Sukhpal Singh

CMA
IIM
Ahmedabad
 Input and output market failure for farmers
• Procurement failure for agro-industry (Cost
and Quality Competitiveness reasons)
Promoting high-value new crops
Lowering cost of production (either by raising
productivity or cutting costs directly)
Raise returns by value addition
Lowering transaction costs
An arrangement for the production and supply of
agril./allied produce under advance contracts, with
a commitment to provide a commodity of a type, at
a time and a price, and in the quantity required by
a known buyer.
Four major aspects - pre-agreed price, quality,
quantity or acreage (mini./maxi.) and time.
Three types of contracts: Procurement/marketing,
Partial input supply and purchase (resource
provision), and Complete - (production mgt.)
Flexible for both parties
Less resource demands on integrator
Sharing of risk
Non-availability/-viability of corporate farming
option
Access to market/technology/credit by farmers
Pressures/opportunities like organic trade, fair
trade, ethical trade
supermarket chain growth including FDI in
retail
international trade and quality issues like
SPS measures, organic trade/fair
trade/ethical trade
banking and input industry push for CF
farming crisis
failure of traditional cooperatives, and
withdrawal of state from agricultural space
 !

APMC regulation including Gujarat’s tri-

partite arrangement
Improving open market efficiency
MSP policy, and
Corporate Farming including leasing of
wastelands
There is so much diversity in the type of
firms, farmers, nature of contracts, crops, and
socio-economic environment that it is better to
focus on specific situation than the generic
institution of contract farming.
The context of the contract is important as
many contextual factors and actors influence
the working and outcome of a contract system.
And, there is no single model suitable for all
conditions but a series of alternatives.
Reasons for Preference to Large Farmers
• They produce better quality crops
• More efficient and business - oriented
• Large volumes availability (Low collection
cost)
• Provision of services by large farmers, e.g.
transport, storage etc.
• Lower transaction costs
Reasons for Working with Small Farmers
• Area dominated by small farmers
• Govt. directive or incentive
• Nature of crop/commodity (gherkins)
• Lower cost small producers
• To spread risk of default
• To use state support for small farmers
• Less organised and easy to ‘manage’
• Image-building exercise
 "!

Different Models across regions, agencies

and crops
Role of state- direct and indirect
Centralised model - private sector
agencies
(many-2 examples)
Company
Supply of
produce

Supply of inputs Farmer

on credit

Fig.1: Bi-partite CF model

 Company Payment
Bank
Payment for inputs

Supply of
produce

Credit and
Payment after
Supply of inputs
on credit Farmer/AoF deduction of dues
/Cooperativ (in some cases)
e

Fig 2: Tri-partite CF model

 #$ % &

Government sponsored/public sector or joint

venture projects

NDDB’s F&V project (Safal)

Agrocel, Kutch (organic cotton and sesame
project)
 # $!

where state, private firms, and

national/international development agencies
are involved
CF in Punjab
 State
Input supply &
payment for produce
(PAIC)

Produce

Payment

Produce
MoU
Farmer
Payment Company
for service

Input
Extension
Company/ies

Fig 3: State-led contract farming system in Punjab

 Direct
Farmer

Extension
co./buying
Machines co./PAFC
and
equipment
PAFC Reimbursement of
extension fee, waiver
of purchase taxes,
and approval of CF

Fig 4: State-led contract farming system in Punjab (revised

model)
 # # – #$

Captive and contract farming both

Ion exchange, Pune (organic farming)
Satluj Organics, New Delhi
 '
( &) * & +
Most of the seed companies
Pepsi in Mah/Kar/MP for potatoes
Food World (Spencer’s)’s Farmer-vendors
Fabindia in textiles and organic food (With a
Difference: 700 groups (7500 artisans) across 20
states in India
Many companies in Punjab/Haryana including
organic
Most predominant model in India and Thailand
 Farmer selection &
documentation Bank
Payment for
produce

Agri
input Payment P
company for inputs a Processor/
y Marketer
m
e
n
Supply of
inputs
t

