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Contract Farming

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Contract Farming

What is contract farming/vertical

coordination?

Contract farming is a system in which agricultural

commodities are produced and supplied to a

particular buyer mostly processors under pre

negotiated terms and conditions such as price,quantity and quality.

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Objective of firms in procuring raw materials :

Right quantity

Right quality

On time

Least cost

Characteristics of agricultural commodities:

Seasonality

Perishable

Variability (Quality)

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Agribusiness

Enterprise

Open Market Contract Farming Corporate Farming

Primary

MarketTrade

Own

Production

Contract

Farmers

Simple ContractResource

Providing

Product

Specification

Procurement Options for Agribusiness Enterprise

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Open market is ideal if the firm is able to meet

Q, Q, T, C

But

There are several intermediaries between the farmer

and the processor

Multiple level handling, (successive mark ups ± cost

increases)

poor storage and improper transportation

Cost increase (margin, recover the losses of wastage)

Information asymmetry between the processors and

farmers

(Price coordinating mechanism)

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Firm incurs

Transaction costs for

Search and information cost

to bargain and take a decision(every time)

Still risk of procuring inferior material

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-- Quality attributes

± intrinsic

--flavour, texture, appearance, nutritional value

--extrinsic

-- pesticide use, genetic modification.

-- Traceability gaining importance

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Transaction cost

In open market the firm has to incur search and

information cost

Availability, quality etc

Bargaining and decision cost

Risk of procuring inferior materials

Market failure

Market failure occurs for goods ± idiosyncratic in nature

Benefits are transaction specific

Need Assurance -- recurrent demand

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Vertical Integration or Corporate Farming

Ideal option --control from sowing to packing

Helps in planning

logistics, other supplies, schedule processing etc

Incorporate market preference in production of the cropsBut

--Organizational constraintsLimitations of management to take production

Core activity of processing and marketing

Type of commodities (plantation)

-- Cost of cultivation highUse of land is seasonal (manpower, machinery idle)Labour becomes a factor of production

--Production risk transferred to the firm

--Landownership politically sensitive

Legislation to prevent concentration

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Contract Farming

Advantages for the firm

Getting the raw material in required quality and quantity in time an

least cost

Helps in logistics, processing schedule and supplies

Introduce new technique or crop to meet changing preferences

For the Farmers

Assured markets

Stable price (Production remains with the farmer)

Access to new technology

Access to outside market no information as mmetr

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Contract Farming ± An institutional innovation

Vehicle--credit, inputs, technology,

Link to the market

Expected to boost agro processing

Multiplier effect on rural economy

New Agricultural Policy 2000, ³private sector

participation will be promoted through contract farming

and land leasing arrangement to allow acceleratedtechnology transfer, capital inflow and assured

marketing of crop production.´

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Partial List of Companies Following Contract Farming

S.No Company Crops State

1 Global Greens Gherkin, baby corn, paprika Karnataka, AP

2 Sterling Agro

Products

Gherkin Karnataka

3 Ken Agri Tech -do- -do-

4 Green Agri Pack -do- -do-

5 Unicorn Agro Tech -do- -do-

6 Golden Sluis -do- -do-

7 Bharat Copper

Cutting Works

-do- -do-

8 Koelman India Ltd -do- -do-

9 Vishal NaturalProducts

-do- -do-

10 Suguna Poultry Broiler TN, AP

11. Pioneer Broiler TN

12 Sri. Venkateshwara

Hatcheries

Broiler AP,TN

13 Swathi Hatcheries Broiler TN

14 Marico Safflower Maharashtra, MP

15 Pepsico Chillies, Basmati, Goundnut Punjab

16 FritoLay(Pepsi) Potato Punjab, UP

17 Satnam Overseas Basmati Punjab

18 Escorts Basmati Punjab

19 Rallis Basmati, Wheat, Fruits and

Vegetables

Punjab, UP, MP, Maharashtra,

Karnataka

20 EID Parry Paddy (Branded rice Ponni) TN

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21 AM Todd Mint Punjab

22 Appachi Cotton

Mills

Cotton TN, Karnataka

23 Super Spinning Cotton TN

24 Rasi Spinning Attur Cotton TN

25 Vardhman Cotton Punjab, TN

26 Sami Labs Medicinal Plants and Herbs TN AP Karnataka

27 Dabur -do- AP, Himachal, UP MP, Haryana

28 Hexagon, Theni,

TN

-do- TN

29 Nandan Agro Farms

(P) Ltd Hyderabad

-do- North East

30 Himalaya

International Ltd

Culinary Herbs

(Dill, Basal and Thyme)

