Unraveling Local Sourcing Problems

Nation Continues to lose billions to raw material imports

In recent years, domestic sourcing, a procurement strategy adopted by companies to purchase their inputs, is gaining momentum due to the fact that localisation brings cost-savings across the supply chain, especially in light of climbing costs in traditionally low-cost regions. However, although many multinational and local companies are investing in the country, Ethiopia lags behind in this regard. Even though the lack of raw materials on the local market has forced companies to lean towards imports, the scarcity of foreign currency is putting extra pressure on their survival. EBR’s Ashenafi Endale investigates the difficulty faced by manufacturers due to low level of raw materials sourcing from domestic suppliers in Ethiopia.

Globally, where and from whom to purchase raw materials, is becoming one of driving factors influencing investors’ location decision. Especially in recent years a shift is being witnessed in the attitudes of multinationals towards various raw material sourcing strategies and their role in corporate policy. In particular, domestic sourcing, purchasing raw materials within the borders of the country where a company resides, is getting attention.

Since there is always a trade-off between distance and cost, multinational companies are moving far away from adopting global sourcing, which entails purchasing raw materials from the world market, as the main procurement strategy. Instead, they are choosing to invest in developing countries where the basic materials necessary for the manufacturing are available in large quantities.

Ethiopia is not an exception. Especially in the last two decades, many local and international investors have opened factories hoping to reap huge untapped resources vital to manufacturing, especially for textile, leather and metal products as well as processing agricultural items.

Yet, the experience of many local as well as international investors reveals that not everything as it seems. When Getachew Biratu bought the 40 year old Akaki Garment in 2005 from the government, he was sure he would turn it into a first class export company within a few years. He spent over ETB10 million in renovations and expansions, replacing old machinery with new. However, the factory has not been able to produce as expected, especially for the last few years, due to shortages of raw materials, especially cotton.

“There is no sustainable cotton supply in the local market or the hard currency to import it,” says Getachew, the general manager of Akaki Garment during a meeting the National Bank of Ethiopia (NBE) held with the private sector representatives two months ago. “We need a solution or it might be better to close down the industries.”

It is not only local investors that are feeling the heat. For instance, the renewed Ayka Addis Textile and Investment Group, which constructed a state-of-the-art manufacturing plant at a cost of USD240 million at Alemgena, 20 kilometers from Addis, has been registering losses for the last four years. On the other hand, Saygin Dima Textile, another Turkish based company temporarily ceased operations in 2016, after the company failed to honor its loan obligations.

This is a common apprehension echoed not only by companies engaged in textile and garment sub-sector. Rather it is observed in almost all manufacturing companies focused on labour-intensive industrial products that take advantage of the country’s relative abundance of labour and low wages.

Metal and metal products manufacturers are among those struggling due to an almost total absence of inputs in the local market. “Our installed capacity is over half a million tons of metal products but we never produced more than 50,000 tons per year at most, due to a lack of raw materials,” explains Sisay Tesfaye, general manager of Walia Metal Industry. “As a result, we are utilizing less than 10Pct of our capacity.” The factory produces hollow sections of different sizes as well as various metal products necessary for manufacturing industries.

In Ethiopia, metal products are produced from scrap and imported billet. Since the scrap available locally is not sufficient and there is no ore extraction and billet production, the sector is largely dependent on imports. The unmatched growth in demand for raw materials and local supply has pushed manufacturing companies like Walia Metal to produce below their capacity. In fact, metal products manufacturers have been producing 32Pct of their installed capacity over the past five years, according to a study conducted by Adama Science and Technology University (ASTU).

The problem also casts a shadow on the prospects of companies engaged in the automotive and electronics sub-sectors. “We are forced to import everything, because there are no local industries that produce components,” says Setwal Tarekegn, Technical and Sales Operation manager at Belayab Motors, which assembles some 700 automobiles per year on average.

The hospitality industry is not also immune from the problem. Currently, many star rated hotels in the Addis Ababa import fresh and processed food items, like Monarch Hotel. “In a country endowed with natural resources, we import foods stuffs,” says Gossa Ashenie, finance manager of the Hotel. “Even though we have an agreement with local suppliers, they are not able to satisfy our demand. “As a result, over 90Pct of our demand is satisfied by imports.”
Ethiopian Airlines, another big player in the hospitality industry, also imports close to 80Pct of the items needed for flight catering, because of a lack of quality and continuous local supply.

Indeed, the absence of local sourcing has an adverse effect on Ethiopia’s industrialization efforts. Even though the country has huge potential in agriculture, everything from wheat to industrial raw materials is imported. For manufacturing companies, being unable to source raw material locally means incurring huge costs in foreign currency, incapacitating them to meet the local demand let alone compete in the international market.

The experience of many investors who ceased operations reveals that there are few drivers for manufacturing companies that encourage localized sourcing, except for cheap labor. The country even imports cotton despite close to three million hectare of land being suitable for cotton production.

“Over 80Pct of the demand for inputs such as cotton is covered by imports,” says, Agazi Gebreyesus, secretary general of the Textile and Garment Manufacturers and Exporters Association. “The demand is fast increasing but it is not found in the local market, and it is difficult to import from abroad due to foreign currency shortage.”

