Vertical coordination in a post-command agricultural system—Can Russian dairy farms be transformed

ELSEVIER

Agricultural Systems, 53 (1997) pp. 253-268 Copyright © 1996 Elsevier Science Ltd

Printed in Great Britain. All rights reserved P l l : S 0 3 0 8 - 5 2 1 X ( 9 6 ) 0 0 0 4 9 - 2 0308-521X/97517.00+0.00

Vertical Coordination in a Post-command Agricultural System Can Russian Dairy Farms be Transformed?

Allan O. McNeiV* & Wil l iam A. Kerr bC

aAlberta Agriculture Food and Rural Development, Field Crop Development Centre, Lacombe, Alberta, Canada

hDepartment of Economics, The University of Calgary, Calgary, Canada "Economics Division, Aberdeen School of Agriculture, University of Aberdeen, Aberdeen, UK

(Received 1 March 1996; accepted 28 March 1996)

A B S T R A C T

The liberalization of the agricultural systems in the former command economies of Eastern Europe and the Soviet Union is a complex and difficult undertaking. As a result of" (1) past investment patterns in physical and human capital," (2) the existing organizational structure and; (3) the lack of market institutions, transformation of the Russian dairy industry may prove to be particularly difficult. Constraints to the liberalization of Russian dairying are examined in detail and the major problem areas outlined. In particular, the problems that may arise from piecemeal liberalization are identified. Emphasis is placed on the need to approach the transformation of the dairy industry as an integrated system extending from the resource base through to the con- sumer. Copyright © 1996 Elsevier Science Lid

INTRODUCTION

Obvious economic failure contributed to the rejection of central planning combined with bureaucratic direction as the system of organizing economic activity in eastern Europe, Russia and the other states of the former Soviet Union. It has been assumed, both in the former command economies and in the West, that a system based on markets would replace the existing organizational structure. While, to varying degrees, markets have been freed and the other requisites for a market economy--transferable property rights, a system of business law, a commercial banking sector, labour mobility, etc.--are being

*To whom correspondence should be addressed.

253

254 A. O. McNeil, W. A. Kerr

introduced, the transformation of former command economies has proved extremely difficult. The movement to the market system has been particularly difficult in the agriculture and food distribution sectors.

The failure to correctly anticipate the problems associated with the movement to a market system can be attributed, in part, to the naivety of Western economists--the overwhelming majority of whom are trained in the neo- classical tradition--regarding the importance of the market institutions underlying their own 'market economies.' In addition, the constraints on transformation imposed by the investment patterns and organizational structure of the command system are poorly understood (Hobbs et al., 1993). The latter problem provides the basis for this paper. The specific objectives of this paper are: (1) to examine the constraints on Russian dairy operations imposed by the investment patterns of the former command system; (2) to explain the effects of the organizational structure put in place under central planning on the operation of dairying as a system; (3) to identify the constraints that the practices outlined in (1) and (2) will impose on the process of transforming the Russian dairy sector into one based on markets; and (4) to determine whether the western model of a family farm based dairy system is the appropriate one for economies in transition.

Part of the difficulty with much of the current discussion relating to the process of transition to an economic system based on markets is that it has been conducted at a level of generalization that masks the complexity of individual agricultural systems. The complexity of the transition problem will be illu- strated by a discussion of one post-command economy dairy operation in Russia. It is hoped that the insights provided, while not necessarily transferable to other post-command agricultural enterprises, will nevertheless indicate the difficult task faced by both those who are directly charged with implementing liberalization and by those from market economies asked to provide advice.

