Does Vertical Integration Increase Efficiency? A Look at Ethanol Plants in the Center-South of Brazil

Brazil is one of the world’s leading ethanol, sugar and sugarcane producer. Sugarcane is produced by farmers (40%) and ethanol plants (60%). Sugarcane production is limited to a certain radius of the mill to minimize transportation costs and avoid sugarcane quality losses. The distance and harvest timeline limitations aligned with the desire to guarantee sugarcane supply or to create barrier of entry to competing firms make vertical integration, a common practice for mills in Brazil. This study estimates the impact of upstream vertical integration on output-oriented technical efficiency using an output-oriented DEA analysis and a tobit censured model. Inputs considered in the model are the amount of crushed sugarcane and the land used, while the quantities of ethanol and sugar produced are the outputs. The sample consists of 154 mills located in the Center-South area of Brazil. The tobit censured model controlled for the percentage of crushed sugarcane produced on lands owned or rented by mills, the type of mill (i.e. mixed mill or one that produces only sugar or only ethanol), if the mill was in the of Sao Paulo, if it was in the Center-West region and its daily sugarcane crushing capacity. An increase in the percentage of the vertical integration decreases output-oriented technical efficiency by 0.0001 at a 10% level of statistical significance. The continued existence of vertical integration, aligned with the results from this study, implies that mills are adopting this strategy for reasons other than gains in efficiency. Mills may be willing to forgo marginal gains in efficiency, from procuring sugarcane from independent producers, to avoid transaction costs. The Brazilian government may be able to reduce vertical integration by subsidizing sugarcane producers, applying contract enforcement measures and, providing farmers with adequate infrastructure (e.g. paved roads). These measures could increase the number of sugarcane suppliers and eliminate barriers to entry created by mills.

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 Record created 2017-04-01, last modified 2018-01-23

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