Contract Farming (CF) -the Concept and the Logic


Ajit Kumar AJIT KUMARWISDOM IAS, New Delhi.

Corporate agribusinesses, both domestic and multinational, interface with smallholders through seed production and supply, other input supply, procurement of produce, and more directly, facilitation of production through CF. CF has also been used in many situations as a policy step by the state to bring about crop diversification for improving farm incomes and employment (Benziger 1996; Singh, 2002).
CF is also seen as a way to reduce costs of cultivation as it can provide access to better inputs and more efficient production methods. The increasing cost of cultivation was the reason for the emergence of CF in Japan and Spain in the 1950s (Asano-Tamanoi, 1988) and in the Indian Punjab in the early 1990s (Singh, 2002). CF can be defined as a system for the production and supply of agricultural and horticultural produce by farmers/primary producers under advance contracts, the essence of such arrangements being a commitment to provide an agricultural commodity of a type (quality/variety), at a specified time, price, and in specified quantity to a known buyer. In fact, CF can be described as a halfway house between independent farm production and corporate/captive farming and can be a case of a step towards complete vertical integration or disintegration depending on the given context. Due to the efficiency (co-ordination and quality control in a vertical system) and equity (smallholder inclusion) benefits of this hybrid system, it has been promoted aggressively in the developing world by various agencies (Glover, 1987). It basically involves four things - pre-agreed price, quality, quantity or acreage (minimum/maximum) and time (Singh, 2002). It is generally undertaken when there is market failure expressed in perishability of produce, quality of produce and technicalities of producing a new/different product (Bijman, 2008).
On the other hand, „contact farming‟ is the practice adopted by most retail chains in India which refers to just having registered farmers without any commitment to buy or sell or a pre-agreed price or quantity specified.
CF is known by different variants like centralised model which is company farmer arrangement, outgrower scheme which is run by government/public sector/joint venture, nucleus-outgrower scheme involving both captive farming and CF by the contracting agency, multi-partite arrangement involving many types of agencies, intermediary model where middlemen are involved between the company and the farmer, and satellite farming referring to any of the above models (Eaton and Shepherd, 2001; GoI, 2003; Bijman, 2008). In fact, CF varies depending on the nature and type of contracting agency, technology, nature of crop/produce, and the local and national context (Swain, 2011). 
The contracts could be of three types; (i) procurement contracts under which only sale and purchase conditions are specified; (ii) partial contracts wherein only some of the inputs are supplied by the contracting firm and produce is bought at pre-agreed prices; and (iii) total contracts under which the contracting firm supplies and manages all the inputs on the farm and the farmer becomes just a supplier of land and labour. The relevance and importance of each type varies from product to product and over time and these types are not mutually exclusive (Hill and Ingersent, 1987; Key and Runsten, 1999; Bijman, 2008). Whereas the first type is generally referred to as marketing contracts, the other two are types of production contracts (Scott, 1984; Welsh, 1997). But, there is a systematic link between product and factor markets under the contract arrangement as contracts require definite quality of produce and, therefore, specific inputs (Scott, 1984; Little, 1994). Also, different types of production contracts allocate production and market risks between the producer and the processor in different ways. The price of the contracted produce can be growers‟ fixed price, residual (profit/loss) sharing by sponsor and grower, open market based price, spot market price, consignment based, two part split price, tournament price (fixed plus variable based on relative performance), base price plus quality based incentive price, or administered price.
For different reasons, both farmers and farm product processors/distributors may prefer contracts to complete vertical integration. A farmer may prefer a contract which can be terminated at reasonably short notice. Also, contracting gives access to additional sources of capital, and a more certain price by shifting part of the risk of adverse price movement to the buyer (Hill and Ingersent, 1987). Farmers also get an access to new technology and inputs, including credit, through contracts which otherwise may be outside their reach (Glover, 1987; Eaton and Shepherd, 2001). For a processor or distributor, contracts are more flexible in the face of market uncertainty, make smaller demands on scarce capital resources, and impose less of an additional burden of labour relations, ownership of land, and production activities, on management (Kirk, 1987). The firm even gets an access to unpaid family labour (White, 1997) and can make use of state funds indirectly through agricultural production sector which are directed at farmers by development agencies (Clapp, 1988). Also, food processors can minimise their overhead costs per unit of production by operating their plants at or near fully capacity as contracting gives assured and stable raw material supplies from farms. The firm can also project an image of working with local producers as a partner when it undertakes CF and may even obtain statal and international agency incentives for its activities as developmental projects, instead of corporate farming (Kirk, 1987). Contracts also help improve product quality by directly introducing incentives and penalties as there are problems of adverse selection and moral hazard in any contractual arrangement resulting in underinvestment or shirking by any of the parties (Wolf et al, 2001).
At more macro economic level, contracting can help to remove market imperfections in produce, capital (credit), land, labor, information and insurance markets; facilitate better co-ordination of local production activities which often involve initial investment in processing, extension etc.; and can help in reducing transaction costs, including for the farmer (Grosh, 1994; Key and Runsten, 1999; IFPRI, 2005; Bijman, 2008).). From an institutional economics perspective, the logic for CF could also come from the creation of positive externalities like employment, market development or infrastructure, if agribusiness firms create them better than the open market or the state (Key and Runsten, 1999). In other words, can CF help people other than those who have direct stakes and pay for it?. CF figures as an institutional arrangement/innovation for agricultural development (Glover, 1987).
Some others recommend CF as the only way to make small scale farming competitive as the services provided by contracting agencies can not be provided by any other agencies (Eaton and Shepherd, 2001). CF is also an alternative to corporate farming which may be costly, risky, and difficult to manage and still not viable (Payer, 1980). Further, in India, supermarket chain growth including likely Foreign Direct Investment (FDI) in retail, international trade and quality issues like Sanitary and Phyto-Sanitary measures, organic trade, fair trade, and ethical trade, promotion of CF by the central and state agencies, banking and input industry push for CF, farming crisis and reverse tenancy, and failure of traditional cooperatives, will help spread of CF across crops and regions as they provide new space to this arrangement in the context of withdrawal of state from agricultural space. Even new Intellectual Property Regime (IPR) which encourages protection and exploitation of proprietary genetics is likely to accelerate CF practice (Wolf et al, 2001). Further, under the new agricultural policy regime, public-private partnership is the main route being taken to bring about transformation in agriculture and the state is providing incentives to corporates to enter agribusiness sector, including through CF.
 
 


Monday, 04th Jan 2016, 10:17:49 AM

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