THE ROLE OF MARKETS IN THE DAIRY INDUSTRY

To understand the problems associated with the transformation of Russian dairying, the mental picture of a Western dairy farm must be first put aside. Instead, it is necessary to think of dairying as a number of individual activities that combine to convert basic raw materials such as sources of nutrients for plants, plant and animal genetic material, etc. into milk, and its various deriva- tive products and bi-products that are ultimately purchased by consumers. This is because the planners in former command economies approached the pro- vision of milk and dairy products to consumers from this perspective. For them, the dairy industry represented a number of separate activities that are primarily constrained by biological parameters--forage production, forage

Can Russian dairy farms be transformed? 255

storage, breeding, ration formulation, feeding, protection of animal health, milking, milk processing, distribution, etc. These activities were approached as individual tasks that, if completed, would lead to a successful dairy industry. Of course, the same basic activities are the basis of the dairy industry in market economies. In the West, however, dairying is approached from the point of view of a system rather than simply the sum of individual tasks. The effective management of a system requires both a holistic vision of the operations that constitute the system and an effective means of collecting, transferring and processing information on all aspects of the system. The organizational structure put in place in the command economies' dairy sectors inhibited the latter because a systems approach was never developed. The result was low productivity.

In market economies, improvements to dairy efficiency come from increasing the total net value of the outputs that can be obtained given the system's numerous biological constraints. At any point in time, these improvements can come from two sources: (1) better application of existing scientific knowledge; and (2) more effective coordination of the activities that make up dairying. Of course, these two factors are not independent as poor coordination can inhibit the effective application of scientific knowledge, and the state of scientific knowledge can determine the form of coordination that will be most effective. Long run efficiency gains come from the development and application of better scientific and managerial technology. It is hypo- thesized that the approach to coordination in place in command economies has shaped the pattern of investment in the Russian dairy industry in ways that may make it difficult to move to an efficient dairy industry based on markets. More important, if the transition is attempted without sufficient forethought, considerable disruptions to milk supplies may result.

According to Mighell & Jones (1963), vertical coordination: "... includes all the ways of harmonizing the successive vertical stages, or steps, of production and marketing. Vertical coordination may be accomplished through the market price system, vertical integration, contracting, cooperation, or any other means, separately or in combination. There is always some kind of vertical coordination if any production takes place" (p. 4).

Within firms, vertical coordination is accomplished through direction by managerial orders (Coase, 1937).

When considered within this framework, a dairy industry based on command and central planning represented a totally integrated system in which markets played no part. Vertical coordination was accomplished through two levels of managerial orders: dairy managers coordinated the movement of products within administrative units that may be called command firms (Hobbs et al., 1993), while bureaucrats in the planning authority coordinated the movement of products between command firms. In the absence of the

256 A. O. McNeil, 14I. A. Kerr

flexibility provided by markets, the vertical coordination o f dairy production, processing and distribution in command economies can be likened to a ' tube' where each activity in the dairy process is linked, without choice, to its resource base, its upstream suppliers and its downstream customers. Man- agers were not allowed to seek out: (1) alternative resource bases in times of poor harvest; (2) alternative suppliers when their designated suppliers failed to provide the correct quanti ty or quality of inputs or; (3) alternative customers when surpluses were available.

In a fully developed market system, the structure of the dairy production, processing and distribution system is determined, everything else equal, by the method of vertical coordinat ion that proves to be the most efficient. Competitive pressures will lead to a system of vertical coordinat ion that minimizes the total production, distribution and transaction (coordination) costs. Where managerial orders are the most efficient mechanism for vertical coordination, transactions will be coordinated within a firm. Where markets prove more efficient, firm-to-firm transactions will take place.

Whereas the size o f dairy farms in a market-based system is determined by the efficiency of managerial orders relative to between-firm transactions, 2 dairy operations in Russia are arbitrary administrative units within the command economy's vertical coordination system. As a result, privatization of Russian dairy operations may produce firms that are too large to operate efficiently.

In modern market economies, the evidence would seem to suggest that the most efficient milk product ion units are herds of 50-350 depending upon the situation in the particular rural economy---centred on a family farm with the owner - -ope ra to r facilitating vertical coordinat ion through managerial orders. 3 It may b e that the farmer must only manage himself, but often managerial orders will be given to family members and/or a small number o f hired workers. The dairy farm interfaces with other firms for supplies o f inputs and downstream disposal of milk and surplus livestock. These farm-