The same goes for the livestock sector. Ethiopia has the tenth largest livestock inventory in the world. The total cattle population is estimated at 59.5 million, according to a livestock survey published by the Central Statistical Agency (CSA) in April 2017. In addition, 30.7 million sheep are estimated to be found in the country while the number of goats stood at 30.2 million. However, the available hide and skin can not satisfy the demand that comes from leather producers operating in the country.

According to information from the Leather Industry Development Institute, there are 32 large leather processors in the country with annual demand around 45 million pieces of hide and skin. The gross annual supply, however, is 21 million pieces.

Eshetayehu Tefera, director of Crops Value Chain at the Agricultural Transformation Agency (ATA), “There is much to be done in increasing agricultural productivity and creating a clean cut market system,” he argues. “Yet local sourcing can be successful if we can work hard in the near future.

Belachew Mekuria, commissioner of the Ethiopian Investment Commission (EIC), is aware of the gap in local sourcing, but says it varies from sector to sector. “Comparatively, it is better in the leather sub-sector, but some industries even import semi-finished leather, because of the poor quality of the raw material found locally.”

As a way out, Eshetayehu recommends incentivizing quality and surplus production, strong certification systems, creating linkages with industries and proper distribution mechanisms, at least in the short run. “The country even imports agricultural items because the market system does not allow bringing products from regions to the central market. In general, focusing on potential areas and effective market distribution is important to ease the current problem in local sourcing.”

But this is not an idea shared by all. “Ethiopia’s deficiency in local sourcing is simply due to the absence of resource mapping,” argues Birhanu Gizaw (Associate Professor), industrial engineer at Addis Ababa University. “If a supply is naturally in short supply in one area, the government usually concludes there is a shortfall all over the country. But it might be found in other part of the country.”

Birhanu says there are two industrial approaches to bridge this gap: bottom-up and top-bottom. “In a bottom-up approach, industries will only access raw materials from the local market if there is surplus. But a top-down approach allows farmers to produce not only for consumption but also considering the demand from industries. Ethiopia has not even tried the second approach in a real manner.”

Of course, countries who follow such strategies manage to attract real investors because domestic sourcing is gaining momentum among multinationals while global sourcing seems to be on the reverse gear. For instance, BMW established a plant in India three years ago after learning that there are plenty of automotive parts suppliers in India. Other German vehicle manufacturers such as Mercedes-Benz and Volkswagen, which erected factories in India, also source up to 80Pct of component parts, locally. Indonesia is the other country currently drawing vehicle manufacturers such as Honda, which procure 85Pct of its raw material, domestically.

Experts who conducted studies on the subject reveals the advantages of domestic sourcing are clear-cut for the investors as well as host countries. According to Indraneel Bardhan managing partner of EOS Intelligence, a professional services firm that delivers decision-enabling research and analysis with offices in India, Brazil and Slovenia, argues manufacturers local sourcing primarily helps manufacturers to reduce the vulnerabilities and logistics costs associated with lengthy supply chains. Especially when it comes to critical parts, Bardhan, who conducted a study about procurement strategies adopted by vehicle manufacturers in Asia, stresses that domestic sourcing minimizes the burden of carrying extra inventory to meet unaccounted demand.

For the host country, on the other hand, local sourcing boosts domestic businesses that supply to manufacturers, which in turn increases manufacturing and processing jobs in local the communities. This, however, is far from happening in Ethiopia.

Belachew does not hide the fact that there is a long road ahead to improve local sourcing. “Agriculture may be the low hanging fruit, but it has no horizontal and vertical linkages. It is a paradox that Ethiopia exports raw agricultural commodities like sesame and coffee, because there are no local industries to add value.”

However, stakeholders point the finger at the government. “The major problem in local sourcing is the absence of strategies supporting local sourcing and investment in potential areas,” argues Isayas Kebede, CEO of EthioAgri-CEFT, a member of MIDROC Group involved in the large scale farming of cereals, fruits, vegetables and tea.

EthioAgri-CEFT buys tea cultivated by 325 small scale farmers located around its Wush Wush and Gumaro tea plantations, cultivated on 1,250 hectares. But because of a lack of clear policy and legal frameworks, the company finds itself in conflict with small scale farmers constantly, according to Isayas.

A few companies such as Heineken Ethiopia have succeeded in local sourcing projects. In 2013, Heineken Ethiopia initiated a public private partnership by subsidizing farmers to produce malt barley, and then supply it to the company. “We supply farmers with two types of improved seed under a revolving loan fund and technical supports from our own agricultural experts,” explains Fekadu Beshah, External Relations and Sustainability manager at Heineken Ethiopia, the largest brewer in Ethiopia.

Not only that, an ETB21 million revolving fund is given to farmers, who repay their loan after the harvesting season. “In doing so, we increased our local sourcing to 28Pct,” he says. “However, we are not getting the required raw material from the local market.”

6th Year • Aug.16 – Sep. 15 2018 • No. 65