Innovative Development Model for Rural Prosperity in Shanxi, July 2009

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Information about Innovative Development Model for Rural Prosperity in Shanxi, July 2009
Business & Mgmt

Published on January 27, 2014

Author: tomorrowmatters

Source: slideshare.net

Description

Participants of GIFT’s second open programme in 2009 spent eight days working on site with the Pohan Farmer’s Association (PFA) in order to develop a plan for the association to convert from conventional to organic cotton production and access new markets for their products. Cotton is among the dirtiest crops, using about 25 per cent of the world’s insecticides and 10 per cent of the world’s pesticides. Organic cotton production has the advantage of promoting soil fertility, and also allows for diverse agriculture while keeping human contact with toxic chemicals to a minimum. The briefing note also discusses the challenges facing rural farmers in China, such as environmental deterioration and inefficiencies of small scale farming.

Global Young Leaders Programme Shanxi Project 2009 Innovative Development Model for Rural Prosperity

Table of Contents I. Executive summary II. Background III. Business opportunity IV. Value proposition V. Marketing plan VI. Management VII. Financial analysis VIII. Economic, social and environmental benefits IX. Risk assessment and mitigation X. Implementation plan

I. Executive Summary • Shanxi province has high levels of rural poverty where agricultural growth is limited by small scale farming structures and rural-urban migration. • However, farming associations in the province are keen to embrace new ideas especially for sustainable organic farming to uplift communities. • The Pohan Farmers Association is the first registered farmers’ association in China comprising 3,800 farmer members and is a successful model of rural entrepreneurship and leadership. • There is an opportunity for organic cotton due to growing global demand (US$3.2 billion market in 2008), growing green awareness and improvements to community livelihoods through sustainable farming.

Executive Summary (cont’d) • The value proposition is to set up a JV company leveraging the association’s strategic advantages by moving up the supply chain to process seed cotton into lint cotton and commanding premium prices for branded cotton products. The association will have dedicated land resources certified to international organic standards to supply the JV. Proposed JV Buyers Farming Seed • • • Ginning Trading Lint • • • Spinning factory Retailer Domestic/foreign buyers etc. Yarn/Fabric The JV, which has strong support from the Provincial Government, will brand the cotton to make it attractive to high end buyers, provide stable market access for the villagers and will transfer management know-how to the local community. A strong branding and marketing strategy will be implemented by keeping the spending low in early years to manage operating costs and ramping up marketing investments from year four onwards. The recommended structure is a contractual joint venture with limited liability of each party to the cooperative agreement between the farmers association and the investor. Under CJV agreement terms, the profit is negotiable i.e. parties can receive different distribution ratios in different years. The management structure can be self determined rather than by governing PRC laws.

Executive Summary (cont’d) • Financial summary: – – – – Total investment cost of ¥2.32 million Short payback period of 5 years Project IRR (10 years) of 30% Strong and consistent cash flows of ¥3.4 million from year 5 onwards (after the organic conversion period) – Excellent growth potential in the Extended Yellow River Region • Benefits to community – By converting to organic cotton farming, the farmers will benefit from organic price premium and increase their income level up to 40%. – With organic cotton farming, use of harmful chemical fertilizers, pesticides and genetically modified cotton seeds will be eliminated. – The JV will create more than 30 job opportunities within the JV and related business and retain young talents in the community. – While the government provides subsidies, with increased funding to the Community Development Fund, there is scope to provide healthcare over and above primary healthcare services.

Executive Summary (cont’d) Initiative Marketing channels Yr 0 Mth 1-3 Set up online presence (join B2B portal, own basic website) Yr 0 Yr 0 Mth 4-6 Mth 7-9 Advertise on China Textile Accessories Magazine Certification Phase 1 land: apply for cert SPOCTE Operations Set up T.E. office, hire GM, HR & Finance heads Ginning Factory Design factory Training Finance Yr 0 Yr 1 Mth 10-12 Yr 2 Yr 3 Yr 4 Yr 5 Build Start joining interactive trade fairs website Phase 1 land: obtain cert Phase 1 land: conversion period Hire other key positions Develop training plan & road map Approach Negotiate & potential conclude JV investors Yr 6 onward Construct factory & Start purchase machines ginning 1st round of team training 1st capital 2nd capital injection: injection: RMB1.2m RMB1.12m Obtain organic cert Implementation Timeframe 6 Phase 2 land: apply for cert

II. Background China Shanxi Province The Cotton Industry Pohan Farmers Association

China – Land of Hope and Despair China is a rapidly developing economy Rural areas are not realising the benefits of development