~Russian dairying is affected by other well understood problems endemic to command economies (e.g. labour markets without flexibility to reward improved performance or the threat of unemployment bred 'shirking' on a massive scale). Furthermore, in the absence of either merit-based incentives or the power to make fundamental changes, managers acted to maximize their personal power by increasing the size of the enterprise which they managed. 2This assumes, of course, that production quotas or other restrictions on output sanctioned by governments are not in place. 3Certainly, larger dairy farms do exist in market economies. They normally represent an upscaling of the family farm model based on superior management and heavy capitalization (although some corporate examples also exist). These large operations can still be considered exceptions--the tail of a distribution--rather than an alternative model of vertical coordination. Those farms with corporate ownership are still based on the systems approach of family farms although they may put a greater emphasis on formal information flows among those undertaking individual tasks than may be the case with large family farms.


to-firm interfaces are likely to be conducted through contracts (milk, machinery, nutrient additives and special feeds, veterinary services, artificial insemination (AI) services, accounting services, haulage) or spot markets (replacement heifers, bull calves, surplus heifers). The downst ream milk processing industry is often organized through a voluntary farmer-owned cooperative or a compulsory government sanctioned, farmer administered, marketing board. The relationship between farms and the processing cooperative/marketing board is, however, largely at arm's length with the movement of milk between a farm and a processor governed through contracts. As this system of vertical coordinat ion can be considered the norm over a diverse set of countries, a similar system might be expected to evolve in the Russian dairy industry. This certainly appears to be the expectation of a large number of those from the West who are providing advice to the dairy sectors in former command economies (McNeil & Kerr, 1995).

T H E D A I R Y I N D U S T R Y IN A C O M M A N D E C O N O M Y

Contrast this stylized Western dairy system with that of the Agroprocombi- nate Lenin 4 located in the Moscow milkshed. 5 Agroprocombinate Lenin is a large umbrella organization overseeing the product ion and processing of a number of agricultural commodities. In addit ion to its farming operations, the organization has a milk plant, a meat plant, maintenance facilities and retail outlets in Moscow. Approximate ly 55000 people work within the organization. Agroprocombinate Lenin's dairy operations are spread over 38 ' command farms '6 with herd sizes ranging from 200 to 2000 milking cows. The total herd size is approximately 16 500 cows and total cattle number about 50 000 head. Average milk product ion for the herd ranges from 3000 to 6000 kg/cow/year with individual cows reaching 9000 kg of milk per year. The average overall herd product ion is abou t 5400 kg per year.

Calves are shipped to two specialized command farms. One farm raises

4This is not the dairy operation's real name. The example provided, however, is based on a real Russian dairy operation in the Moscow area. As many of the individuals in decision making roles remain in their positions at this time, we have decided to respect their interest in confidentiality. Colleagues with a professional interest in the dairy operation's identity should contact one of the authors. 5It is not clear whether a 'typical' Russian dairy operation exists, but the Agroprocombinate Lenin appears to have a number of features that are common in the Russian dairy sector. 6The designation 'command farm' is made to emphasize that the existing bundle of enterprises that the command system denoted as farms is not the same as a farm in a market economy whose bundle of enterprises is determined by the relative efficiency of managerial orders compared to other means of achieving vertical coordination such as contracts or spot markets.


bull calves for meat, while the other raises heifers for dairy cow replace- ments. The milk plant processes approximately 3000 tonnes per operating day (84 000 tonnes per year).

In the pre-liberalization period, the management structure was hierarchical and ownership effectively vested in the state although some of the farms were nominally owned by members of collectives. With the current reforms, the ownership structure is no longer well defined. Certain operations, such as the AI unit and feed milling, will remain under state control, while some of the state and collective 'command farms' within the Agroprocombinate's structure are moving to 'Joint Stock Association' (JSA) ownership. Under JSA ownership, all workers previously employed by the command farm receive shares based on seniority and salary. Each JSA farm still works within the overall Agroprocombinate structure but has its own management. Even though there has been a change in ownership, management personnel remain in place.

While collectivization of agriculture was largely accomplished during the 1930s, the major thrust of the post-Stalinist Soviet organizational reforms was the amalgamation of smaller work units into larger work units, smaller collective or state farms into larger enterprises and ultimately, all agro- industrial operations within a geographical area into agricultural--industrial complexes (AICs) such as Agroprocombinate Lenin. This path had been chosen due to the belief that large-scale operations were inherently more efficient than small-scale operations (Gaisford et al., 1994).

