Tea Bonuses Demystified: How Tea Factories Arrive at Bonus Prices

Kenya Tea Development Agency Management Services (KTDA- MS), recently announced a 21% improvement in second payments (popularly referred to as ‘bonus’) to smallholder tea farmers for the year ending July 2015. The improved payments, which have already been released to farmers, are as a result of more volumes of tea sold, a strengthening dollar against the shilling and improved tea prices at the global markets.

This comes as a relief to the sector that last year faced declines in earnings as a result of overproduction, which caused a glut in the global market and forced down tea prices.

Tea bonus rates paid to each of the tea factories were itemised in the daily press. Each factory had a specific rate (bonus) which it pays to its farmers based on the factory directors’ approval. To understand how these rates are arrived at, it is important to understand the relationship between the Agency and its managed factories.

KTDA is a tea marketing agency that provides critical services in the management, processing and marketing of high quality tea grown by Kenyan smallholder farmers. The Agency is owned by smallholder farmers who hold shares in their respective tea factories, which are corporate entities in themselves. In its current structure, 54 tea factory companies, representing the 66 factories that are managed by KTDA, are corporate shareholders of KTDA.

To put this into context, it means that the 560,000 smallholder tea farmers in Kenya are shareholders of KTDA through their factories. Each year, these farmers elect representatives (directors) from amongst themselves to the tea factory company boards which oversee the running of the factories.

From amongst these directors, some are elected to sit in the main KTDA Board to oversee the shareholders’ investments in KTDA and its subsidiaries. KTDA Management Services, a subsidiary of KTDA Holdings, oversees the management of the smallholder tea factories.

One of the roles of these directors is to ensure good financial health of the respective factories after a year of trading, usually ending 30th June of every year. Factory company directors then declare the 2nd payment to be paid out of the performance of the factory companies.

This unique model allows each farmer a representation in the running of their respective factory. It also allows KTDA to leverage on economies of scale afforded by the 66 tea factories, to purchase important inputs such as fertilizers, facilitate construction of new factories and expansion of existing ones, as well as negotiate for competitive finance facilities (loans).

It is important to note that farmers receive monthly pay at the rate of Ksh14 per kilogram of green leaf delivered to the factory in addition to the 2nd payment (bonus).

There have been concerns that there is unfairness in how bonuses are paid out across the factories. There are various reasons for income variations. Factories process varied volumes of tea depending on the size of the catchment areas and the volumes of tea produced. This determines factory capacity utilisation and hence cost efficiency.

Teas from the factories also fetch different prices at the markets – either through the auction or direct markets. Their quality is determined by the quality of green leaf and that of processed tea. Consumer preferences also affect pricing, with some markets preferring teas from specific factories.

The quality of green leaf is further determined by ecological and climatic features such as types of soil and quantity of rainfall, as well as the quality of farm management practices such as application of fertilizer, pruning and plucking.

Further, the cost of production varies from factory to factory based on labour and energy efficiencies, cost of credit and investment income. Factories with expansion projects that are financed by loans will incur higher finance costs than those which are not expanding. Given the current interest rates regime, such costs can be substantial.

On the other hand, factories with healthy cash flows and which have no need to borrow will ultimately invest their surplus and earn more income. It is this combination of factors that determine what income individual factories pay their farmers.

Tea as a business operates in an environment with unique dynamics, and tea factories, as the drivers of this business, also operate in different business environments. As a managing agency, KTDA is involved in ensuring factories reduce their costs of operation by investing in the tea value chain via subsidiaries that either enhance services or reduce costs for farmers.

The Agency is also encouraging farmers to grow other crops that will supplement their incomes in times when tea prices or income is down, as happens from time-to-time. At the same time, factories have instituted measures to manage costs in factories, key among them investment in hydropower that will considerably reduce the cost of energy.