BACKGROUND: CHINA Rapid economic growth and huge capacity • 9% annual growth rate in 2008 • 4.4 trillion USD in 2008, No.3 in the world Low per capita GDP • USD 3,381 per capita, No. 104 in the world Huge GAP in per capita income between urban and rural area • Urban area: RMB 15,481 • Rural area: RMB 4,761 Rural community NOT benefiting enough from China’s robust and rapid economic growth 9

BACKGROUND: SHANXI PROVINCE Demographics: • • Population: 34 million 34 minority groups; 0.32% of population Economics: • • 2.12% of China’s annual GDP • No.18 out of 34 provinces Per capita GDP • • RMB 20,398 (USD 2,985); RMB 2,242 lower than national average Annual household income • • Urban: RMB13,119 Rural: RMB4,097; RMB664 lower than national average

Challenges and Opportunities in Shanxi Challenges Opportunities • High levels of rural poverty • Small scale farming structures limit agricultural growth • Rural-urban migration • Environmental deterioration. • • • Converting to organic farming can make a significant impact on the environment. Growing global demand for organic products Farming associations are already established in the region and are keen to embrace new ideas for sustainable organic farming. Shanxi Province can benefit widely from improvements in farming techniques.

Cotton Industry Worldwide: World Lint Cotton Production Distribution in 2008 • • • 31 million ha (465 million mu) or 2.4 % of global arable land used for cotton production. 50 million farmers employed in over 100 countries Production of cotton in 2008 = 23.3 million metric tons. U.S.A ; 3.2 Others; 5.1 12% Uzbekistan; 1.1 20% China; 7.8 4% 30% 5% Brazil; 1.4 8% 20% Pakistan; 2 1mu = 0.06 ha India; 5.1 Million Tons

Cotton Industry China: • • The biggest cotton producer and consumer Producing 7.8 million metric tons and consuming 9.9 million metric tons in 2008. • About 14 million Chinese farmers directly involved in cotton production in regions as above. Organic cotton is the way forward

Organic Cotton Farming Organic agriculture combines tradition, innovation and science to benefit the shared environment and promote fair relationships and a good quality of life for all involved. —International Federation of Organic Agriculture Movements[4] • • • • Land Management No Pesticides No Herbicides No Genetically Modified Seeds • Natural Fertilisers • Fair Treatment of workers • Water management Organic cotton farming uses the earth’s natural resources for sustainability

Organic Cotton Benefits • Elimination of toxic chemicals • Water savings • Elimination of genetically modified seeds • Long term soil fertility • Organic certification requires fair working conditions for all worker along

Pohan Farmers’ Association (PFA) • 1st registered farmers’ association in China in 2004 • Membership: approx. 3,800 farmers (Average income: 2,400RMB/mu/yr) • Established in 1998 by Ms. Zheng Bin (Nominated for the 1000 Global Women Nobel Peace Prize 2005, Top 10 rural entrepreneurs in China in 2008) • Ms. Zheng: Visionary Leader Current Status - Well organized farmers’ association with a mission to uplift rural livelihoods today and providing 28 full-time jobs

PFA Key Projects Application of Farming technique, Hands-on experiences Youth Organic Farming Group Basic education, vocational skills, transfer of farming know-how Transfer of Experience & Track Record Farmers’ school Organic Farming & Trading Association Growing & Selling of Cotton Women’s Handicraft cooperative Fertilizers based on Chinese tradition medicine Rural retail chains Fertilizers based on Chinese traditional medicine Green Family Group Vision and Inspiration: Harmonious Society

PFA’s Vision Strategic Goals: • Promote entrepreneurship and organic farming • Strengthen bargaining power • Improve quality of life • Enhance community welfare • Promote sustainable • development Implementation: • Selling products • Provide information • Adult education • Engaging youth Promoting Sustainable Development and better MARKET ACCESS

Business Opportunity Organic Cotton Opportunity International Certification

Organic Cotton Opportunity Global Organic Cotton Supply/Demand Mismatch Strong & Increasing Global Demand IRR of 30% within 10 years 30% Price Premium over conventional cotton Growing Awareness of Green Movement Great Social Impact & Improve Community Livelihoods Source: Organic Exchange Supply 45% Demand 55%

Global Organic Cotton Production Global Production 2007 26% Domestic Production 2007 18% 14% 42% Others 5% Xinjiang 95% India Turkey China Others China ranked 3rd producer globally amongst 24 countries in 2008 with Xinjiang dominating China’s production market Source: Organic Exchange, ‘Textile Information Weekly’

Organic Cotton in the World Growing Demand & Internationally-Driven Global Retail Sales of Organic Cotton Products 3.5 3 2.5 2 Sales Value ($billion) 1.5 1 0.5 0 2005 2006 2007 2008 Growing demand from retail drives the global production A 25 – 55% annual growth rate of organic cotton products in next 5 years forecasted by Organic Trade Association. Source : Organic Exchange & International Federation of Organic Agriculture Movements