The AICs are responsible for a wide variety of commodities and all levels of vertical coordination from primary production through processing, distribution and sales. Management authority is vested in an AIC's General Director who has line authority over the directors of command farms and processing enterprises. There is little, if any, delegation of authority to AIC staff (as opposed to the staff of individual command farms) who have expertise in a specific facet of farm production or processing. Furthermore, AIC staffdo not have any line authority over activities on individual farms or processing facilities.

The directors (managers) of Agroprocombinate Lenin's individual command farms are responsible for both the economic operations and the social welfare aspects of their farm. The directors indicated that well over half of their time was taken up with social welfare oriented functions. Not only are the directors responsible for managing people, they are also responsible for the housing, food, medical care, etc. for their 'command farm. '7

7The time spent on non-income producing activities is a direct result of the size of the units for which a director is responsible. For example, the feed mill with a production capacity of ! 500 tonnes per day, has 300 people on staff or associated with the operation. One JSA farm (with greenhouse, field vegetable, potato and dairy/meat activities as well as the requisite maintenance facilities) has a staff of 2000, 130 trucks and cars, 100 tractors and 600 other machines.


The large size of the dairy operations require that vertical coordination of milk production be divided among a number of individuals. The system is hierarchical so that individuals responsible for the various activities which comprise milk production report to the farm director. There is limited communication or cooperation among the different enterprises along the stages of production. The primary responsibility for milk production lies with the breeder who is also responsible for herd health (see Fig. 1.) The model is 'milk cow' centred with animal health and breeding considered central components of dairy cow management. The objective of the breeder is simply to produce milk to meet production goals provided by the command farm's director. The breeders are given their production targets, the milking equipment they will use, the barn designs they will milk in, the staff they must work with, the feeds they must use, etc. by their directors. As a result, the individual with the central responsibility for milk production is narrowly focused on the two activities under their control-breeding and animal health. Activities across the dotted lines are not his managerial concern. There is little room for independent initiative.

The problems arising from constraints on independent activity are com- pounded by the compartmentalization of management. For example, the agronomists report through a different channel than the breeder and have a different goal--that of maximizing forage production. They are often

Purchasing

People Mgmt.

Sanite~on

Nutrition

Financial Mgmt.

Main- tenance

Quality Control

Milking Equipment

[.Forag e

Engineering I

I Decision Making

[ Heifer Rearing

MILK COW

BREEDING

Animal Health

Milk Processing i

l Meat Production I

Laboratory Distribution Systems

Transport Customer

IdenlJflcatJon

Product Packaging

Customer Service

Wholesaling Oual~y Cor~ol

Maintenance

Sanitation

Fig. !. This illustrates a Milk Cow centered model for dairy production systems in Russia. Dairy farm managers can only control animal health and breeding. Factors shown to the left and right of the Milk Cow are either "given" with little input from the manager or "provided" and no longer the manager's concern. Factors shown to the left and right of the solid lines are

almost entirely beyond the manager's control and are not considered.


physically separated from and have no incentive to work with the dairy personnel, i.e. there is little communicat ion across the dotted lines. With the single goal of maximizing milk production, forage quality is not the concern of dairy personnel. A Chief Engineer - -no t the local farm staff--is responsible for the maintenance of the milking equipment. As a result, sanitary control has to be dealt with through hierarchical channels rather than by those able to identify problems. While the breeder may be responsible for genetic selection, the important step of calf rearing, both for beef product ion and, in particular, replacement heifers is someone else's responsibility.

As one moves further from the milk cow (beyond the solid lines), the activities become psychologically remote from dairy management . Milk quality, for example, is not the responsibility of the breeder. With no incentives or penalties for milk sanitation or quality on the farm, the shelf life of milk is reduced to 36 hours compared to the 2 weeks common in modern market economies. Note that retail activity is so far removed from farm level activities that it is not even included in the model depicted in Fig. 1.

