Contract Farming A Profitable Business Proposition for Farmers

Contract Farming

Some authors (Vermeulen & Cotula, 2010) have focussed on un-packaging the different contractual models that have historically existed in agriculture, namely lease arrangements, tenancy farming, joint ventures, farmer-owned businesses and contract farming. Today’s contract farming is different on various counts from other models in terms of ownership, voice, risk and rewards:

• The ownership of business and its decisions lie with the company and the land rights with the farmers;
• The risks are shared, i.e. production risks are borne by the farmers and marketing risks are borne by the company;
• Farmers are rewarded with a pre-determined price for their produce and hence the marketing problem of their produce is deemed to be solved;
• The voice or the negotiating power differs in various situations. In some contracts, farmers don’t have the negotiating power to demand the price for their produce; they just accept the price offered by the company.

Advantages and Disadvantages

Theoretically, there are possible advantages and disadvantages for both farmers and companies.

Advantages to Farmers:
• Market access;
• Provision of inputs;
• Access to credit;
• Technology transfer;
• Reduction in the uncertainity of market fluctuations.

Disadvantages to Farmers:

• Production risks;
• Marketing risks;
• Manipulation of quotas and quality specifications;
• Domination of monopolistic firm and its adverse effects.

Advantages to Firms:

• Reliable supply of raw materials – even if one or two farmers breach, there is assured supply from other farmers;
• Quality specifications that can be controlled by contracting terms.

Disadvantages to Firms:

• Land unsuitability to the contracted crops;
• Social and cultural constraints;
• Extra contractual sales by farmers;
• Input diversion by farmers.

Contract Farming around the World

Rapidly expanding demand for high-value food commodities gives farmers incentives to diversify their production portfolio towards commodities that have a strong potential for higher returns. High-value agriculture is best suited to smallholder production systems, as the production of these agricultural commodities requires more labour resources and smallholders have plenty of family labour. It is said that companies prefer to buy from a large number of small farmers because there is less default (even if one or two default, there is assured supply of raw materials), but in reality companies prefer to contract with large farmers in order to reduce the transacting costs (as collection of crops is easier and less costlier from a few large farmers, than with numerous small farmers (Key & Runsten, 1999).

As some authors point out, there is evidence of both inclusion of small farmers in contract farming ventures (in resource providing contracts particularly) and exclusion of small farmers (when there are scale constraints). These studies show the necessity for the inclusion of small farmers in the contracts and the contestation whether in reality they are included in all contracting ventures.

Many a time, the farmers, particularly small and marginal, can use the contract as collateral with commercial banks to get credit for the purchase of production inputs. This gives better access to credit particularly to small and marginal farmers (Key & Runsten, 1999). In the paper by Key and Runsten, the authors have highlighted the fact that contract farming in Mexico as a economic institution has emerged as a response to imperfect or missing markets in the areas of credit, insurance, information, factors of production and raw produce. And they have analysed the effects of contract farming in the light of income benefits these ventures provide small farmers.

Unsuitable technology and crop incompatibility can result in adverse effects on the social life of the agricultural community and loss of employment in the contracted farms. In Papua New Guinea, for example, people from the highlands were resettled in coastal areas to cultivate oil palm and rubber. This affected people’s social life as they were traditionally sweet potato growers and eaters. Moreover, cultivation techniques differed (Koczberski, 2007).

Contract Farming in India

Contract farming is prevalent in various parts of India for commercial crops like sugarcane, cotton, tea and coffee. Recently, there have been several private sector initiatives for direct procurement from farmers by companies, like M/s Pepsi Foods Pvt Ltd, Tata Rallies, Mahindra Shubh Labh and Cargill India. Corporate companies are entering into partnership with farmers and providing them with inputs, R&D, extension support, credit, processing services and marketing avenues (Patnaik, 2011).