Organic Cotton in the World Growing Demand & Internationally-Driven Major Consumer Countries (2006) Metric Tons 1) United States 9,500 2) Switzerland 2,500 3) Germany 1,500 4) United Kingdom 750 5) France 650 6) Sweden 350 7) Japan 350 8) Italy 250 9) Netherlands 100 23

Organic Cotton in the World Growing Demand & Internationally-Driven Brand Demand for Organic Cotton is on the rise 2008 Green Initiatives of two of the global largest users: 173,272MT 92,998MT 74,839MT 2007 33% 2008 2009 25% Source: Organic Exchange, Nike & Wal-Mart Company Website Purchased more than 12.7 thousand tons of organic cotton and an additional 5.5 tons of transitional cotton from 1000 farmers at certified organic prices. For every cottoncontaining apparel product to contain at least 5 percent organic cotton by 2011.

Organic Cotton: Opportunities & Challenges Opportunities • • • • • Challenges • Growing global demand for organic cotton (2008: US$3.2 billion vs. 2007: US$1.9 billion) Increasing demand for organic cotton from brand-name buyers Growing awareness of the green movement Environmentally friendly: eliminating the misuse of pesticide and fertilizer Improve community livelihoods with sustainable farming system • • • 25 Sales may be susceptible to economic cycle Currently in the start-up phase and testing land-conversion High certification-associated fees and lengthy implementation process Less credibility in the domestic certification process -> gives rise to many potential entrants in the organic market

Why International Organic Certification is Required 1) Certified products command organic cotton premium 2) Most end-buyers require international certification 3) Certification from China is typically not recognized in the international market 4) Largest organic cotton end-consumers are US, EU & Japan Main Market Standards: 1) US NOP, 2) EU 2091/2, 3) Japan JAS • Certain brand-name retailers may have other sets of requirements International Certification • Standards need to be applied across the value-chain down to the farm & ginning factory • Need to engage a accredited certification company for the application process • Certifies both the land & specified product • Annual inspection & renewal 26

Organic Certification Process Engage Certification company Pre-Conversion Cost: 25,000 RMB /year Engage certification company which are accredited by the standards bodies Certification company execute first inspection: 1.Farming standard 2.Requirement 1.Application form 2.Documentation etc. Timeframe: 6 months Conversion Period 85,000RMB /year Yearly Renewal 85,000RMB /year Certification company inspect conversion process Required Conversion Period US: 3 years EU: 2 years JPN: 2 years 2 months to complete certification process 2.5-3.5 years Certification Process Requires 4 Years Validity Period: 1 year Inspection required every year

Value Proposition Value Proposition JV Vision Business Model Rationale Competitive Advantage

Value Proposition • • • • The value proposition is to set up a JV company leveraging OFTA’s strategic advantages and moving up the supply chain to process seed cotton into lint cotton. The JV company will focus on organic cotton with a dedicated ginning factory for organic lint cotton production. Through its trading arm, the JV will command premium prices for its branded organic lint cotton. The OFTA will have dedicated land resources certified to international organic standards to supply organic seed cotton to the JV Proposed JV Buyers Farming Seed Ginning Trading Lint • Spinning factory • Retailer • Domestic/foreign buyers etc. Yarn/Fabric By trading directly with the JV, farmers will avoid being exploited by the middlemen and obtain fair prices for their products.

JV Vision 1. China’s Leading Organic Lint Cotton Producer – Provide branded organic lint cotton, which will be certified to international standards and sold at a competitive price to high end buyers 2. Future Growth – To achieve annual compounded sales growth of 30% over 10 years 3. Opportunities for the Community – To provide economic opportunities for the community through employment of young farmers as well as nurturing local talent, management capabilities and leadership skills 4. Sustainable development – To promote sustainable development in Shanxi Province and the rest of China through the elimination of chemical fertilizers, pesticides, herbicides and genetically modified cotton seeds as well as reduced water usage.

