Contract Farming

Sukhmandeep Singh

Contract Farming
An arrangement for the production and supply of agri./allied produce under advance contracts, with a commitment to provide a commodity of a type, at a time, place and a price, and in the quantity required by a known buyer. Five aspects - pre-agreed price, quality, quantity/acreage (mini./maxi.), place, and time. Procurement/marketing, Resource provision, and Production mgt. contracts

Contract Farming Act

Model Act for contract farming is adopted by State Agricultural Produce Marketing committees (Development and Regulation Act 2003). With section on Contract Farming in this act, Contracting Company registers with the marketing committee. It will sign an agreement with the firm and the farmers to be registered. Disputes to be referred to the prescribed authority of the committee under force of the decree of civil court. Features of a Model Contract act includes, Area committed (Quantity), Price or compensation (fixed or market linked), Quality parameters, Input supply and terms, Monitoring and Supervision, Transport (lifting at the farm or delivery at the factory), Payment stream (part or full), Mode of payment (cash or cheque). Some successful examples of Model contract act are certified seed production, gherkin and broiler chickens.

Gherkin, a new crop introduced in the country in the early 1990s. Consumers of this crop were Europe, Russia, North America and Japan. Companies organize production after getting firm orders as for this crop, new seed has to be supplied by the company. Importers insisted on use of pesticides permitted in those countries to ensure the use of right kind of pesticide. Processing should be done within 10 hours of picking. No local market is there, so all the production is supplied to the contracting company. Companys commitment is heavy due to supply of seed and pesticide and also fulfilling the obligation to overseas clients.

Certified seed production goes on smoothly for more than forty years in the country without much problem. Breeder seed is supplied by the seed companies and cultural practices to be followed by farmer are according to company. The seed company had invested on plant and machinery and in return farmer delivers whole quantity of produce to the company. Pepsico introduced tomatoes in Punjab, on the condition of investing in agro processing industry. Tomato was identified by the company as potential crop, improvement on yield, solid matter, prolong processing days. It entered into contract farming with the farmers on pre negotiated price higher than open market.

Reasons for CF
Flexible for both parties Less resource demands on integrator Sharing of risk Non-availability/-viability of corporate farming option Access to market/technology/credit for farmers

Rationale for Contract Farming

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

Types of Contract Farming

These are a few of the models of contract farming that are accepted globally: -Centralized model -Nucleus Estate model -Multipartite model -Informal model -Intermediary model

Centralized model. The contracting company provides support to the production of the crop by smallholder farmers, purchases the crop from the farmers, and then processes, packages and markets the product, thereby tightly controlling its quality. This can be used for crops such as tobacco, cotton, paprika, sugar cane, banana, coffee, tea, cocoa and rubber. This may involve tens of thousands of farmers. The level of involvement of the contracting company in supporting production may vary.

Nucleus Estate model. This is a variation of the centralized model. The promoter also owns and manages an estate plantation (usually close to a processing plant) and the estate is often fairly large in order to provide some guarantee of throughput for the plant. It is mainly used for tree crops, but can also be for, e.g., fresh vegetables and fruits for export.

Multipartite model. The multipartite model usually involves the government, statutory bodies and private companies jointly participating with the local farmers. The model may have separate organizations responsible for credit provision, production, management, processing and marketing of the produce

Informal model. This model is basically run by individual entrepreneurs or small companies who make simple, informal production contracts with farmers on a seasonal basis. The crops usually require only a minimal amount of processing or packaging for resale to the retail trade or local markets, as with vegetables, watermelons, and fruits. Financial investment is usually minimal. This is perhaps the most speculative of all contract-farming models, with a risk of default by both promoter and farmer

Intermediary model. This model has formal subcontracting by companies to intermediaries (collectors, farmer groups, NGOs) and the intermediaries have their own (informal) arrangements with farmers. The main disadvantage in this model is it disconnects the link between company and farmer.

