumption (i.e. at the poultry farms). It
was unprecedented for Russia case by that time. The specialists of OGO company elaborate balanced rations
of feeding for each customer (which are the large scale agricultural enterprises), taking into account genetical
potential of particular poultry crosses or livestock breeds, the geographical allocation of the agricultural
Chapter page 14

enterprises and the level of their production. They also provided livestock producers with assistance in
elaboration of feeding programs and fulfilled controlling functions.
Source: Nichols, J. et al. (2002)
The agroholdings have in their disposal enough means to maintain quality and standards control and
comply with international standards requirements.
Due to mentioned merits coupled with the huge scale of production allowing them to collect
commercially more competitive lot of commodities the agroholdings have bigger market power inside the
country and abroad, they have better access to the financial resources because of better collaterals.
So, from one side their development has imparted energy and quality to the growth of Russia’s
agriculture last several years, notably increase its competitiveness and productivity. However, there are a
number of disquieting sides of this process.
The agroholdings follows a labor-intensive pattern of development. Modernization of the farming
business increases labor productivity and correspondingly decreases demand for labor force in rural areas.
More over, faced with the too costly control over the workers in the large-scale farm enterprises, agroholdings
tend to substitute labor with machinery (wide-cut machinery, automatic equipment, space technologies, etc).
This tactic leads to unemployment growth in rural area. The Soviet epoch left a heavy burden of sever lack of
non-agricultural jobs in rural areas, therefore fired laborers from the farms have no jobs in the villages and
spatial greatness of the major part of Russian regions do not allow commuting employment of township. In
result the more agroholdings develop their business the more unemployed people appear in rural areas of their
operation. This causes the social tension, which is only aggravated with a growing inequality in incomes of
the village dwellers. Half of surveyed agroholdings complain about pilfering and vandalism of their farms.
Many of them run own guard services (see Box 4), some – pay external guards. Some companies develop
social programs in the villages they operate in order to keep a social piece there. Regardless what way the
companies try to solve this problem, our estimate shows that corresponding spending makes around 10% of
total production costs, what means 10% loss in competitiveness.
Another visible problem of the agroholdings is over-investment. External for agro-food sector
investors normally take the world best practice for the technological development of their farming business.
However, these technologies are introduced into economical environment, where labor and land are extremely
cheap. Marginal product of these technologies is below their marginal costs. So allocative efficiency of the
farms belonging to the agroholdings is low. Of course, it can be short-run effect and in a mid-term investment
into high technology will be paid-off. However, the agroholdings face with the huge competition of the best
Chapter page 15

traditional farms. Although Rostov survey dealt with a severely small sample it exhibits this result in a certain
extent: Table 1 shows that on average the agroholdings had worse yield and higher production costs for wheat
verse traditional farm enterprises. In the BASIS project (Lerman) the allocative efficiency for 144 farm
enterprises were estimated (with the production function method). For 9 farm enterprises, which belonged to
the agroholdings, allocative efficiency was lower that for the traditional farm enterprises for the same region2.
If one recall that agroholdings are usually established by the huge national capitals with the great lobbying
power, it will be clear that in this situation the agroholdings started to request protectionist measures from the
Russia’s government. This is one of the reasons of growth in protectionism in Russia’s agri-food sector in last
three-four years (IET).
Traditional agricultural economy proceeds from the axiom that farming sector is non-monopolistic in
principle. The practice of the agroholding functioning disproves this postulate. In particular on the regional
level, the biggest agroholdings monopolize the main agri-food markets with all demerits of monopoly.
7. References
Coase R. (2001) The Nature of the Firm. “Delo”, Moscow, (in Russian)
IET. (2005) Russian Economy in 2004. http://iet.ru (accessed 15 December 2005)
Gataulina, E., Petrikov, A., Uzun, V., and Yanbykh, R. Vertical Integration in an Agroindustrial
Complex: Agrofirms and Agroholdings in Russia. In: Swinnen, J.F.M. (ed.) The Dynamics of Vertical
Coordination in Agrifood Chains in Eastern Europe and Central Asia. Working Paper No. 42. World
bank (in press)
Koester U. (2003) A revival of large farms in Eastern Europe? How important are institutions? Paper
delivered on the 25th Conference of IAAE, Durban, 16-22 August, 2003. http://www.iaae-
agecon.org/conf/durban_papers/papers/Koester.pdf (accessed 15 December 2005)
Nichols, J, Serova, Eu., Khramova, I.. (2002) Case study of grain company OGO. Taxes A&M
Lee, W. F., Boehlje, V. D., Nelson, A. G., and Murray, W. G. (1988) Agricultural Finance. Iowa State
Uni Press. Ames.
Lerman, Z. (2005) Factor Market Constraints on Economic Growth in Russian Agriculture-Golitzino
Papers: An introduction to Special Issue. Comparative Economic Studies. Volume 47,#1, pp. 80-84
Rylko, D. and Jolly, R.M. (2005) Development of Agroholdings in Russian Agriculture. Comparative
Economic Studies. Volume 47,#1, pp.115-126
Serova, Eu. (1999) Agrarian Economics. Higher School of Economics. Moscow (In Russian)
2 The result are not published yet.
Chapter page 16