The Business Model OFTA Investors Jointly Owned JV Other Organic Cotton Growers Purchases seed cotton Consists of • Ginning Factory • Sales and Marketing Sales of Excess Seed Cotton Other Ginning Factories Sales of Organic Lint Cotton • Spinning Factories • Domestic Buyers for international Market Sales of Cotton Seed Buyers

Relationship Between OFTA and the JV OFTA • Facilitates organic conversion of land • Provides technical support to farmers on organic farming • Part ownership of JV JV • Ownership of ginning factory • Buys organic seed cotton from farmers through OFTA • Converts seed cotton into lint cotton • Branding of organic lint cotton (西 厢 棉) • Markets and sells lint cotton to high-end buyers • Sells by-product cotton seeds • Profits distributed to OFTA

Rationale • The JV will brand the organic lint cotton to make it attractive to high end buyers such as buyers for brand retailers (e.g. Muji, Walmart, C&A, Nike, Hugo Boss etc.) and as such obtain a 30% higher premium • The JV will also provide stable market access for the villagers, which will encourage them to make long term planning and be more responsive to market changes. • The JV has strong support from the Commerce Administration Department of the Provincial Government who wish to stimulate development of rural enterprises. • Working with an investor partner, OFTA will benefit from financial support and management know-how (which will be eventually transferred to the local community). Model is consistent with worldwide organic fair trade best practice

Competitive Advantage of JV • International Certification in Organic Cotton Production – aimed to achieve in 4 years time to command a higher price • • • Geographical advantages – Suitable weather in growing organic cotton – Possesses land reserve which can expand to larger scale production to meet demand from larger buyers – Possesses transportation, utilities and production infrastructures (one of the 5 conventional cotton production bases in China.) Integrated process controlled by PFA – includes a ginning factory to provide more value-added products and eliminate middlemen Early Mover – strategically positioned for early market entry with strong presence and brand recognition among handful of established producers Local but Global 34

Organic Cotton – Goods of the Future 35

Marketing Plan Objectives/Strategies Branding Logo Product Channels Pricing Strategy

Marketing Objective Become the Most Respected, Ethically & Socially Responsible Organic Cotton Producer in China 37

Branding Objectives Objectives of branding the trading the entity Branding Signifies • • • • • Delivers a clear message Confirms credibility Connects with target customers Motivates the buyer Concretes User Loyalty •Name of the JV Company Shanxi Pohan Organic Cotton Trading Enterprise (SPOCTE) signifying the province, name of the farmers association, product and business. A Social Enterprise for the Pohan Farmers Association

Branding Strategy and Positioning Branding Strategy Economy Penetration Skimming Brand Positioning Logo Brand name Brand identity Premium Brand Positioning: - Premium Organic Cotton • Creating a distinctive Brand Image • Differentiate product • Top Organic cotton product in China • Green and environment friendly Product (Organic cotton) • Top Organic cotton product in China • Key Themes – going green, Organic and local significance • XiXiang Mian(西厢棉) • Xixiang Ji (西厢记)is one of the most well known classic love stories in China, which 39 happened in Yongji City (Location of SPOCTE) • The brand identity indicates green farming, healthy and environmental friendly product and local significance

Recommended Brand logos for SPOCTE 西 厢 棉 Chinese No.1 organic cotton 西 厢 棉 Chinese No.1 organic cotton Chinese No.1 organic cotton 西厢棉 西 厢 棉 Chinese No.1 organic cotton

Marketing Campaign Plan will align with Production Ramp-Up Year 1 • • • • Year 2 • Advertising in the textile magazine with two insertions per year. Year 3 Creating a static content website for SPOCTE Advertising in the textile magazine with two insertions per year. Listing SPOCTE on B2B website’s (e.g. Alibaba) Register SPOCTE with the nearest cotton exchange • Advertising in the textile magazine with two insertions per year. Year 4 • Advertising in the textile magazine with two insertions per year. • Upgrade website to an interactive with e-marketing website • Participate in trade fairs Year 5 Onwards • Advertising in the textile magazine with four insertions per year • Advertising in Textile Newspaper • Participate in trade fairs

Marketing Campaign Plan will align with Production Ramp-Up Available Land for Cotton Production 30,000 25,000 mu 20,000 Scenario 1 15,000 Scenario 2 10,000 TOTAL mu 5,000 Year Year Year Year Year Year Year Year Year Year Year 0 1 2 3 4 5 6 7 8 9 10 Scenario 1: Utilizing the 80,000 mu available in Pohan Scenario 2: Utilizing 300,000 mu available in Yellow River Region 1mu = 0.06 ha

Breakup of Marketing Spends Assumption: inflation rate is 7% YOY Marketing spends and intensity ramps up with increase in production.

Marketing Strategy Media Plan Advertising in textile magazine: Niche targeted magazine to ensure higher reach in the most cost effective way. Advertising in Textile Newspaper: Niche and cost effective. Online plan •Creating the static content website in year 1; Upgrade to an interactive emarketing website in year four •List SPOCTE on B2B website's (e.g. Alibaba) to get access to the online fraternity On ground plan •Register SPOCTE with the nearest cotton exchange. •SPOCTE takes part in trade fair’s since that will provide direct access to interested buyers. Strategy: keep the spends low in early years to manage operating costs and ramp up marketing investments from year four onwards.

