Course on

OPERATIONAL AND LEGAL ASPECTS OF CONTRACT

FARMING SCHEMES

MODULE 1: BASIC CONCEPTS IN CONTRACT

FARMING

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Contents
You will better understand:
• Value chain development, smallholders and
agrifood systems modernization
• Contract farming: what, who, how, why
• Pros and cons of contract farming for producers
and buyers
• Contract farming models
• Critical issues for successful contract farming
• Conclusions
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1. Value chain development,
smallholders and agrifood systems
modernization

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Value chain development
• VC concepts not new, but became dominant
paradigm in development thinking and practice

• Initial emphasis on efficiency, but recent concern

with other dimensions, such as inclusiveness
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Why the concern with
inclusiveness in value Region/Country Average
Farm size
Smallholder
s (106)
chain development? (ha)
Africa 1.6 33
• Poverty is essentially rural Asia 1.6 351
▫ 70% of the estimated 1.4 Latin America & 67.0 5
billion poor live in rural areas Caribbean

• Smallholder farming is Europe* 27.0 32

North America 121.0 —
predominant and essential China 0.4 193
for food security India 1.4 93
▫ More than 500 million Ethiopia 1.0 9
smallholder farmers in the Indonesia 0.9 17
world D.R. Congo 0.5 4
▫ 75% of smallholders are poor World — >500
•Data include Eastern Europe for farm size only
•Source: von Braun (2005), FAO World of Agriculture, Nagayets (2005), and Altieri
(2009).
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 Why the concern with
inclusiveness? Region / Farms with less
Country than 2 Ha
(%)

• Small farms occupy 70 to 80% ASIA

of farm land and produce China 189,394,000 98
India 92,822,000 80
more than 80% of the world’s Indonesia 17,268,123 88
food in value terms AFRICA
• Worldwide, farms of less than Ethiopia 9,374,455 87
1 hectare account for 72% of Nigeria 6,252,235 74
all farms but control only 8% D. R. 4,351,000 97
Congo
of all agricultural land AMERICAS
• Slightly larger farms between Mexico 2,174,931 49
1 and 2 hectares account for 12 Peru 1,004,668 58
percent of all farms and Brazil 983,330 21
EUROPE
control 4% of the land
Russia* 16,000,000 98
Ucraine 6,214,800 99
Romania 2,279,297 58
* Less tan 1 ha.
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Source: Nagayets, O. (2005). Small Farms: Current Status and Key Trends.
Regional
Distribution of
Small Farms

Data source: Nagayets, O. (2005). Small Farms: Current

Status and Key Trends.

Smallholder farmer - Myanmar Smallholder farmer - Malawi

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Why the concern
with inclusiveness ?
• Agrarian structures
▫ Inclusiveness based on the idea of
tapping into already existing structures
in order to avoid obstacles in the
business-environment
• No philanthropy – but good
business sense:
▫ In most countries, small and medium-
sized farms tend to have higher
agricultural crop yields per hectare than
larger farms because they manage
resources and labor more intensively
▫ Consumer responsiveness
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 Why the concern with inclusiveness?
Livelihoods of smallholder famers under
threat: recent changes in agrifood systems
• Dramatic changes
▫ The “industrialization of
agriculture”
▫ The rapid rise of the
supermarket
▫ The new consumer
▫ Safety and quality standards

• Changes driven by
▫ Demographics
▫ Income growth
▫ Technology advances
▫ Globalization
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How to promote inclusiveness?
Four main drivers to link farmers to markets:
▫ Intermediary model
 Commonly led by NGO’s, involve the provision of technical
assistance and agribusiness development to
improve smallholder market linkages
▫ Public driven
 Schools, hospitals, food reserve authorities,
food aid and school feeding programs
▫ Producer driven
 Cooperatives, lead farmers, organized
farmer groups
▫ Buyer driven
 specialized wholesalers, traditional traders
 Contract farming
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2. What is contract farming, who is
involved and how does it work?

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Contract farming: basic concepts
• What
▫ “Agricultural production carried out according to an agreement between
farmers and a buyer which places conditions on the production and / or
marketing of the commodity”
• Who
▫ Producers
▫ Processors
▫ Traders, retailers/wholesalers
▫ Public institutions, NGO’s
• How
▫ Formal and informal agreements
 Market specifications
 Resource provision
 Production management
• Why?
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Why the renewed interest?
• Contracts are not a new concept
▫ references to use in the 19th century in Asia and Latin America
▫ much use in the Americas in the 20th century
• Intensified interest and adoption in the recent past
▫ the USA: from 11% of agricultural production value in 1969 to
39% in 2008; 90% of poultry, tobacco and sugar beet production;
68% of hog production
▫ Brazil: 75% of poultry production under contracts; a new law on
contract farming passed in May 2016
▫ India, Vietnam, Morocco, Malawi, Thailand, etc.: policies to
promote contracts
▫ The literature: extensive coverage; mounting number of
references

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 Why the growing interest?
• The renewed interest in contract farming is a consequence
of the recent transformations in global agrifood systems
• Changing demand and requirements
• Growing competition in food markets
• Other factors such as demographic changes, technology or certain standards

• Supply chains increasingly need to be better coordinated

• alignment of operations: input provision, production operations, meeting
stringent standards, meeting delivery schedules, etc.

