#2 The Agruppa Model: Assumptions vs. Reality
Every business is built on assumptions at the start. In this post we would like to share more details about the Agruppa business model and some of the key assumptions behind it, which held true in the beginning and started to tumble as we grew. We hope these lessons learned can help other entrepreneurs avoid crashing into the same walls we did — or at least crash more softly.
There are many business models out there with similar missions to Agruppa’s: creating closer links between rural producers and urban consumers. How was Agruppa different? Mainly because we detected an opportunity at the so-called Bottom of the Pyramid (BoP), specifically in the small mom-and-pop shops. Contrary to other businesses targeting economically strong end consumers (like upper class households), or restaurants and hotels in the cities, Agruppa made the small shop the focus of its value proposition.
In Colombia, each one of these small shops moves impressive quantities of fruits and vegetables, which makes them an interesting customer segment. On average, a mom-and-pop shop in Bogota purchases fruits and vegetables worth almost $1,300 USD per month. These small shops sell around 70% of the food consumed in the region (FAO 2010), which means that seven in ten Colombians do their food shopping predominantly in a small shop. The majority of mom-and-pop shops are located in lower-income neighbourhoods, which are in turn home to most of Colombia’s population.
When taken together, these small shops add up to an enormous market power. However, each one of them is the last link in a long and intermediated supply chain between the farm and the city. According to our own research in Agruppa, we estimate that in Colombia, produce passes through the hands of 4–5 middlemen between the farm and the mom-and-pop shop, generating a price increase of at least 45%.
First, farmers — especially the small ones — are subject to informal middlemen in order to bring their produce to market. Second, in this process, the product sees a significant price increase without any value add (such as processing, packaging, etc.). Third, without sufficient capital to buy in bulk and lacking storage space, small shop owners purchase the produce they will sell practically on a day-to-day basis. As a result, they lose on average 15 hours per week on trips to the central market while spending up to 20% of their income on transport. Consequently, it is the shop owner and the end customer who pay for the overhead generated by inefficiency.
Seeing these inefficiencies in the current supply chain is what led us to create Agruppa: a virtual buying group for urban small shops, aggregating their demand for fruits and vegetables in order to buy directly at the farm, bring produce to a distribution center in the city, and distribute to the shops based on their orders. Doing this, Agruppa could save each shop owner up to six minimum salaries per year (approx. $1,700 USD) between transport and produce cost savings, while at the same time giving the farmer direct access to a market in the city. In theory, it was a win-win model for farmers, shop owners, and Agruppa.
We did not try to reinvent the wheel at all, but rather tried to make it run more smoothly. Our objective was to leverage (1) mobile technology, (2) the powerful segment of the mom-and-pop shops, and (3) economies of scale in order to make the current fruit and vegetable supply chain more efficient.
However, in the two years of operation, little by little we realised that the basic assumptions behind the Agruppa model, while obvious in theory, in practice — and especially at scale — did not always hold true anymore. These are three of the key assumptions which we started doubting the more we grew:
- Significant cost savings would make Agruppa an obvious choice for shop owners: Delivering lower priced produce directly to their shop, and thus saving them the time and money spent on transport to go out and get it, did not actually guarantee that mom-and-pop shops preferred Agruppa to their old ways. Being able to save up to six minimum salaries, and over 100 hours per year, did sometimes seem to not mean a thing. Over time, we identified two distinct types of small shops. On the one hand, there are shop owners who truly value not having to travel to the central market anymore: they have children or elderly to care for, they are tired or have security concerns. For these shop owners, Agruppa’s value proposition was 100% attractive; it was obvious. On the other hand, there are shop owners who love to negotiate and hussle. They believe no one can negotiate better than they do, and having the piece of mind of having selected and purchased their stock themselves weighs out the cost and effort of travelling to the central market. In addition, the trip to the market is the only moment of the day they spend outside their shop, an excuse for socialising, having a drink or even see a lover. The first market segment was too small to build a solid business around; and we did not find a convincing argument for the second to change their culture and idiosyncrasy.