Products and channels Product Range: - Cotton Seed, Raw cotton and Lint cotton Sales process Sales channels Shanxi Pohan Organic Cotton Trading Enterprise Local farmers/factories (ginning / spinning etc ) provide Farming (raw cotton) “Raw cotton” Raw Cotton Trading Section (marketing /sales) provide “Raw cotton” Ginning (Lint cotton) provide “Cotton seeds" and “Lint cotton” Direct Sales to Domestic buyers Cotton Seeds Lint Cotton Advertising on Online BtoB market place (e.g. alibaba) Web-site (links to sales team from Trading company)

Pricing Strategy Quality Objective Short to medium term (3 – 5 years) - To launch the product successfully - To gain and expand market shares in target markets Long term (5+ years) - Premium product image - Top Organic cotton producer in China P r i c e Low High Economy Penetration Skimming L o w Premium h i g h Rationale - Demand exceeds Supply - Xinjiang is the only dominant producer in domestic market - Pro-organic cotton and domestic sourcing policy of Chinese government

Pricing Strategy (cont’d) Market Entry Pricing • Conversion Stage I1 Price = avg. market price4 X 80% (20% discount) Marketing Penetration Pricing • Conversion Stage II2 Price = avg. market price4 X 90% (10% discount) Steady Stage Pricing • Certified Organic3 Notes: 1- Year 1&2 2- Year 3&4 3- Year 5 & onward 4- Prevailing Organic Cotton Market Price Price = Xinjiang product price X 95%

Management & Governance Objective Structure Governance Training and Development

OBJECTIVE •Assist SPOCTE’s sustainable organic cotton production through: – Structure – clear organizational chain of command – Leadership – commitment towards accountability, efficient operations & profitability – Transparency – open and regular communication with various stakeholders on key compliance and financial indicators http://www.wilsenachvanwyk.co.za/images/Management%20Team.jpg

Corporate Structure of SPOCTE • Creating most favourable partnership between PFA and Investor to ensure SPOCTE as most reliable ethically & socially responsible organic cotton producer in China while sustaining profitable growth. Recommended structure Contractual Joint Venture (CJV) as Limited Liability Company – – – – – – Limits liability of each party to the cooperative agreement Established through cooperative agreement between PFA and Investor Governed under CJV Agreement terms as negotiated between PFA & Investor rather than governing PRC laws. * Profit negotiable; parties can receive different distribution ratios in different years as agreed by PFA and Investor under CJV Agreement Investor may receive profit prior to CJV corporate income tax & prior to CJV distribution of profits Management Organization Structure can be self determined under CJV Agreement terms rather than governing PRC laws. N.B. See appendix for Cost & Procedure diagram of incorporating CJV * Investor receives higher % profit for stated period of time for purposes such as recovering invested capital.

Organization Structure of SPOCTE Board of Directors General Manager (1) Company Audit (1) Sales & Marketing (2) Production & Supply Chain (2) Financial Controller and Deputy Controller (2) Factory Workers (Part-time) (15) Technician (1) Quality Assurance (1) ( ) denotes headcount HR, PR & Community (2)

Leadership Roles & Responsibilities General Manager Oversees all of the company's sales & marketing as well as the daily operation of the company, and reports to the Board of Director. Sales & Marketing Promoting the product to the market to develop business opportunities for the company and ensure the implementation of the annual sales target. Production To source the raw material for the factory and be responsible for all the & Supply production processes in the factory. Chain Financial Responsible for the accounting issues, prepare monthly financial report and prepare budgeting proposal to the General Manager as well as the Board. HR, PR & Responsible for the management, training and development of the organization, Community and liaising with relevant parties, such as government & certification companies. Company Audit Responsible for management, training & development of CJV, liaise with relevant parties such as governmental department, certified agents. Ensure governance of CJV in meeting Financial, CSR and Organic Production commitments, reporting directly to Board of Directors.

Members in Board of Directors • It is advised that the Board of Directors contain executive & nonexecutive members as follows: EXECUTIVE PFA Representative General Manager Investor Representative NON-EXECUTIVE Local Government Representative Independent Director (Accounting background) Related NGO Representative (e.g. FuPing) Independent Director (Agricultural background)

Governance Challenge Several predictable challenges: • • • • • To recruit competent audit talent, who possess the knowledge and skills for finance, CSR and Organic cotton farming and ginning in local; Governance should be strengthened because some the farmers with small plots can potentially damage the credibility of the organic cotton due to some of their practices; To raise the awareness on health, safety, and labor issues in the Ginning factory and seek compliance with the overall mission to be ethically and socially responsible; Meet the international and domestic standard on Health, Safety & Environment Meet the international and domestic standard on labor 54

Governance - CSR check list Environmental, Health & Safety • Is the noise level monitored in the workshop? • Is the management aware of noise hazard? • Is the management aware of hazards of dust? • Are the workers provided with necessary personal protective equipments(个人保护用品)n the factory • Are there regular safety and health trainings for the factory workers Labor • What is the local minimum hiring age? • What system is in the factory to prevent child labor hiring? • What is the local minimum wage? • What is the lowest basic salary in the factory? • How does the factory pay Saturday and Sunday work?