Those activities listed in the columns on the left and right sides of Fig. 1 are considered an integral part of dairy product ion in modern market economies but were not part of, or received only limited attention on, the Russian farm. There was no communicat ion between the breeder and the upstream or downstream management .

Quality

HEIFER MILK REARING

People Forage Animal Health

Purchasing Maintenance

Financial Engineering

Waste

Sanitation Nutrition

PRODUCTION

Quality Processed/",.A

~ . ~ Product ~ / ]

MILK MILK PROCESSING MARKETING

People People People Sanitation Financial Transport E Milking Quality

quipment Purchasing Control Milk Quality Financial Breeding Sanitation Sanitation Mastitus Quality Purchasing Forage Control Maintenance

Engineering Waste Transport Distribution

Customer Nutrition Laboratory Service

Maintenance Engineering Retail

FIG. 2. This illustrates the processed based dairy systems model for a market economy in the West. Dairy farm managers must be cognizant of all factors shown in the model and the importance of their efforts in the success of each sector of the industry. Not only does milk flow toward the retailer but market and economic information flows back to the dairy man-

ager based on the success of the industry in the free market.


Contrast the Russian model with the model of a dairy system in a modern market economy (MME) presented in Fig. 2. Each step in the MME system-- heifer rearing, lactation, milk processing and milk marketing--is based on the previous step and receives feedback from the following step. Products flow down the vertical production--marketing chain. A healthy calf is the result of a large number of factors which must be coordinated as a system. Raw milk quality is determined, in part, by the health of the calves used in milk production. The quality of processed products is related in no small part to the quality of raw milk. Hence, for example, barn milk line sanitation reduces the bacterial count in milk, extending shelf life in the retail store, resulting in increased marketing flexibility. The flow of information back down the chain is the key to a successful system--the arrows at the bottom of Fig. 2.

There are many individual factors relating to each production step that must be monitored, assessed and acted upon as needs dictate. The heart of dairy industries in MMEs is the owner/operator who has a direct incentive to produce the most desired mix of quality and quantity which the farm's resource base can provide. The owner/operator collects and processes a great deal of information himself. Herd size and farm operations are of a size which can be directly monitored. Small numbers of hired labour keep supervision activities to a minimum. When the farmer deals with elements of the system outside his direct control, price premiums or penalties built into milk supply contracts provide information expectations relating to and incentives for sanitation and quality. Market competition guides input and secondary output markets such as bull calf production with farmers free to change who they deal with. Consistent poor management and/or insufficient resources will eventually lead to business failure.

REFORM OF THE RUSSIAN DAIRY INDUSTRY

The major question, given the current structure of the Russian industry, is how to reform it in a way that preserves a functioning dairy system while creating an industry that has long run viability. There would appear to be two possibilities. First, one could attempt to foster the family farm model common in MMEs or second, one could attempt to reform the existing Russian industry while leaving its basic structure intact. There are in both cases, however, fundamental questions regarding the methods by which vertical coordination is to be accomplished.

The family farm model

Any examination of the process of moving to a 'family farm' based dairy industry must be premised by an assumption that the crucial questions of


herd and property division have been solved in a satisfactory fashion, i.e. that a farm family has been selected which has acquired a herd of approximately I00 cows from the command farm's herd and sufficient land to provide all, or at least the majority of, the required forage. These are clearly difficult questions both from a property rights point of view and in terms of personnel. Given that the existing 'command farms' are currently overstaffed by MME standards, equitable division of the existing resources, both livestock and land, would lead to very small farm units. 8 While, over the long run, consolidation via the exit of the least competitive family farms from dairying might take place, in the short run, considerable disruptions to the milk supply may be envisioned. Furthermore, even if a decision to establish dairy farms of a size comparable to those in MMEs could be reached, the question of who should receive the allocations remains. There are no obvious farmers. The command system's investment in specialized human capital has led to no generalists with an operational appreciation of dairying as a unified system. In fact, the hierarchical structure actively discouraged individuals from acquiring a working knowledge of the entire system. Even if these difficult problems can be satisfactorily resolved, however, the current infrastructure may prevent the establishment of an efficient market based system.