Farmer Produce supply under

agreement

Fig 5: The Quad-partite CF model

 Fig 6: The six-partite (networking) CF model

Farmer selection &

documentation under Bank
Payment for
c agreement
Agri input cos. produce
o under
n agreement
t Franchisee
r Payment P
a for inputs
a Processor/
c Marketer
y
t Supply of
inputs/extension m
for a fee
e
contract n
Agri input co./ agreement
facilitator t
agreement
Subfranchisee
Farmer
agreement

Produce supply under

agreement
PAFC
 Fig. 7: Tri-partite (Intermediary) model of contract farming

Contract production
organization, supply of Local
company seed (with Middleman
Grower part advance payment /Facilitator/
by grower), extension,
Farmer and input credit under
production
selection, agreement with no organiser
package of liability on company
practices,
payment for Farmer
produce (thru adoption and
bank* to tripartite
Procurement
farmer and agreements,
at fixed or
facilitator), and procurement
mkt. linked
supervision , & local
price,
under quality lab Seed supply, payment of
grading &
agreement mgt. under commission for extension,
quality
agreement procurement & seed
testing of Supply of produce
produce by through facilitator distribution services under
facilitator under tripartite agreement &
agreement with no reimbursement of
liability on company Company seed/other costs & seed
for any loss replacement
Company
Collection
Centre/
Factory

* Bank finances contract production @ Rs. 10,000/acre (NABARD norm is Rs. 13,000/acre for potato) at
7.5% rate of interest. It receives the money from the company for payment to the farmer for his produce,
from which it pays the facilitator (as per the authorization given by the grower), deducts its own dues, and
transfers the remaining amount in the farmer’s bank account.
Intermediary model due to the transactions
cost logic and competitive national and
international food/fibre markets where
cost and quality will determine success. It
is already being practiced in different forms
by many CF agencies. But, the exclusion of
small farmers will remain an issue and their
deprivation is likely to increase in the
absence of more competitive open markets
Co-operative-Corporate Alignment
Thai PGC with Frito-Lay Thailand (Pepsico)
Bimandiri model in Indonesia
It works with farmer groups on the basis of agreed
quantities for supply only to Carrefour.
Prices are either fixed in advance or related to
returns within a floor/ceiling price range.
The company’s margins are said to be fully
transparent.
 Contract Farming System in Thailand

Seed/Inputs/ Seed / Inputs/

Payments Payments/ Commission
Broker/Collector/
Farmer/Farmer Cooperative (PGC/LSC) formal
Group verbal Company
/Local Co.

(Direct)
Produce Produce

Credit &
Coordination &
Extension
Facilitation
State (BAAC & DOAE)
 "!

Default by companies and farmers (Moral

Hazard problem)
High transaction cost of dealing with small
farmers
Farmer level performance – higher returns
but also higher cost, undue quality cuts,
delayed deliveries and payments, low price
(‘agribusiness normalisation‘), poor extension, and
seed/crop failures
 "!
Farmer’s production risk not shared
Prices based on open market prices, including for
organic produce (even market risk not shared!). Issue
of what is fair price for the primary grower remains as
there is little transparency in pricing and costing of
operations
Monopsonistic situation faced by the growers
Biased contracts
Penalties for failure to meet contract terms
Business ethics/commitment - withdraw/ move away
after exhausting potential
 !
Small farmer exclusion (due to admission criteria) e.g.
MARKFED, and NESTLE
Nestle follows two types of contracts- direct legal with
large farmers with more than 25 animals and indirect
(through agents with legal contracts) for small farmers
with a few cattle/buffalo only. The latter mode
dominates procurement.
Employment increase but sustainability (mechanisation)
and gender and child labour issues
Ecological sustainability – perpetuation of chemical
input intensity, except when organic/export market
driven
Socio-economic differentiation – perpetuation of
‘reverse tenancy’
 * %
, ( !
Mandatory and optional provisions
Mandatory (who can do CF, contract
specifications, liabilities, farmer asset
indemnity, and dispute resolution)
Optional (farm practices, insurance,
monitoring, farmer body, and support)
 * %
, ( !
Registration with the local authority
Quite fair contract in terms of sharing of costs
and risks but silent on delayed payments
and deliveries, contract cancellation
damages, production risk sharing,
tournaments, and forbidden acts
Gujarat APMC Act amendment
 *$