HP

31 United Breweries Barley Punjab

32 Jain Irrigation Onion Maharashtra

33 Mc Cain Potatoes Gujarat

34 Wimco Poplar Haryana, UP

35 Ion Exchange

Enviro Farms Ltd

Organic products of banana,

pineapple, papaya, wheat,

basmati, cotton,

TN, MP, Gujarat, Haryana,

Maharashtra

36 AV Thomas ? Vanilla Kerala

37 Prime Bio Products Cotton, Maize Sunflower Mostly TN, small presence in

Karnataka

38 Century AgroTech Jatropha TN

39 Golden Fries Ltd Potato TN

40 Mahindra Subhlabh Many crops Maharashtra, Punjab

Source: Press statements, WebPages of the companies

Note: Some may be pilot projects, others may be very small operations, while some others are third party

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Most of the agreements are bilateral in nature i.e

between the firm and the farmers

Tripartite and Multipartite agreements as well in

some cases

Tripartite agreement typically involve bank for financing the farmers

Sometimes even input dealers are involved ± Jain

irrigation, Escorts

Multipartite agreement involves input dealers

Rallis ± Farmers²SBI²HLL

Dabur²Leasing govt land --Village ± farmers

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Contract Farming Models

Centralized Model, Nucleus Estate Model, Informal

model, Intermediary model,

The nature of products dictates the kind of arrangement

under contract farming

Centralised Model

Several hundred farmers linked to central processing

plant.

Firm may be getting right quantity and quality materials

Degree of firm¶s involvement varies with the type of

crops and the market it serves

Resource providing (inputs: seed, fertilizer,

technical advice)

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Nucleus Estate Model

Processing firms owns and manages ± tea,coffee, rubber etc

They also procure from farmers around the estate

called satellite growers

Informal Model

Found in crops that need minimum processing.Sorting and grading is involved.

Most of the super markets follow the model for

fruits and vegetables to ensure supply.

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Intermediary Model

The processing company appoints intermediaries to

procure the products.

Concern about quantity rather than quality

Depends on the trade off

Rallis for HLL, Consultants for super spinning

cotton mills, Marico mandi agents

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Opportunism

Ex post advantage i.e after the investment hadbeen made

Opportunistic behaviour ± not honouring the

contract

Contract farming ± opportunistic behviour is a

major problem

More so in asset specific investments

Asset specificity ± physical, site, temporal

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Asset Specificity

The degree to which assets are specifically designed or

located for a particular use or user.

Once specific assets are locked into a relationship they can be

redeployed only at a great loss in productive value

Because relationship specific assets have much lower value in

other uses by other users. They reduce the number of

potential trading partners.

Hence, the investing party will be subject to hold up or

exploitative self interested actions by the other party to

appropriate the quasi rents and generate above normal

returns

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-- Ex post opportunistic behaviour of the farmers

Opportunistic behaviour is one in which one party

tries to take advantage after the investment has

been made and fail to honour its commitment to the

other party.

Change in weather, price, consumer preference etc

may cause opportunistic behaviour

When the firm is not an exclusive buyer of the

commodity

Several alternative uses of the commodity

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By the F irm

--Instances of firm renege on the contract to buy from

the farmers

Due to sheer mismanagement of resources, fail to read

the market

Exploit the vulnerability of the farmer (especially in long

term crops)

Cocoa, bamboo, poplar etc

Several suggestion to address opportunistic behaviour

(legislation, share holding etc)

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Model Act--State Agricultural Produce Marketing

(Development and Regulation Act 2003).

Section on Contract Farming

--Contracting company to register with the

marketing committee

--Agreement with the firm and the farmers ± to

be registered

-- Disputes to be referred to the prescribed

authority of the committee

-- Force of the decree of civil court.

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Features of a Model Contract

-- Area committed (Quantity)

-- Price or compensation (fixed or market linked)

-- Quality parameters (objective)

-- 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)

-- Penalt Clauses

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Asset Specificity

Relationship would be smooth²firm and the

farmer are locked in asset specific investments

Alternative use of the investment is smaller than

the specified use.

Survival of both parties²closely linked ± contract

± self enforcing

Some examples--certified seed production

--gherkin

--broiler chickens

--coleus

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Gherkin

New Crop± introduced in the country in the early 1990s

Consumers ± Europe, Russia, North America, Japan

Companies organise production after getting firm orders

As the crop is 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 company supply them

Processing should be done within 10 hours of picking

No local market so all the production is supplied to the contractingcompany

Company¶s commitment is heavy due to supply of seed and

pesticide

Fulfill the obligation to overseas clients.