Birthal, Joshi and Gulati (2005) studied the advantages of contract farming to farmers in North India. One of the prime advantages for the farmer is that the company will take all the produce grown within specified quality and quantity parameters (this will solve the problem of market access for the farmers). They studied three products that are being contracted from small farmers in North India namely broilers, milk and vegetables, and found out that contract farmers had more reliable market access than non-contract farmers and their income increased manifold in the case of vegetables and milk. In the case of broilers, income was fluctuating. They also argued that accessibility to the markets was one of the criteria that affected participation of small farmers in these contracts.

Singh (2005) analyses the role of the state in the promotion of contract farming in the initial stages and how the role of the state has changed over time in the context of contract farming in Thailand. However, there are no major studies conducted in India that analyses the role of the state in the promotion of contract farming.

Farmers face increased risks associated with higher returns in the contract farming arrangements. These may include production risks associated with the compatibility of land that may result in smaller yields. Farmers may also face market risks associated with the size of market and inaccurate price levels. Companies are also unwilling to share the risks with farmers, which can result in resentment amongst them. For example in Thailand, due to heavy mortality rate among chickens, the company charged a levy on farmers’ income to offset the risk (Singh, 2005).

Some authors focus on differences in contract farming in terms of the targeted markets: crops that target international markets; those specifically targeted for domestic markets; and those which are for processing industries. They highlight the perceptions of risks and returns among farmers for the participation in contracts. And contract farming instead of coming in the form of legal and formal agreements is more informal and subject to changes over time due to relationship building between farmers and firms (Narayanan, 2012).

Is Contract Farming Profitable?

There is significant variation in terms of profits for small farmers across crops and firms. In some crops, the profits for small farmers are high and in others, the profits by small farmers are low. And these profits also vary and show significant differences from various contracting companies. This may lead to switching of companies by the farmers.

As the global literature on contract farming suggests, ventures in contract farming in India are also governed by institutional concerns. There are many case studies which show that farmers and firms enter into contracts in order to minimise transaction costs. And the missing markets or imperfect markets of credit, insurance, information, specialised inputs and product markets are the main reasons for the farmers to enter into contracts. As the contracts fill up the gaps of missing markets, farmers are venturing into these contracts (Birthal, Joshi, & Gulati, 2005).

Though, the theoretical literature suggests that farmers and firms enter into contracts in order to minimise transaction costs, and gain mutually; whether the contracts are really a win-win situation or a win-lose situation depends on the particular intricacies of the contract as suggested by the empirical studies (Oya, 2012).


References:

Birthal, P. S., Joshi, P., & Gulati, A. (2005). Vertical coordination of High-Value food crops-Implications for smallholders. IFPRI paper l .

Key, N., & Runsten, D. (1999). Contract Farming, Smallholders, and Rural Development in Latin America: The Organization of Agro processing Firms and the Scale of Out grower Production,. World Development , 27 (2), 381-401.

Narayanan, S. (2012). Safe Gambles? Farmer perceptions of transactional certainty and risk-return tradeoffs in contract farming schemes in southern India. IGIDR Working paper .

Oya, C. (2012). Contract Farming in Sub-Saharan Africa: A Survey of Approaches, Debates and Issues. Journal of Agrarian Change , 12 (1), 1-33.

Patnaik, G. (2011). Status of Agricultural Marketing Reforms. IGIDR Proceedings/Projects.

Singh, S. (2002). Contracting Out Solutions: Political Economy of Contract Farming in the Indian Punjab. World Development, , 30 (9), 1621-38.

SIngh, S. (2005). Role of the State in Contract Farming in Thailand : Experience and Lessons. ASEAN Economic Bulletin Vol. 22, No. 2 (2005), pp. 217–28 , 22 (2), 217-28.

Vermeulen, S., & Cotula, L. (2010). Making the most of agricultural investment:A survey of business modelsthat provide opportunities for smallholders. FAO and IIED.

About Author: G Surabi is a Research Scholar at MIDS.