Training & Development Aim • To refresh and upgrade employees’ and farmers’ knowledge and skills, so as to achieve SPOCTE’s production and sales goals Focus Areas • • • • • Organic agricultural standards and methods Health and safety standards and methods Business-related concepts and skills e.g. marketing, law Leadership and team building IT and technical skills Modes • • Classroom workshops (leveraging on farmer school) On-site field training Resources • • • • SPOCTE HR staff Farmer school teachers OFTA leaders & experts e.g. technical support team, YOTG members External experts e.g. agriculture university academics, certification company experts

Training & Development – Improve farming techniques Invite external agriculture experts to improve current farming school’s quality of training. – Expand knowledge Invest resources into current farming school and educate teachers to expand and modernize training

Training & Development Company vision • Company culture • Safety awareness • Employee attitude and behavior • Company policy • Organic agriculture and environment Knowledge • Reading • Basic English for young leaders • Communication • Team building • Time management • Effective Supply Chain management • To be a modern farmer Skill • How to learn by computer • How to do business-sell products • Basic international trading knowledge • Negotiation skill Technical • Organic cotton planting • Organic cotton quality control • Environment (soil, water) for organic Cotton • Ginning techniques • Quality control on ginning

Financial Analysis Investment Requirements Key Assumptions Financial Projections Summary

Investment Requirements • Benefits of SPOCTE funding: – Higher price premium with more value-added products – Increased income by dealing directly with buyers – Both OFTA and SPOCTE will benefit by fair returns • An upfront ¥2.32 million capital injection to cover the investment costs, which will be incurred in first 12 months comprising: – ¥ 2.2 million initial investment for the ginning factory, including: machinery and installation, land, workshop, office, and initial working capital – ¥0.12 million investment for the sales and marketing department to set up the company’s website 60

Key Financial Assumptions • • • • • • • The financial model is based on equity funding for ginning factory with capacity of 6 tons/day of lint cotton for 10 years. The conversion ratio of raw cotton (raw material) to lint cotton is 3:1. 2 sources of revenues are available: lint cotton and cotton seeds. Straight line method is applied for depreciation. 4-year conversion period for organic certification will be observed. The organic cotton enjoys a premium of 30% after conversion period. Relevant expenses contain certification, maintenance, marketing, salaries, operation and set up cost. Ginning Factory Assumption Yield –steady 200kg/mu Planted area-steady 15867mu Raw cotton Variable operating cost ¥5/kg ¥0.3/kg lint cotton Fixed operating cost ¥100,000/year Maintenance cost ¥30,000/year Pre-operating cost ¥200,000 Training cost ¥30,000/year Cotton seed ¥2/kg Organic lint cotton Certification fee 61 ¥19.5/kg ¥85,000/year

Key Financial Assumptions • The organic conversion process will be carried out in 2 phases:  Phase 1 – Utilizing the 80,000Mu available in the Pohan area  Phase 2 – Utilizing the 300,000Mu available in the Extended Yellow River Region Land converted to Organic Cotton Production (Mu) 30,000 25,000 mu 20,000 Phase 1 15,000 Phase 2 TOTAL mu 10,000 5,000 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 1mu = 0.06 ha 62 Year 6 Year 7 Year 8 Year 9 Year 10

Financial Projections (Net Income) Net Income Projections - Phase 1: Current Pohan area ¥ million 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 1 2 3 4 5 6 7 8 9 10 -1.0 Year Steady net income of ¥3.2 million from year 5 onwards (after the organic conversion period) 63

Financial Projections (Net Income) Phase 1 Net Income Projections - Phase 1 + Phase 2 (Extended Yellow River Region) Phase 1 + Phase 2 12.0 10.0 ¥ million 8.0 6.0 4.0 2.0 0.0 1 2 3 4 5 6 7 8 9 10 -2.0 Year Strong growth potential from the Extended Yellow River Region 64

Financial Projections (Cash Flows) ¥ million Free Cash Flow Projections - Phase 1: Current Pohan area 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 0 1 2 3 4 5 6 7 8 9 10 Year  Strong positive cash flow of ¥3.4 million from year 5 onwards  Short payback period of 5 years 65