Serova. Eu. and Khramova, I. (2000). Emerging Supply Chain Management in Russia’s Agri-Food
Sector. Discussion papers. Series: Russian Agri-Food Sector in transition. Bonn, July #14
Serova. Eu. and Khramova, I. (2002). Non-Agricultural Capital in Russia’s Agriculture: Vertical
Integration or Business Diversification. Unpublished.
Serova. Eu. and Khramova, I.. (2003). Farms and Factors Markets in Russia’s Agriculture. In: Spoor,
M. (ed.) Transition, Institutions, and the Rural Sector. Lexington books, pp.61-80
Serova, Eu. (2002). Evolution of the Farm Structure in Russia’s Agriculture: Background and
Perspectives. In: Proceedings of International Seminar “Pre-Accession Strategy of Czech Agriculture
towards EU”, pp.62-177
Serova, Eu. and Shick, O. (2005). Markets for Purchased Farm Inputs in Russia. Comparative
Economic Studies. Volume 47,#1, 154-166
Shagaida, N. (2005) Agricultural Land Market in Russia: Living with Constraints. Comparative
Economic Studies. Volume 47, #1, 127-140
Uzun, V.Y. (2001) Organizational Types of the Agricultural Production in Russia. In: The Markets of
Production Factor in Russia’s Agriculture. AFE, Moscow.
Williamson, O. (1996) Economic Institutes of the Capitalism, St.-Petersburg (in Russian)
8. Tables
Table 1: Rostov area: comparison of operation of average surveyed agroholdings and average
area farm enterprise
Per one average operation Units
Agroholdings Farm enterprise
#=14 #=949
land in use thousand hectares 31.6 6.0
wheat area thousand hectares 18,2 1,3
Wheat output thousand tons 98,6 3,8
wheat yield kg/hectare 29,4 29,9
wheat production cost rouble/ton 1,2 1,1
Sourse: Centre AFE survey in Rostov area, 2002
Chapter page 17

Table 2: Rostov area: surveyed sample of agroholdings
## of agroholding Year of establishment Land in use, hectares
1 1998 0
2 2000 2021
3 2000 4600
4 2000 6000
5 1995 7500
6 1997 14000
7 1992 15853
8 2000 25000
9 1999 26000
10 2000 36000
11 1998 45000
12 2000 53000
13 1992 58000
14 1993 150000
Source: Centre AFE survey in Rostov area, 2002
Chapter page 18

Table 3: Rostov area: Incentives for expanding the original business towards primary
agriculture in 14 surveyed agroholdings
Incentive # of answers*
Secure raw-material deliveries 8
Expand market for manufactured inputs 5
Ensure collection of outstanding debt 6
Profitable business 5
Risk aversion by portfolio diversification 3
Enforcement/recommendation regional authorities 8
*Multiple answers allowed.
Source: Centre AFE survey in Rostov area, 2002
Chapter page 19

