**4. The case study: Yerevan brandy company**

The YBC is (still) the leading brandy-producing enterprise of Armenia. Currently, the YBC has around 2500 private farmers delivering grapes to the company on a contract basis. It produces a range of brandies of different ages. The brand Ararat belongs to the company. The YBC exports up to 90% of the production to 33 countries worldwide. The primary export destination is Russia. The company comprises four production sites, in three grapes are received, the juice is fermented, and the interim product (wine) is distilled. In all four sites, the distillate is aged. The fourth site is in Yerevan, where the ageing, blending and bottling facilities as well as other divisions such as HR, IT, accountancy and administration are situated. The YBC has branches in Ararat, Armavir and Tavush.

To gain insights into the production structures, operational procedures and business relationship to the smallholders which supply grapes to the company, a qualitative research approach was chosen. Qualitative research is dedicated to a limited number of cases that are investigated as precisely as possible. Therefore, face-to-face individual interviews were conducted with different industry participants. Besides representatives of the company itself, we interviewed smallholders (grape producers) and industry experts from politics and education as well as experts from foreign help organisations, e.g. Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ), Center for Agribusiness and Rural Development (CARD), Centre for the Promotion of Imports (CBI) from developing countries, etc. Additionally, we interviewed the director of the Vine and Wine Foundation of Armenia, who represents all grape growers and processors in the industry. Regarding the company's perspective, we interviewed the heads of grape purchasing and quality control at the YBC and two of the YBC agronomists, who work directly together with the farmers in the vineyards. Moreover, we conducted interviews with 15 smallholders who have a contract with the company. To cover all production sites of the YBC, we have interviewed five farmers from each region. Some of the farmers have worked with the YBC for many years, and others have just recently started the collaboration. Interviews are based on a semi-structured interview guideline and were carried out by the authors personally. The interviews took place between May 2018 and January 2020. The interviews were conducted in Armenian and then translated into English to guarantee full exploitation of information.

For the qualitative analysis of the interviews, the approach of Gläser and Laudel [37] was used. They use a method called extractive qualitative content analysis. It is based on a structuring technique to extract relevant and complex information during the whole process. The process is completely open for new and unexpected information. After the information is extracted from the original text material (transcribed interviews), the information is processed and analysed.

The case study of the YBC shows how an international company manages to integrate local smallholders (grape growers) into their national and international value chains by using means of vertical coordination in the form of contracting. Moreover, the case study demonstrates how a procurement system can be installed successfully in a weak institutional setting. The YBC was the first company in Armenia to introduce the contracting system between the grape growers and processors in 2003. Later it was recognised by the government as an exemplary one.

After the Yerevan Brandy Company became part of the Pernod Ricard Group in 1998, an internal restructuring process has taken place to tackle the issues of the brandy industry and to align them with the international standards of the markets. Main changes were carried out in infrastructure, refurbishment, huge investments specifically in winemaking facilities and distilleries were made, but the most important changes were made in business management. The introduction of the first written, enforceable and long-term contracts changed the standards of the wine and brandy industry in Armenia.

The main reason why the YBC entered into contracting was to ensure sustainable grape supply in terms of quantity. To secure the needed quantity, the company has to purchase all their grapes from independent grape growers, as the YBC does not possess a large area of own vineyards except for 0.5 ha of trial vineyard. The company is forced to include smallholders to ensure the required quantity.

The contract, which is set up between the company and the grape growers, contains specifically the grape quantity, variety, contract length, characteristics of the plot where the grapes are grown and a few quality criteria such as the healthiness of the grapes and the minimum sugar level. One interviewed grape grower mentioned, for instance: "It is required to deliver healthy grapes. The delivered quantity should contain the smallest possible amount of material other than grapes (e.g. leaves, stones). The contract also includes the grape varieties which can be delivered to the company". The guaranteed quantity enables grape growers to plan in terms of income, input supplies and production. Through the long-lasting approach (3–5 years of contracting), trust is built between both parties. As one interview partner said: "For me it's not only the profit that matters. Most important is the long-term collaboration with the YBC, as it gives me a feeling of stability".