Past investments have meant that most existing 'command farms' have large-scale, milking and milk handling facilities. This means that it will not be possible for farmers to have individual milking facilities. As a result, problems of scheduling will arise for milking facilities and, as milk from a number of farmers must be held in the bulk milk tanks, an extensive system of monitoring will be required to prevent individual farms from 'cheating' on sanitation and quality standards. The existing large-scale animal handling facilities may also mean that initially, animals from different farms may have to be mixed, leading to herd health problems. Existing animal feeding facilities will make it difficult to allow for separate feeding of an individual farmer's stock. Silage and forage storage facilities are large scale making it virtually impossible for individual farmers to exercise quality control over their forage. Arrangements would have to be made for the cleaning, maintenance and possibly replacement of the large scale and, hence, communally used milking and milk storage systems. As milking activities are centralized, this means that farmers are likely to have to travel to their fields, necessitat- ing physical separation from their animals for long periods each day in the growing season. In addition, the demands of twice-a-day milking will require considerable travel time.

8The size of farm suggested might be considered the minimum efficient size. Given the large number of potential family farmers, privatization into larger individually owned herds seems politically unfeasible.


While, over time, complete reinvestment in milk and animal facilities by individual families may be possible, given the low levels of profitability likely in the short run and poor rural capital markets, such a changeover will only be possible over a considerable period of time. Further, as more individual farmers are able to acquire their own facilities, fewer and fewer farmers would continue to use the existing system, meaning that the increasing bur- den of fixed cost and maintenance would have to be borne by those remain- ing. This will lower the likelihood that they would have sufficient profits to acquire separate facilities or to maintain viable enterprises. As a result, milk supplies may be disrupted before a sufficient number of farms with individual facilities exist to supply the market.

If the individual dairy farms are privatized under separate ownership from the processing system, then farmers would face a single purchaser of milk. It should be remembered that the AICs were established as monopoly suppliers in geographic areas. The problem of monopoly processing and distribution systems has already been identified as a major constraint to privatization of the Russian energy system (Considine & Kerr, 1993). A single, privatized milk processor would lead to unequal bargaining power in the negotiation of farmers' milk contracts (Gaisford et al., 1994). This problem could be over- come, as it has in many MMEs, by vesting ownership of the processing industry in the privatized farmers. Overall management of processing would be in the hands of farmers with the coordination of movements of milk between farmers and processors handled by 'arm's length' contracts.

The input industries, however, present a more difficult problem. Agri- cultural industrial complexes such as Agroprocombinate Lenin have made investments in large-scale feed mills, maintenance and AI facilities. If they were privatized in a JSA scheme, these facilities would become monopoly suppliers of those services. According to Gady & Peyton (1992), in Russia and Eastern Europe: "Many of the large stage monopolies still exist. Conse- quently, there is little competition to bring about many of the operating effi- ciencies that need to occur. Furthermore, many of the existing monopolies have been able to raise prices to punitive levels because of lack of competition, making life difficult for businesses having to buy or sell to these monopolies" (p. 1180).

In addition to the problem of monopolistic prices, in the absence of competition, vertical coordination between input suppliers and dairy farmers would be accomplished through bilateral contracts rather than spot markets. This creates a dependency between buyer and seller. According to Hobbs et al. (1993): "Bilateral private contracts without competitive alternatives create asset specificity and the conditions which allow for opportunistic behaviour. Asset specificity arises when productive assets or goods are restricted in alternative uses. In the case of ex-command firms, linked to... their suppliers...

264 A. O. McNeil, IV. A. Kerr

without competitive alternatives, asset specificity will be endemic. A firm dependent on firms.., upstream in the tube will face the risk that the other party in the contract may act opportunistically; i.e., renege on the contract for economic gain... In the former Soviet Union, where commercial law is in its infancy, the problem of opportunistic behaviour is likely to be widespread. As a result, firms will not be able to recover the full value of their investment in specific assets and may face eventual bankruptcy" (pp. 137-138).