Dampeners for CF in India

APMC regulation including Gujarats tripartite Arrangement Improving open market efficiency MSP policy, and Corporate Farming including leasing of wastelands

Key benefits of contract farming The key benefits of contract farming for farmers can be summarized as: 1) improved access to local markets; 2)assured markets and prices (lower risks) especially for non-traditional crops; 3) assured and often higher returns; and 4) enhanced farmer access to production inputs, mechanization and transport services, and extension advice

Additional key benefits for contract partners and rural development often include: 1) assured quality and timeliness in delivery of farmers products; 2) improved local infrastructure, such as roads and irrigation facilities in sugar outgrower areas, tea roads, dairy coolers/collection centres, etc. And 3) lower transport costs, as coordinated and larger loads are planned, an especially important feature in the case of more dispersed producers.

Issues of concern related to contract farming As with any form of contractual relationship, there are potential disadvantages and risks associated with contract farming. If the terms of the contract are not respected by one of the contracting parties, then the affected party stands to lose. Common contractual problems include farmer sales to a buyer other than the one to whom the farmer is contracted (side selling or extracontractual marketing), a company's refusal to buy products at the agreed prices, or the downgrading of produce quality by the buyer. Side selling by farmers to competing buyers is perhaps the greatest problem constraining the growth of contract farming. Contractors also may default by failing to pay agreed prices or by buying less than the pre-agreed quantities.

Another concern about contract farming arrangements is the potential for buyers to take advantage of farmers. Buying firms, which are invariably more powerful than farmers, may use their bargaining clout to their financial advantage. Indeed, if farmers are not well organised or where there are few alternative buyers for the crop or it is not easy to change the crop, there is a danger that farmers may have an unfair deal. Tactics sometimes used are changing pre-agreed standards, downgrading crops on delivery so offering lower prices, or over-pricing for inputs and transport provided. Strengthening farmer organisations to better access appropriate services such as credit, extension services and market information and improving their contract negotiating skills can redress the potential for exploitation of farmers and poorly formulated contracts and their enforcement.

Indian Experience of CF
Different Models across regions, agencies and crops: Bi-partite, Tri-partite (with Bank or Agri-facilitator) Quad-partite (processor, agril. input co., bank, and farmer), Intermediary (public/private (agent/franchisee) model

Cases of CF success in India

Frito Lay India (FLI/Pepsi) in Potato in Mah/Karnataka AM Todd in Mint in Punjab Agrocel in Basmati paddy in Haryana

Profile of Contracts
Two direct (Agrocel and AM Todd) and one thru middleman (Frito Lay India/Pepsi) Fixed price generally but pricing option in case of FLI/Pepsi- fixed contract price and market price based flexible price

Profile of Contracts
Limited input/Post-harvest material supply on credit and free extension Very specific quality parameters Purchase of lower quality produce at lower price Delivery at specified point at farmer cost Payment within specified time period after delivery of produce No compensation for crop failure

Farmer Logic of Contracting

Better and more reliable income due to assured market and better prices Better quality inputs, on credit New technology and seeds

Experience of Mint in Punjab

Cost of production and transaction cost
under contracts lower than that for noncontract production Yields under contract lower by 35% due to new varieties but higher prices than under non-contract Net income 60% higher than under noncontract

Contract Design for Success

Minimize production costs and lower production risk (insurance by FLI and intercropping by AM Todd) Minimize or share risk and uncertainty (insurance and flexible pricing by FLI) Reduce the costs of pre- and post contractual opportunism (adverse selection and moral hazard) through contract allocation and monitoring mechanisms like social pressure, incentive structure, or group contract/incentives (moral hazard) and 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 (adverse selection)

Contract Design for Success

Encourage group or co-operative action among producers to lower transaction costs and ensure better compliance (Agrocel), Motivate long term contracts to reduce hold up problem (Agrocel), Design Clear terms contracts (AM Todd and FLI) Reduce direct costs of contracting (FLI) and Use transparent contracts

Thanx