Scrutiny of contracts, public contract terms, and

competition in procurement (monopsony)
Legal protection to growers like in Japan/USA
(clear written terms contract, and forbidden acts
like advance payments, compulsory purchase of
inputs, forced price reduction, and refusal to buy;
monitoring by FTC in Japan)
Fixed price or Pricing options, not market price
based price
 , # , -.///
-
Requires contracts to be:
in plain language and disclose material risks,
provides a three days cancellation period for the
producer to review and discuss production
contracts with their advisors,
provides for producers to be first priority lien for
payments due under a contract in case of
contracting company bankruptcy,
protects against undue cancellation of contracts by
companies, and
prohibits ‘tournaments’ (contracts where
compensation to grower is determined by his
performance relative to others)
 , $
Encourage group contracting – lowers
transaction cost, ensure better compliance,
and builds local capability
Link credit to CF, though not mandatory or
exclusive (lower interest rates for CF (Thai
model)?)
Remove policy indifference to small farmers
(MFPI and Punjab schemes)
 , $
Strong producer organisations/groups to
negotiate (the Thai potato groups and the
PGC)
Institutional innovations like the NGCs for
input and output, Franchising, Producer
companies, Co-operatives as contractors
(marriage of Co-operation and CF)
Encourage use of fair trade, SA 8000, and
ethical trade standards in dealing with
growers to protect the grower and the labour
interest.
Is there enough rationale for CF (market
failure)?
Crops suitable for small farmer CF - short
duration, labour intensive, not high cost
Marketing extension: Market information,
Product planning, Accessing markets,
Alternative markets, Market orientation
Build trust by: Fair contracts, crop insurance
(Pepsi with Agril Insurance Co and Gherkin
firms with New India Assurance Co), and
remunerative prices or lower costs. EQUITY
Shares?
Designing a Workable Contract
Co-ordination, Motivation and Transaction costs
are three pillars of a contract arrangement
(i) co-ordinating to minimize production costs which
means using price signals or instructions or both,
(ii) balancing decentralization and centralisation in
farm decisions which impacts problems like moral
hazard and hold up,
(iii) minimizing or sharing risk and uncertainty,
(iv) reducing the costs of post contractual
opportunism (Moral hazard) by various mechanisms
of monitoring contracts like other party bears part of
the cost, Social pressure, Incentive structure, and
Group contract/incentives
Designing a Workable Contract
(V) Reducing the cost of pre-contractual opportunism (Adverse
selection) by Rationing i.e. offer a contract suited only for some
‘good’ farmers; ‘Menu of contracts’ for screening farmers so that
they reveal their true type by choosing certain contracts; Group
contracts, and Individual risk rating/information collection before
contract is signed
(vi) Do Not Kill Co-operation: encouraging group or co-
operative action among producers to lower costs and ensure
better compliance,
(vii) Motivate Long term Contracts to reduce hold up problem
(viii) balancing pros and cons of renegotiation of contracts
over time,
(ix) reducing direct costs of contracting, and
(X) using transparent contracts
 #

Competition in CF
Let CF whither away? But, it may not
Small farmer upgradation
/organisation/incentives for inclusion
Too many hopes from CF?
Regulation must - not more, but better
 ! ' ! #
Target
Educated small farmers only? Needed and Relevant
for south Asia?
Niche markets- product differentiation and branding
e.g. fair trade, organic, place of origin, poor
producer concern, co-op. products
Domestic markets – supermarkets and
fresh/processed markets
Large scale Corporate farming- poverty reduction
through wage linkage? Bharti’s Fieldfresh model in
Punjab
Thanks