When firms cannot expect to recover the full value of their investment, they will tend to reduce the level of investment (Anderson et al., 1992). As a result, there will be under investment in privatized dairy farms and, hence, reduced levels of efficiency.

According to Hobbs et al. (1993): "In market economies, the problem of asset specificity is often solved through the extension of ownership forward or backward in the vertical coordination chain" (p. 138).

This suggests that to have efficient levels of investment in the privatized dairy sector, ownership of the AICs' input enterprises should be vested in the dairy farmers. However, it would appear that much of the AIC structure would be simply reconstructed as farmers would control both the upstream and downstream components of the dairy system. The prices that input suppliers charge and the price that farmers receive for milk would be set bureaucratically--as opposed to the monopoly alternative--and markets would play no part. The previous investments in large-scale production systems in the command economy era appear to limit the opportunity to create a dairy system modelled on those in MMEs.

While it might be argued that private farms could be encouraged to operate totally outside the existing structure, initially these farms would have to rely on the existing AICs for inputs and access to the processing and distribution system. The AICs would likely perceive such individual farmers as competitors and act to limit their success. Abandoning the infrastructure in the existing system is not a feasible alternative in the short run as milk supplies would be disrupted. Given that creating a dairy system which mirrors those in MMEs is likely to be fraught with difficulties, what are the prospects for introducing effective reforms while leaving the existing structure largely intact?

Reform of the existing Russian structure

The major difference between an operation the size of a family dairy operation and the larger command farms is that more people are involved in the operation. The fundamental biological operations are simply duplicated by adding more cows. This suggests that the transaction costs associated with supervising labour activities and monitoring the factors controlling output


quality rise steeply when the herd exceeds a size that is directly manageable by the owner-operator and trusted family members (Eggertssen, 1990). While it may be relatively easy for managers to devise work plans for large- scale dairy farms, ensuring that they are carried out may be very costly. Compared to a compact factory with standardized tasks, monitoring labour activity is more difficult as farming activities are spread over large areas and most tasks are non-standardized. Without adequate supervision, workers will have the opportunity to 'shirk'.

The problem of monitoring the factors controlling output quality is extremely difficult in dairying. Unlike industrial processes, the individual biological processes that make up dairying are each subject to considerable performance variability. Further, dairying requires the melding of a number of biological activities. Changes in one biological process can interact with a number of other biological processes which ultimately affect herd performance and output quality. When large numbers of people are responsible for different aspects of the process, it becomes difficult to isolate the factors that are negatively impacting performance. Furthermore, as there is often a considerable time lag between a fault in the system and an observable effect on output, identifying the source of the problem and the individual responsible may not be possible. Direct supervision of all activities in large-scale operations is simply prohibitively expensive given the level of technology currently available in Russia. 9

If adequate supervision on the job is not possible, one alternative might be to provide incentives to induce the worker's desired performance. Incentives, however, only tend to work well when the output can be easily monitored and processes are independent (Jensen & Mecklin, 1992). These are not the attri- butes of a system. Most outputs in the dairy industry have a large number of quality characteristics which complicates the monitoring process. Also, workers are unlikely to accept incentive schemes because the performance of their activity will be dependent on a number of other activities in the system that are the responsibility of others. Again, the time lag between the point where decisions are taken and when the outputs of a dairy system can be assessed makes it virtually impossible to unbundle the contribution of various components of the system for the purpose of incentive-related rewards. It would seem that using managerial orders and/or incentives to coordinate a dairy system employing large numbers of people has inherent inefficiencies when compared to managerially compact family farms.

9Large dairy farms in MMEs are characterized by a high degree of technical sophistication in both production and information gathering and processing. As a result, little labour is required eliminating most of the problems associated with monitoring and coordinating large units. The investment capital and technical support requirements of such a system are simply not available in rural Russia at this time.