Financial Projections (Cash Flows) Free Cash Flow Projections - Phase 1 + Phase 2 (Extended Yellow River Region) Phase 1 Phase 1 + Phase 2 12.0 10.0 ¥ million 8.0 6.0 4.0 2.0 0.0 0 1 2 3 4 5 6 7 8 9 10 -2.0 Year Excellent growth potential from the Extended Yellow River Region 66

Summary of Key Financials • Total investment cost of ¥2.32 million • Short payback period of 5 years • Project IRR (10 years) of 30% • Strong and consistent cash flows of ¥3.4 million from year 5 onwards (after the organic conversion period) • Excellent growth potential in the Extended Yellow River Region 67

Economic, Social and Environmental Benefits Impacts Benefits Empowerment

Sustainability of Community Benefits Sustainable environment is fundamental for future economic growth Establish JV Invest in Organic Farming Environment Knowledge leads to higher awareness of action impacting the environment Economic Social Provide continuous education through Farmers’ School Increased Income leads to better livelihood through social development

Economic benefits to community • Setting up JV – Create jobs within the community – Provide a platform for farmers to increase their bargaining power for organic cotton trading – Buffer income shocks from crop variability and volatile commodity prices – Provide opportunity to take ownership in the company – Encourage agricultural entrepreneurship By converting to organic cotton farming, the farmers will benefit from organic price premium and increase their income level up to 40%.

Economic benefits to community 40% of PFA’s share of overall JV’s profits will be directly distributed to farmers in form of bonuses.

Environmental impacts Conventional cotton farming has following impacts: • High usage of chemical fertilizers and pesticides leaking into surrounding ecosystems • Accounts for 22.5 - 25% of insecticide and 8-10% of pesticide usage worldwide Every year 20,000 deaths result from pesticide usage worldwide, many of which are due to cotton farming. Source: World Health Organization (WHO)

Environmental impacts Conventional cotton farming has following impacts: • • • Every year 2.6 % of the world’s water is used in cotton production (20,000 liters of water is used for the production of a T- shirt and a pair of jeans) 73% of global cotton harvest comes from irrigated land As cotton farming requires abundant water reserves, low humidity and long daylight, the existing farm sites often face constraints in expansion due to lack of water reserves. Water management is key component of successful organic cotton farming

Environmental benefits Two key benefits of converting to organic cotton are: 1. Soil Fertility – With organic cotton farming, use of chemical fertilizers, pesticides and genetically modified cotton seeds will be eliminated. – Traditional methods will be used as a substitute (Chinese medicine and use of manure). 2. Water conservation – In the long term, we will introduce Drip Irrigation Systems which will save about 50% of the water currently being used.

Social impact and benefits Rural Urban Migration for Shanxi Province between 2000 - 2005 In Shanxi Out Net 255,000 827,000 -572,000 -1.5%  Currently there are limited opportunities in rural China  572,000 people left Shanxi province between 2000- 2005 in search of a better life and higher income Our plan will create more than 30 job opportunities within the JV and related business and retain young talents in the community. Source: White Paper: Internal Labor Migration in China (University of Washington, Seattle)

Social impact and benefits Education Healthcare Social Wellbeing Harmonious Society 30% of the Profits of the JV will be allocated for Community Development

Empowerment through education • Additional Funding will directly benefit the expansion of the Farmers School and the Community: i) Farmers • Empower farmers through continuous technical education (organic farming methods including soil fertility management, technical training on ginning practices) ii) Women • Empower women through continuous adult education and increase of self-esteem • Additional income for women through more job opportunities iii) Youth • Empower rural youth with no tertiary education through education especially in IT and management skills. • In the long term the School could be expanded to provide specialized education in organic farming beyond the Shanxi Province . Education is key to sustainable development

Healthcare benefits – By lessening the exposure to chemical fertilizer and pesticides, we can improve the health conditions of farmers. – While the government and PFA provide subsidies, with increased funding to the Community Development Fund, there is scope to provide healthcare over and above primary healthcare. 78

Risk Assessment Risk Priority Mapping Mitigation Measures

Risk Priority Mapping • Not enough organic-related skills • Pollution of water, air, soil • Increased foreign competition (including lower tariffs) • Drop in available financing High Likelihood • Not enough raw materials e.g. non-GM seeds, organic fertilizers • Bad weather e.g. floods • Export restrictions • Customers unconvinced of organic benefits • Counter-party risks e.g. buyer non-payment • Increased local competition Low • • • • • • Currency risks • Dissatisfaction from farmers due to unrealized benefits Not enough fertile land Not enough labor Setting up of heavy industry nearby Speculative dive in organic cotton prices Lower government support Low Impact 80 High