The interviewed farmers stated that the duration of the long-term contracts in the past was even 7 years.

Furthermore, the contract includes terms of payments and delivery (e.g. number and time of payments). All types of contracts include minimal prices. The company philosophy aims to purchase grapes at a price above the farmer's production cost, which is company-wide evaluated before harvest.

In general, the price is announced in spring, which gives farmers the possibility to decide what to do. However, in some exceptional years (e.g. 2018) pricing details can vary, so the YBC announces the updated price before the harvest. As prices are included in the contracts and the contracts are legally enforceable, neither the farmer nor the YBC can negotiate on prices after the contract has been set up.

An annex of the contract takes into account the potential deviation from the contractual agreements due to quantity fluctuations. In August, shortly before the harvest starts, the YBC agronomists visit the vineyards and calculate the potential yield. If weather conditions were unfavourable and the farmer could not obtain the required quantity (or, in turn, the yield is higher than expected), the agronomists and farmers can fix the required quantity according to the situation. A grape grower stated: "The yield is always predicted by the agronomists beforehand. Depending on year the quantities can be higher or lower, but it is negotiable by the contract annex".

Ten agronomists are working at the YBC doing quality control within the contracted vineyards to provide consultancy to the farmers. One of the farmers, for instance, said: "There was a time we were implementing old cultivation methods damaging our crop. In the beginning it was difficult to change our mind-set and follow the instructions of the YBC agronomists. Time proved the effectiveness of their consultancy so we became more open to their suggestions, even more motivated to find out new information, learn new cultivation technologies". The consultancy includes good agricultural practices such as pruning, canopy management, spraying times with herbicides/pesticides, greenings, etc. Additionally, the agronomists also conduct monitoring to make sure that the expected grape quality and yield are going to be received. Based on the evaluation of the agronomists, the company subsidises smallholders with farm input assistance—if needed—with pesticides, herbicides and fertilisers. Another grape grower mentioned: "The company provides tools, sprayers, and pesticides at convenient prices. The payment for these inputs is directly taken out from the pay-out we receive for the delivered grapes".

To provide knowledge and new techniques, the YBC owns 0.5 ha of experimental plots for trials. For instance, in 2006 the company started some trials on their experimental plots together with the Pernod Ricard research centre, to demonstrate their grape suppliers that new cultivation methods in the grape production can be less time-consuming and more profitable.

For smallholders, the main motivating factors to enter into contracts with the YBC are based on the benefits the farmers receive from working with the company. The YBC provides constant market access for grapes and gives the smallholders a guarantee of grape purchase. Farmers who do not breach the contract have a stable, reliable and almost predictable profit/income. The long-term relationship between the company and the farmers offers the opportunity to build trust between the contracting parties. This increases reliability between them and gives income security to the farmers. Besides some 1-year contracts, mostly 3–5 years of contract length (if there is no contract breach), are used. Another advantage is that grape delivery and payments are scheduled ahead; hence, no price negotiations of the YBC are possible if the farmer meets the contract requirement due to legal enforcement. The company provides farm assistance in the form of inputs (chemicals, fertilisers, etc.) and consultancy (pruning, irrigation, spraying times, dosage and frequency,

etc.), if necessary. Farmers have access to knowledge and new techniques through the YBC. Grape producers also benefit from working with the YBC because they are delivering high-quality grapes for high-quality brandy production and thus benefit of the company's reputation.

One of the smallholders, for example, said as a concluding remark: "My father and I were practicing grape cultivation ever since land privatisation in Armenia. We had a small plot and low quantities. Slowly, gaining experience in this field, our expectations rose, and at the same time, the vineyard territories expanded, especially in the period when PR bought the YBC and we started collaboration. The organizational skills of the company positively surprised us from the very beginning. It was the first time in Armenia, when the farmer delivers the grapes without being stuck in huge queue. Everything was planned with a contract".