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C oleus

Is a medicinal plant found in the wild

Belongs to the mint family

Used for pickles and in ayurvedic medicines

Sami Labs, Bangalore

U.S. subsidiary Sabinsa

Several patents in US

Patent for Forslean

Extract from the plant ± coleus forskholii

Forskholin causes weight loss, helps to increase lean body mass

Sabinsa supplies forslean to major pharmaceutical companies in the US

4000 acres (2300 TN, 1000 Karnataka and 700 acres in AP)

Organize production through Intermediary

Sami labs is the sole purchaser farmers have no alternative but to supply.

As Sami labs has to supply to its overseas client it cannot afford to fail its

commitment so purchases all the produce from the farmers

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Broilers

--Survival of hatcheries

--Affected the layer farming

-- Broiler chicken rearing not popular because of volatility of the

market

-- Idea of a feed mill owner with some farmers

--Integrated Approach

--Decentralization of rearing

--Supply of day old chicks, fee, medicines

--Lift the birds after six weeks

-- Growers paid on the basis of feed to meat conversion ratio

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M int in P unjab

AM Todd US based multinational a leading supplier of mint oils

Supplies to food, beverages and cosmetic industry

Supplier of intermediate product

Entered India in the mid 90s and chose Punjab

For the farmers the cops fits well in the crop cycle

Paddy, Potato and Mint

Volatility of price, exploitative nature of the trade

Chose contract farming

AM Todd better price, prompt payment

Returns better than other crops at the time of the year

AM Todd commitment to it clients

Farmers alternative channel unreliable

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C ertified S eed P roduction

--Certified seed production goes on smoothly for more than forty years in the

country without much problem

--Breeder seed ± supplied by the seed companies

--Cultural practices to be followed- price ± delivery at the plant etc form part of

the agreement

--Seed grower not in a position to divert the entire produce at higher price than

the contracted price ± Supply the entire produce to the company

--The seed company had invested on plant and machinery ± alternative use of

the investment is low

--Company had to cater to its loyal clients

--Cannot dishonour its commitment to the seed growers

--The relationship is working well

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S afflower in M aharashtra

Marico industries ± health and wellness segment

Saffola positioned as healthy oil

Developed a niche market

A near monopoly of Safflower oil in the organized sector

Safflower minor crop little public research

Farmers switched to more remunerative crop ± area declined

Imports from Brazil and Mexico ± high landed cost and uncertainty

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Marico promoted the crop

Entered into contract agreement with the farmers

Pre negotiated price

When the contract system was introduced

Crop failure in Brazil and Mexico

Safflower available was cornered by traders for exports

Higher price lured the farmers

Before the company could react it lost the crop

Abandoned the arrangement ± Revising the strategy for procurement

Farmers behaved opportunistically ± alternative channel offered higher

price

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W heat in U ttar P radesh

Rallis leading input manufacturer (pesticide)

Threat from spurious pesticide

Kisan Kendras (Farmers¶ centres)

Extension services to the members

Integrate input suppy and output marketing

Supplied seed and fertilizer

Not an agro processor ± contacted leading processor ± made the Kisan Kendras

procurement hub

Initial effort was in wheat in Uttar Pradesh, Fruits and Vegetable in Karnataka

Open market prices went up only 60 percent procurement by Rallis

Not able to fulfill the commitment to the clients

Abandoned the contract farming

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T omatoes in P unjab

Pepsico entered India on the condition of investing in agroprocessing

Tomato was identified by the company

Improvement on yield, solid matter, prolong processing days

Entered into contract farming with the farmers

Pre negotiated price

Open market price higher ± farmers¶ diverted the crop

Havoc in the co planning and processing schedule

Eventually the plant and scheme was abandoned

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C ocoa in K erala

Multinational chocolate manufacturer promoted cocoa cultivation in the 70s

Pre negotiated price ± assurance of good returns

But the company reneged on the commitment when the tree stated to yield

Reason international prices crashed

Company could source from anywhere

Farmers ± ruined because of long term crop

Gestation period ± economic life quite long

Opportunistic behaviour by the company

Farmers suffered because of asset specificity

No alternative buyers ± floated their own cooperative

One case of integration

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Gherkin. Coleus, Mint ,Broiler chicken

Both the farm and the farmers are locked in a specific

relationship

The investment made in the asset is specific to that

transaction

As both the farmers and the firm are hostage to each

other the contract is self enforcing

In case of Wheat, Safflower, Tomato

The farmers had alternative channels the crops were

not specific to the relationship to the company

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In case of cocoa

The firm behaved opportunistically -- tried to

hold up the farmers for a lower price as it wasa monopsony in cocoa

Farmers¶ response was to integrate forward

into chocolate manufacturing

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