Mitigation Measures Risk dimension Mitigation Measures High Impact, High Likelihood • Not enough organic-related skills • Regular training, monitoring and inspection • Pollution of water, air, soil • Frequent analysis of water, air, soil • Increased foreign competition (including lower tariffs) • Build local industry network, ensure consistent high quality and even production, lock-in buyers • Drop in available financing • Secure strong investor with long-term, social view 81

Mitigation Measures Risk dimension Mitigation Measures High Impact, Medium Likelihood • Not enough suitable raw materials e.g. non-GM seeds, organic fertilizers • SPOCTE to source for alternative suppliers, conduct careful testing before usage • Seek government support (materials sourced locally will be assured full supply by provincial government & incorporated into province plans) (Provisions for the Encouragement of Foreign Investment in Shanxi) • Bad weather e.g. floods • Monitor climate and geographical developments • Export restrictions • Build local industry network, join lobby group if necessary • Customers unconvinced of organic benefits • Build brand in China, build local industry network and support industry promotion efforts • Counter-party risks e.g. buyer non-payment • Use trading facilities e.g. Letter of Credit 82

Implementation Timeframe

Implementation Timeframe Initiative Marketing channels Yr 0 Mth 1-3 Set up online presence (join B2B portal, own basic website) Yr 0 Yr 0 Mth 4-6 Mth 7-9 Advertise on China Textile Accessories Magazine Certification Phase 1 land: apply for cert SPOCTE Operations Set up T.E. office, hire GM, HR & Finance heads Ginning Factory Design factory Training Finance Yr 0 Yr 1 Mth 10-12 Yr 2 Yr 3 Yr 4 Yr 5 Build Start joining interactive trade fairs website Phase 1 land: obtain cert Phase 1 land: conversion period Hire other key positions Develop training plan & road map Approach Negotiate & potential conclude JV investors Yr 6 onward Construct factory & Start purchase machines ginning 1st round of team training 1st capital 2nd capital injection: injection: RMB1.2m RMB1.12m Obtain organic cert 84 Phase 2 land: apply for cert

APPENDICES 85

Appendix A. List of Organic Cotton Suppliers

87

88

89

90

91

Appendix B. Preliminary Costs for incorporating JV

Set Up of Cooperative Joint Venture Joint Venture Cooperation (JV) in China PFA / Domestic-investor Foreign-investor (FI) Obtain Letter of Opinions 1. Acquire Permission reports from county level or industry authorized dept. 2. Apply foreign-funded enterprise license 3. Obtain feasibility research report 4. Establish foreign enterprise constitution 5. Report the legal person or director candidates 6. Obtain FI legal dox and QC dox 7. Get approvals from local gov’t and related depts. Apply Project Application Confirmation Report Perform JV Name Check Obtain the Contracts & Articles of Association Handle registration procedures and receive business license Open Bank Account Apply Customs Registration Apply Taxation Registration Apply Foreign Exchange Registration

Preliminary Costs for incorporating JV Procedures Fee(RMB) Company name approval 80 Company approval 20 Trademark Registration 1000 *Company registration fee (base on USD$200,000 capital) 1333 Business IC card 280 Company Seal 500 Organization Code license 228 RMB currency a/c IC card 250 Foreign currency a/c IC card 250 Tax registration 100 Custom registration 175 Check capital (base on USD$200,000 capital) 3000 Statistical license 20 Finance license 20 Total: Approx. RMB 6,600 * < RMB 10 million, 1‰ of registered capital > RMB 10 million, portion over 10mil charged at 0.5‰. Portion > RMB 100 million not charged. N.B. Figures may fluctuate slightly in accordance with local & central government laws

Appendix C. List of Participants

List of Participants • Mr. Robert Zhou (Nike Inc.) • Ms. Marike • Mr. Hideki Oka (Infotree) • Ms. Sandy Hsu (HKUST) • Ms. Melinda Mears (Meinhardt) • • Mr. Liu Chi On (Meinhardt) Ms. Janelle Zai (Chinese University of Hong Kong) • Mr. Phillip Xiao (Lever Style) • Ms. Jie Zheng (Tsinghua University) • Ms. Feng • • Ms. Sherin Goh (IMC) Ms. Sherry Ma (Tsinghua University) • Mr. Sin-Hong Leong (IMC) • • Mr. Takashi Kumon (JETRO) Mr. Jeffrey Song (Tsinghua University) • Mr. Rohit Suri (Turner) • Ms. Hui -Yi University) • Mr. Zero Sham (Awake Limited) • Ms. Reimi Imaizumi (CLSA) Li (Lever Style) Jensen (HKUST) Lin (Tsinghua

Thank you If you are interested in this investment opportunity, please contact Chandran Nair at GIFT at (852) 3571 8103 or cnair@global-inst.com.

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