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Viability Gap Funding (Cold chain)

This commentary is intended to present queries on the concept and the need for Viability Gap Funding (VGF) for the cold-chain industry in India. It is hoped that views; both for and against, shall be generated to allow a more cohesive debate on the matter and to allow policy makers to understand the need if any, the policy constraints if any and possible solutions to the agenda of faster cold-chain development in the country.

There is only one preliminary premise in this discussion, that we need more of the cold-chain and that this should happen with private sector participation.

First, a quick review of what are the five measures within the underlying principles of Viability Gap Funding (VGF)-
  1. The task should be clearly understood as a Public Service. This also implies that a captive need exists; in business terms a steady long term “revenue stream”.
  2. The project is undertaken under PPP mode and state government participates through provision of necessary land.
  3. The Project has pre-determined user tariff indices, basis which revenue returns are assessed.
  4. There is a viability gap between revenue profits and private investment projected, basis which the proviso for a viability gap fund is factored.
  5. The project is an opened for bid by private participants, wherein the assessed VGF requirement is also a selection criterion among others.
Cold-chain could surely be viewed as a necessary public service as the supply chain it entails will surely benefit the nation (public) at large as it enables better quality food, greater access to markets for the producers, a wider basket of foods to the consumer and reduction in losses incurred through wastage, poor handling, etc. But....

The question is; can a facility and the associated supply chain system be assured a captive revenue stream? With our open market system and ever widening choice to buyers, the revenue stream through any particular project might not be perpetual.

If a guaranteed revenue option is not possible in a particular project, then even if the task is for public good, the tariff for the said task cannot be projected with any real accuracy. If the tariff cannot be detailed to cover all kinds of variances (specially ambiguity in weather, yield, utility, demand), then the ascertained gap in the viability of a project will stay open to debate. In such a case, can a project be tabled for a workable scientific bid?

Cold-chain is frequently misunderstood as mere storage. It is an integrated supply-chain (albeit under environment controls), and by a little stretch of its definition, it could include the period that some goods spend in a cold warehouse. This specifically applies to the use of cold storages for long term storage of spices, seeds, pulses, dry fruits, even potato.

Why do these products enter a temperature or environment controlled warehouse? Because such storage alleviates degradation of quality and so the product can fetch a higher price at a later date. Time (and price) arbitrage! Infrastructure that caters to this model is best applied by the producer or owner of the produce. The cold space is a mere enabler to the prime business model of selling goods stored within at an appropriate date when the best price can be realised. In such cases, the owner of the goods is again subject to vagaries of a future price of the commodity. The main income enabler is the storage but the real value it provides can only be confirmed at a future sale date.

In other cases, the cold-chain has a more integrated set of activities that service the continuous supply of perishables to destination. In these instances, the entire chain impacts upon price realisation through timely delivery to end consumer or retailer. A distance-time arbitrage is applicable here! Effectively, the cold-chain enables the produce to reach a better paying market, usually at large distances from source, allowing for a more immediate cash flow situation. Instead of waiting for time (seasons) to pass to collect a sale, this service model covers distance within the time in hand to make a sale.

In the first model, Time-Price arbitrage (let us call this Time arbitrage), if a cold storage owner is not the owner of the produce, his business will typically work out a cost-plus arrangement for his service fees. The business risk of a future sale, as well as the reward is borne by the owner of the produce. The risk that entails during specialised storage and care whilst in storage is expected to be countered through service level agreements (this is not always the case due to demand-supply gap in infrastructure).

Alternately the infrastructure owner is also the produce owner (not necessarily the producer), wherein the cost of operating the cold storage is only an expense item to factor into when evaluating the final proceeds from selling the produce. A combination of the above can also be applied so that the cold storage owner can defer his fees for a share of the produce sales, provided the risks in future downside of value are also shared.

In either situation the cold store is a tool that enables the future trade and unless business risks are correlated between parties, the cold storage owner can only depend on a cost-plus rental income. The ‘plus’ is a factor of demand and service ability.