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 Supply chains in practice: the frozen
vegetable processor dilemma
• How to organize my raw material
supply chain?
▫ Produce my own vegetables?
▫ Buy from farmers?
▫ A bit of both?
Contracts,
Internal
External (full
(markets) Alliances, etc. vertical integration)

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2. Pros and cons of contracting to
link smallholders to value chains

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The pros and cons of contract farming
•Advantages for agribusiness firms
▫ greater regularity of agricultural product supplies to
the firm
▫ greater conformity to desirable product quality
attributes and to safety standards
▫ access to land is facilitated.
▫ input costs per unit are reduced
▫ access to agricultural credit and eventual financial
incentives and subsidies is facilitated
▫ labour costs are reduced
▫ expansion and contraction of production is facilitated
▫ managerial efficiency in farming may be favoured

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The pros and cons of contract farming
•Advantages for farmers
▫ inputs can be provided (less uncertainty regarding
availability, timing, credit, etc.)
▫ services can be provided (mechanization,
transportation, etc.)
▫ technological assistance can be provided
▫ production and management skills enhanced, with spill-
over effects
▫ market outlet is secured
▫ income stabilization is promoted
▫ credit access enhanced (in kind or via banks)
▫ by-products can be used
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The pros and cons of contract farming
• Disadvantages for agribusiness firms
▫ risk of contractual hold-ups
▫ transaction costs of dealing with large numbers of
farmers are high
▫ risk of misuse or side-selling of supplied inputs and of
final products
▫ internalization of support service costs
▫ loss of flexibility to seek alternative supply sources
▫ risk of undermining the corporate image

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The pros and cons of contract farming
• Disadvantages for farmers
▫ firms might renege on contractual terms if market
circumstances change or if other conditions for
opportunistic behaviour arise
▫ vulnerability to output and productivity manipulation
by agribusiness firms
▫ delivery schedules might be set by firms so as to
influence prices paid to farmers
▫ unintentional lack of transparency in price discovery
▫ loss of flexibility in enterprise choice

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The pros and cons of contract farming
• Disadvantages for farmers
▫ former linkages with markets are lost
▫ traditional farming practices lost
▫ risks associated with monoculture are enhanced
▫ social structures might be disrupted
▫ risk of indebtedness grows
▫ risk of dependency on the contracting firm on
non-farming issues

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 IMPORTANT:
The business environment has to be
carefully assessed in order to ensure
the long-term success of the
contract farming arrangement for
all involved parties.

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3. Contract farming models and
the contractual instrument

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Contract farming models
• The Centralized Model
▫ A company negotiates contracts with farmers, who supply the
desired agricultural products
▫ Common with commodities such as tea, coffee, cotton, tobacco,
poultry, etc.
▫ Normally, this model offers farmers a high level of technical
inputs, fertilizer/chemical advances and in-field management
through experienced extension officers.
 Fertilizer, chemicals and seed are usually bulk ordered by firms and issued on credit to
their farmers.
▫ In some instances machinery and farm infrastructure linked to
the contracted crop or livestock are also advanced.

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Contract farming models
• The Nucleus Model
▫ A variation of the Centralized Model in which firms
cultivate crops or raise livestock themselves, but also
negotiate contracts with satellite growers.
▫ Useful for teaching and demonstration purposes when
introducing new crops or animal rearing enterprises to
farming communities.
▫ Popular in Asia for resettlement and transmigration
schemes.

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 Contract farming models
• The Multipartite Model
▫ Jointly involves multiple actors, such as government entities,
farmer cooperatives and sometimes private companies.
▫ Normally each partner has separate responsibilities, such as
finance, management, processing and marketing.
▫ In Mexico and a number of African countries, governments have
encouraged CF in harmony with private sector interests.
▫ In China, multipartite CF ventures are made with village
committees, county governments and overseas private firms.
• Others
▫ Informal model
▫ Intermediary model

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The contractual instrument
• Contracts establish the terms and conditions for
the commercial transaction agreed among
farmers and buyers
▫ Characterizes who is involved
▫ Specifies the objective of the transaction
▫ Sets forth a number of clauses specifying what is
expected from the partners
• We will discuss contracts and legal issues in
detail during this workshop

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4. Critical issues for successful
contract farming

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Maximizing impacts of CF: critical
issues
• Basic principle
▫ Contractual relationships will only be sustainable if partners
perceive that they are better off by engaging in it
▫ Consequence: contract farming will fail if parties do not
develop mutual trust and reciprocal dependency (synergy/
cooperation is the key word)
• The importance of the enabling environment
▫ No successful contracting scheme can exist or remain
sustainable where the institutional and political setting is
not conducive to it

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Critical Issues
• Minimization of contractual hold-ups
▫ farmer: enhancement of bargaining power via collective action
▫ firm: group lending; improved communication; quality and scope
of services provided; strict treatment of defaulters; extend
contract duration

• Need to countervail uneven balance of power (an

element of enabling environment)
▫ promote farmers association
▫ third party mediation
▫ legal provisions

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More critical issues
• Need to reduce the
transaction costs of
dealing with multiple
contracting parties
▫ work with groups
▫ the preference for larger
farmers
• Need to ensure gender
equality
• Need to promote
environmental concerns
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More critical issues
• Appropriate consideration of production and
marketing risks in the design of contracts
▫ some risk sources can be known ex-ante; others not
▫ insurance funds; arbitrage mechanisms
• Choice of enterprise
▫ no a priori exception but: high value, processing and
exports are better candidates
• The legal framework
▫ to be discussed later

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In sum
• As agri-food systems change, supply chains will become
increasingly coordinated
▫ Need to deal with new asset specificities and uncertainties
• Contracts are an appealing mode of coordination
▫ Evidence suggests that potential advantages outweigh potential
disadvantages
• But! Contracts are no universal cure: may be ill-advised under
some circumstances
• Good planning, fairness, transparency and sound
implementation are essential
• Need for measures to maximize development impact
▫ A task for all involved!

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http://www.fao.org/in-action/contract-farming

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