If it comes to the credit situation of the smallholders, the YBC is not helping them directly by providing loans, loan guarantees or trade credits. However, smallholders who work with the YBC over a longer period increase their chances to get a credit or loan at external institutions because of the fixed, long-term contracts with the YBC and, hence, a stable and enhanced profitability or improved future cash flows based on their past performances. This provides security to external institutions, improving the probability for smallholders to finance investments. One statement of an interviewed grape grower was: "Having larger vineyards, one always needs financial support to do investments in, for example, the trellising system (metal wires, etc.). Recently I expanded my vineyard and needed a bank loan. When applying for the loan the bank considers your current economic situation as well as where you are trading your product. Seeing our contract with a serious company such as the YBC, the bank never rejects the application". In this setting, the YBC helps indirectly with access to capital.

In case a farmer cannot deliver the settled quality and/or quantity of grapes to the YBC, the contract is breached. Additionally, the competition among smallholders to work with the YBC is huge, creating societal pressure to follow the restrictions.

The contract design, as mentioned above, shows that the YBC is on the one hand working with marketing contracts to secure grape quantities and qualities for their brandy production. In general, the brandy production itself does not require highly differentiated grapes. Grape quality is mainly defined by a minimum sugar level and a minimum of the healthiness of grapes close to the harvest. However, the YBC sets up higher-quality restrictions. For instance, the company only purchases highlevel healthy grapes (pest-free, disease-free, no foreign bodies, etc.) and certain grape varieties. The YBC does not purchase all grape varieties which can be used for brandy production.

In contrast to that, grape production for wine is more differentiated, and quality is also defined by sugar and healthiness, but it includes further grape characteristics such as colour, tannins and sugar and acid ratios. However, if we consider on the other hand the provided farm input assistance in the form of chemicals, fertilisers, etc. and the consultancy, e.g., pruning, irrigation and spraying times, this depicts a high involvement during the production process. The YBC actively engages in many critical decisions within the production process, adding production contract features.

Further interviews with some producers of table wine and experts from related fields such as education, politics and related fields/companies were conducted additionally. The interviews revealed that after the successful implementation of contracts in the brandy sector, many table wine producers followed. One of the experts stated: "Most of the time grape purchases for table wine were based on customary rearrangements. In that area a very well developed relationship, only one company has. This is Yerevan Brandy Company, having written contracts with their

*Including Smallholders with Vertical Coordination DOI: http://dx.doi.org/10.5772/intechopen.92395*

#### **Figure 4.**

*Results of vertical coordination in the YBC case study.*

farmers. In this sense, Yerevan Brandy was a role model". Another expert added that within the last years, a steady increase in contracts in the grape purchase was notable. Overall, the influence of the YBC in the brandy and wine sector of Armenia was shown.

**Figure 4** sums up the results of vertical coordination mechanisms used in the productive partnerships of the YBC and the grape growers.

#### **5. Conclusion**

As a result of land privatisation which was part of the transition process, the average plot sizes of farmers are small. In 2017, overall, 66,544 farmers cultivated grapes in an average plot size of 0.23 ha. Due to their plot sizes, many smallholders cannot manage to finance their winemaking facilities and/or get access to the market to sell the high-valued final product, resulting in a high dependency of smallholders on grape sales to processors. In this context, the aim was to show how to integrate smallholders into national and international value chains by successfully installing a procurement system in weak institutional environments. In our case study of the Yerevan Brandy Company, we found that the company uses specification contracts as one type of vertical coordination, where independent individuals or firms of different stages in the value chain decide to collaborate. Currently, the YBC has around 2500 private farmers delivering grapes to the company on a contract basis. In order to avoid the disruptions in supply and inferior quality, the company introduced contracting from the early beginning. As a result, major disruptions in quantity and quality never occurred.