266 A. O. McNeil, I4/. A. Kerr

This does not mean, however, that considerable improvement cannot be made within the existing Russian dairy structure. Certainly, considerable productivity gains could be made by altering the hierarchical management structure so that there is a manager responsible for all dairy operations on an individual 'command farm.' This should include forage production and storage, breeding decisions, nutrition, herd health, milking, waste disposal, day- to-day equipment maintenance, sanitation, on-farm holding of milk, heifer rearing and monitoring of forage and milk quality--in essence removing the vertical lines in Fig. 1. The directors of such dairy units should be encouraged to adopt a team approach to management involving all section managers in the decision process. Section managers should be required to spend considerable time in all other sections so that an appreciation of broader concerns and problems can be gained--the information flows in Fig. 2 need to be initiated. At all times, management should be encouraged to approach problems from the point of view of the system as a whole. All of this is basic management as understood in MMEs. Managers and sub-managers of dairy units should, if possible, be provided with training in business management. Japanese success in manufacturing can, in part, be attributed to their alternative to managerial direction for the coordination of labour activities wherein workers are both encouraged to collectively take initiative and to be involved in problem solving. Again, the Japanese emphasis is on the system rather than worker specialization. This model of labour management may be better suited to dairy systems than hierarchical managerial orders.

Privatization through the use of JSAs (or an alternative) must be under- taken with a view to the wider system. Even large privatized dairy farms may not prosper if they must deal with a separately privatized monopoly feed mill and a separately privatized monopoly processing plant. In this situation, Gaisford et al. (1995) conclude that: "Consumers have no assurance that the market system will provide a reasonable level of food security. Even in the fortuitous case where such short-run disruptions do not occur, the quantities that are available will be restricted and final prices to consumers will be high" (p. 195).

Hence, until new investments can be made in sufficient alternative input supply facilities and milk processing facilities to ensure competition, piecemeal privatization of the dairy operations of AICs should not be fostered.

CONCLUSION

Those who work in the Russian agricultural sector have been asked to have faith in privatization and markets as the means of providing their livelihood. However, operationalizing the transition from vertical coordination based


on the command system to that where vertical coordination is based on market forces is extremely complex. This paper had four objectives. The first was to identify the constraints imposed by past investments. The investments in large-scale dairy facilities will create 'sharing' problems if family farm sized units are the result of privatization. These 'sharing' problems will make it very difficult for an individual farmer to manage their system. The investments in large-scale input suppliers and processing plants will give them monopoly power leaving individual farmers in a poor bargaining position.

The second objective was to examine the legacy of the previous organizational structure. The most obvious legacy is that no one is likely to have an appreciation of dairying as a system. This means there are no obvious can- didates to be privatized dairy farmers. Further, a great deal of re-education will probably be required if the barriers to communication along the production and marketing chain are to be removed. The combination of past investments and organization structure will make the transformation of Russian dairy production very difficult (objective 3). In modern market economies, markets are one of the major means by which information is passed along the chain. It will take considerable time for the sophisticated market institutions required for the effective functioning of a dairy system to evolve.

Finally, is the family farm model appropriate for Russia? The answer would appear to be 'not at this time'. Reform of the existing structure, while not without difficulties, appears more feasible as an interim measure. If a systems approach to management can be created, over time conditions may be created that are more conducive to the family farm structure. In part, this will depend on how the farm input and processing sectors evolve.

In the long run, privatization and functioning markets can lead to an efficient Russian dairy system. The challenge is to create the conditions that will foster competitive market institutions without leading to collapse in ability of the industry to supply milk. To accomplish this, conditions need to be created whereby new entrants into dairying, not just farmers, but also into the input industries and processing, are encouraged. To the extent that Agroprocombinate Lenin typifies existing AICs, considerable power will remain within the existing structure. In their own self-interest, AICs are likely to attempt to stifle competition.

Approaching the task of transforming the Russian dairy industry from the fundamental problem of how interdependent biological processes will be coordinated illustrates the necessity of approaching dairying as a system. As a result, the role played by markets (as well as managerial orders) in the vertical coordination of the dairy industries of modern market economies is highlighted. Taking into consideration the inherited physical infrastructure and the existing system for coordinating Russian dairy activities, the

268 A. O. McNeil, IV. A. Kerr

t ransformation of the Russian dairy system is likely to be much more complex than may have first been imagined.

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Vertical coordination in a post-command agricultural system—Can Russian dairy farms be transformed

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