Table 4: Rostov area: The ways of land acquisition by agroholdings
#of answers*
joint venture with farm enterprise 1
investment into farm enterprise equity 1
land share purchase 1
land purchase 1
land use right from federal authorities 2
rent of land 2
rent of land share 8
*Multiple answers allowed.
Source: Centre AFE survey in Rostov area, 2002.
Chapter page 20

Table 5: Rostov area: The ways of farm enterprises acquisition by agroholdings
#of answers*
initial privatization 2
purchase in bankruptcy procedure 7
joint venture with existing farm enterprise (s) 1
new enterprise 4
*Multiple answers allowed.
Sourse: Centre AFE survey in Rostov area, 2002.
Chapter page 21

Table 6: Rostov area: management and control within agroholdings
Centralized functions #of answers*
Redistribution of farm profits by holding company 13
For farm uses 13
For other uses 5
Centralized product sales 11
Control of selling prices within the group 14
Obligation of intra-firm transactions 12
Centralized input purchasing 11
Inputs supplied by holding company at transfer prices 7
Inputs purchased at market prices with intermediation of holding company 4
Appointment of farm managers 12
Intervention in labor hiring 4
*Multiple answers allowed.
Sourse: Centre AFE survey in Rostov area, 2002.
Chapter page 22

9. Figures
Figure 1: Land use by type of farms, %
1991
Farm enterprises
Farmers
Households
2000
Source: calculated from Russian Cadastre Service data
Figure 2: Gross agricultural output by type of farms, %
1991
69%
31%
0%
Farm enterprises
Households
Farmers
2003
40%
55%
5%
Source: calculated from Russian Statistic Service data
Figure 3: Index of gross agricultural output originated from farm enterprises and households
25
45
65
85
105
125
145
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
Fram enterprises Households
Source: calculated from Russian Statistic Service data
Chapter page 23

Figure 4: Rate of growth in gross agricultural output,%
-15
-10
-5
0
5
10
19 8 5
19 9 0
19 9 1
19 9 2
19 9 3
19 9 4
19 9 5
19 9 6
19 9 7
19 9 8
19 9 9
20 0 0
20 0 1
20 0 2
20 0 3
20 0 4
Source: calculated from Russian Statistic Service data
Figure 5: Investment into food industry and farming, billion roubles, fixed prices of 1995
4
6
8
10
12
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005,
es tim ate
farming food
Source: calculated from Russian Statistic Service data
Figure 6: Foreign investment into farming sector, million US dollars
0
20
40
60
80
100
120
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005,
es t im ate
Total FDI (direct)
Source: calculated from Russian Statistic Service data
Chapter page 24

Figure 7: Distribution of surveyed agroholdings by year of establishment
601
2323
2256
0
500
1000
1500
2000
2500
<1998 1999-2000 2001-2003
Source: calculated from Rylko&Jolly,2005
Figure 8: “OGO”: Share of Single Product Segments in Total Turnover, 2000
1. Grain trade - 8% 2. Milling - 14%
3. Compoud feeds production - 15% 4. Meal and vegetable o il production - 12%
5. Fuel department - 27% 6. Petrol-chemical products - 7%
7. Poultry and eggs production - 11% 8. Food production -3%
9. Other - 3%
Source: Nichols, J. et al (2002)
Figure 9. “OGO”: Share of Single Product s Segments in Total Capital, 2000
1. Grain trade - 6% 2. Milling and Compoud feeds production - 38%
3. Meal and vegetable oil production - 21% 4. Fuel department - 4%
5. Poultry and eggs production - 16% 6. Other - 15%
Source: Nichols, J. et al (2002)
Chapter page 25

Figure 10: Rostov oblast: Vertical coordinated contracts for purchases of mineral fertilizers, as
% of total purchases
57%
9%
2%
6%
26%
32%
Big middlemen Manufacturer Agrokhimia Output buyer Holding
Source: BASIS survey data, 2002
Figure 11: Rostov oblast: Vertical coordinated contracts for purchases of gasoline, as % of total
purchases
15%
30%
11%
21%
23%
44%
gasoline station
middlemen
other
output buyer
holding
Source: BASIS survey data, 2002
Chapter page 26