- The higher the aggregated demand, the more negotiating power at the farm: Agruppa was built on the assumption that economies of scale would ensure progressively and significantly lower purchase prices in our procurement of produce. By buy aggregating demand from the shops in the city and bulk buying directly at the farm, we aimed at capturing a significant portion of that 45% margen we described above. At the beginning, this assumptions seemed accurate, and with higher purchase volumes we obtained better prices both at the central markets and directly at the farm. However, we stumbled onto two realities that made things more complicated: First, the discount we achieved for buying high volumes directly from the producer stalled at some point — not because there was not any room for negotiation, but rather because farmers ignored previous agreements and preferred selling to whoever offered most that day. Confronted with this practice, we aimed to establish future contracts with our suppliers, guaranteeing a price for their production before the harvest and thereby reducing their vulnerability to the usual price fluctuations of agricultural products. At that point, we found ourselves subject to a second reality: the majority of farmers are not interested in future contracts because (a) they have been traditionally breached and do not trust in anyone, (b) they are not interested in fixing prices, but prefer betting on selling their harvest at the highest possible price while assuming the constant risk of selling below production costs, and (c) they do not necessarily hold a level of (financial) education that allows them to see the economic benefits, or the long term vision to embrace this outlook. The farmers Agruppa approached preferred assuming the risks and follow the same processes their families had for centuries. This inability to capture significant margins through bulk purchasing delayed Agruppa’s profitability to the medium or long term.
- Agruppa would be able to standardise produce quality and price for all customers: In order to create economies of scale, Agruppa had to buy a lot of the same product of the same standards. It meant that all the tomato we bought, for example, had to be of the same variety, size, ripeness and quality.
During our research and pilot project, this looked viable due to the high similarities between shops’ product portfolios. Together with the projected savings on produce and transport, we thought it would be enough for shop owners not to mind receiving a product that was slightly different from what they would have otherwise bought themselves at the central market. However, the reality is that the price-quality balance that each shop prefers varies significantly not only between shops, but also over time for the same shop. It varies according to season, market prices, and the money available for purchases that day. As a result, we received orders with detailed product specifications which we were not able to fulfill with our operating processes of the time. Shop owners dreamed of a “personal shopper”, while Agruppa needed to buy the same for everyone in order to scale and build a viable business model, ending up with a constant struggle to reduce prices or increase product quality (or even more difficult: both) in order to make customers happy. Following this dynamic, we only cultivated false expectations and made our our model less viable in the long term.
We had validated these three key assumptions in our first pilot project with 20 shops. However, when starting our growth phase, each of these assumptions became progressively less certain.
Today we understand that we would have needed better mechanisms for constant customer feedback, which would have allowed us to detect the phenomena we suggest in points #1 and #3 in real time. We should have gone back to do the same customer surveys we did initially at regular intervals. We should have tried to discover new insights about our market segment. And we should have tried even harder to immerse ourselves in their culture and idiosyncrasy.
By now, we also understand the importance of treating our suppliers as customers of their own, creating a compelling value proposition for them, as we suggest in point #2. If Agruppa had had a relationship with farmers beyond the purely commercial, maybe our purchase discounts would not have stalled and margins would have been more attractive. Maybe we would have realised the importance of productive partnerships with farmers earlier, or even integrated the Agruppa model vertically (which raises a whole different debate).
We continue convinced that there is in an enormous opportunity in delivering produce directly to mom-and-pop shops in the city. But we are certain that in order to make it work, it needs a business model based on refined assumptions and an even deeper understanding of both ends of the value chain. And more so, it needs a a model that reduces the ever present uncertainty and volatility at (at least) one of the two sides.
We hope these learnings help others on their path, and are curious to see the future achievements of other initiatives and social enterprises in revolutionising the supply chain between the farm and the city.
(written with Agruppa Co-Founder Carolina Medina)
This is the second in a series of posts about the creation, growth and closure of our social enterprise in Colombia. In post #1 we share the reasons that led to our decision to close down. Check post #3 for our fundraising battle (and success).