In 1998, Pernod Ricard Group bought the Yerevan Brandy Company, the most important Armenian brandy-producing company known by its Ararat brandy. This was when the first contracts between producers and smallholders were introduced. The YBC serves as a role model for other post-Soviet countries with similar issues up to the present.

Introducing the contracting system Yerevan Brandy Company reached a synchronisation of successive stages in the vertical marketing channel from producers to consumers to overcome problems of supply and quality. The YBC is taking different measures regarding vertical coordination. For example, the company uses mostly 3- to 5-year contracts, which include specifications of the grape quantity, variety, contract length, characteristics of the plot where the grapes are grown and a few quality criteria such as the healthiness of the grapes and the minimum sugar level. This shows that the YBC uses production contracts rather than pure marketing contracts. The company also offers farm assistance in the form of consultancy of YBC agronomists who closely work together with the farmers in the vineyards and in the form of input supply. Agronomists provide consultancy for viticultural practices, special viticultural issues, measures to take if yields are lower or higher than expected and input supply. The example of the YBC also shows that foreign direct investment not only brings capital, production facilities and technology transfers but also creates employment, provokes new job skills and offers management expertise.

The business environment in Armenia should embrace and reduce the obstacles for foreign companies to make investments in Armenia. This opens the opportunity for domestic producers to benefit financially, knowledge- and technology-wise, access to export markets as well as in business management from foreign direct investments.

In addition, the legal framework has to be improved to guarantee the enforcement of contracts and oral agreements. Especially grape growers, who are in a weak bargaining spot, would benefit from a legal improvement. Furthermore, NGOs or the ministry of agriculture could provide contract templates to reduce the numbers of oral agreements, as the legal setting for written contracts is more developed and enforcement exists.

The study finds that the institutional arrangements used in Armenia in the form of contract farming as part of vertical coordination are beneficial for both the processing company and the smallholders. In these contracts, the farmers agree to produce and supply agreed quantities of grapes. The study could not find any disadvantage for smallholders in terms of contract farming. In contrast, farmers who have a contract with the YBC benefit of secured market access, secured and stable income, access to bank loans, education, farm assistance in the form of consultancy or input supply.

For farmers who are not working with the YBC, a general recommendation is a higher financial support from the government or other institutions, which would help to ease their situation. The financial support in forms of credits or loans enables the grape growers to invest into more demanded varieties (e.g. red grapes for table winemaking) or even into other crops (e.g. lemons, peaches) which are more profitable.

Another option to support smallholders is the establishment of cooperatives. Cooperatives are beneficial for smallholders, as the bundling of quantities improves their bargain situation and knowledge—as well as investment—sharing is possible. The delivered grapes can be divided into quality categories, which then can be sold in different price segments to different market participants. The offer of differentiated quality levels with different prices leads to higher overall profits. Farmers who produce high-quality grapes gain higher patronage, giving an incentive for high-quality production. If wine or brandy producers need grapes or wine, they can bargain with the cooperative as a single entity for their needed quality category, and they do not have to bargain with many farmers to gain the same quantity.

All in all, the YBC manages to integrate smallholders (grape growers) into their national and international value chains by successfully installing a procurement system by using different measures of vertical coordination. Additionally, the YBC contributed to the development of the sector. Other companies start to adapt and

*Including Smallholders with Vertical Coordination DOI: http://dx.doi.org/10.5772/intechopen.92395*

take the YBC as a role model. In future, the standards set by the YBC and the ongoing development (education, knowledge, experience, etc.) will improve the performance of many farmers and equalise the produced qualities on the market. Sugar levels, healthiness of the grapes and usage of certain grape varieties become basic quality requirements. When the higher-quality products become standardised (e.g. IFS or GlobalGAP certified), mainly marketing contracts will be used. Thus, in the long run, it can be assumed that the degree of vertical coordination will decrease and the contracts will further tend towards pure marketing contracts. However, in the short and medium term, the adjustment will assumingly be rather slow.