In the second model, what I call Distance arbitrage, the entire chain of activities is intended to lead to an excursion free delivery mechanism – a pipe line without leaks – that affords a faster sales cycle and feeds an immediate market demand. The majority of perishable horticulture foods need such a service. Case in example is litchi from China, kiwi from New Zealand, our grapes into Europe, lettuce to every hamburger store, green chilli exports, apples, etc. This model, which is the prevalent cold-chain worldwide, is the one that truly serves the farming community by offering them the controls to reach ready markets. Some of the ambiguity of effecting a future sale is minimised, each day in the cold-chain brings the produce closer to the shelf.

In this model, the chain of custody is best when kept singular and a series of operational processes and checks are used to maximise final delivery and price realisation of the goods. The cold-chain here prices itself on service excellence and evaluates against the current price of goods at destination.

This cold-chain practise can also negatively impact the product, specially as the most susceptible of perishables (those that have little storage longevity) are the major items serviced. Since a longer series of activities including handling, a higher perishability matrix, storage and distribution are involved, this integrated cold-chain could also be considered as a value-preserving service; one that has the highest impact on final price realisation. In fact, on understanding the importance they play in a product’s life cycle, all the great cold-chain companies in the world also became producer owners. While the service provider can be owner of the produce, even service provision itself is seen as a valid business model.

What is really involved in any logistics trade: a service based delivery system that involves activities such as handling, storage, haulage, distribution. The delivery is necessitated to the market and entails service levels including inventory control and involves multi-locational management. The biggest bottleneck is that since the market and source are not common, reverse loads for capacity utilisation is important for optimising costs. All of this applies to the cold-chain with the added proviso of perishability which requires a higher specialisation in handling and care.

Back to VGF – in understanding that cold-chain is basically not localised to a specific spot or location but is intrinsically designed for cross regional footprints, the involvement of multiple state or regional governments comes into play. Furthermore, in a cold-chain, the infrastructure is rooted across locales:
  1. Multiple pack-houses with precoolers and staging cold room at source point (farm-gate infrastructure)
  2. Connecting transport to a hubbing cold store (mobile infrastructure).
  3. The mid-point hub or aggregating cold store (static infrastructure).
  4. Long haul over rail or land (mobile infrastructure).
  5. Receiving cold store at destination (static infrastructure).
  6. Secondary and tertiary distribution (mobile infrastructure).
Items 3 to 5 can be optimised and optional in a network. A receiving destination could also be a food processing unit as the end point to the cold-chain. In some cases processing may require an onwards continuation of the cold-chain. In case of even longer hauls (exports), air and sea modes of transports may be used. The need for reverse logistics also means multiple utility of the transport.

How can VGF be calculated to a venture that has varied type of infrastructure requirements across regions and utility?

In the case of cold-warehousing (long term cold storage only of produce), a single location infrastructure is used. But in this case the viability can be assessed on the basis and akin to commodity trading. Such inventory depends on timing the market for supply gaps, an opportunity option best applied by an opportunistic entity and this may be arguably not for the consuming public’s good. Can VGF assist be applicable in such a case?

Lastly, the question on a viability gap itself is raised for your feedback?
With the huge demand supply gap and growth trends projected, is the cold-chain an unviable business? In comparison, are any of the lesser logistics businesses more viable?
Why do entrepreneurs who start with one cold store, end up investing in many more?
Of the three major components in cold-chain (storage, transport and originating points), which one offers the least returns on investment and why?

Do you have any innovative models to PPP and VGF for cold-chain development please share?
If a gap in viability does exist, would dole in form of gap funding change the situation?
From the items that impact viability in this business, which ones can we alleviate to narrow the gap permanently?

Will technology support and knowledge support help in making a project more viable? Should the government offer a onetime VGF give out or would its support in upgrading technology, market linked incentives, knowledge base and compliance linked support be the preferred option for this country?

I look forward to comments.

Seeking reflections, Pawanexh Kohli

VGF for cold-chain in meats, ice creams etc. is not referenced as these are already considered valuable networks. In fact large synergy amongst cold-chain segments exists and maybe one solution would be to club these segments to bring economy of scale and capacity utilisation.