Contract farming can benefit local producers if the contracts are correctly structured and monitored. The Indian experience suggests the need for alternative institutional mechanisms if contracting is to be used as a development tool.

By Sukhpal Singh

Centre for Management in Agriculture, Indian Institute of Management, Ahmedabad

SUMMARY

Globalisation and liberalisation have popularised the concept of contract farming, whereby a farmer enters into a contract with a processing/marketing firm to supply a pre-arranged quantity and quality of produce at a pre-arranged price and time (click here to read the full text of the paper).

Theoretically, contract farming is attractive to the farmer because it gives him access to additional sources of capital, brings in new technology, and ensures a more certain, and possibly better, price for his produce.

The contract farming company benefits because the system makes smaller demands on scarce capital resources, is an alternative to costly and risky corporate farming, and often provides access to unpaid family labour and state-aided agricultural schemes.

Proponents of agribusiness promotion argue that contract farming leads to big jumps in income and employment in agriculturally backward regions. It increases low levels of productivity and eliminates instability in production. Thus, overall, it puts the local economy on a dynamic path to growth and development.

In political economy terms, though, contract farming is viewed as capitalist penetration of agriculture for capital accumulation. It is seen as a way for agribusiness companies to exploit the weak farming sector in order to maximise their own profits.

This paper looks at the basic economic rationale of contract farming. It explores the existing practices and their implications. It concludes that there are many imperfections in the method that must be addressed if contract farming is to bring benefits to both producer and distributor.

WHY CONTRACT FARMING?

The production, marketing and distribution of agricultural products have all become increasingly sophisticated. Modern advances in technology have made it feasible for agricultural products to be produced to “specification” and preserved in a fresh condition. The sheer scale of operations has also been increasing, and new selling methods have emerged, emphasising the need for a brand image based on consistent quality.

Consumers too are becoming more discriminating in their tastes. They demand better quality and year-round supplies. All this has given an impetus to the search for ways of improving the co-ordination of production, processing and distribution, especially with respect to timing and quality control.

NATURE AND EFFECT OF CONTRACT FARMING

There are various types of contracts, just as there are different contracting parties. It is important that the right model and type of contract be chosen. Since farmers are not always well informed, they could end up signing contracts that exploit them.

Companies can sign contracts with big capitalist farmers who use wage labour, with small peasant farmers who use family labour, and even with the landless who lease land for contract farming. Most agribusiness companies, however, favour big farmers who can deliver in bulk and are better equipped to withstand risk. Small farmers are favoured when they dominate a region, or when they benefit from government support.

Various studies have shown that there is an adverse fallout of the contract system. For example, agribusiness firms have been found to overprice their services, pass on the risk to the producers, offer low prices for produce, and delay payments. Some firms look at contracts only as a management tool and a strategy to overcome procurement and related business problems.

Contract farming tends to shift production in favour of export-oriented and cash crops at the cost of basic food crops for the poor. This could lead to higher prices for food commodities and products, especially for non-contract farmers. The contract system could also lead to over-exploitation of resources. Firms tend to move on to new growers and lands after exhausting local resources such as land and water.

Contract farming has serious implications for existing agribusiness cooperatives. They will now have to compete with the multinational firms in terms of providing competitive prices and other incentives to retain their producer members.

THE INDIAN EXPERIENCE

Contract farming in India is currently being led by multinationals such as Unilever (tomato, chicory, tea, milk), Pepsi (potato, chillies, groundnut), Cadbury (cocoa), ITC Ltd (tobacco, wood trees, oilseeds), Cargill (seeds), domestic corporates like Ballarpur Industries Ltd, JK Paper and Wimco (eucalyptus and poplar trees), and many more.

Contract farming models involve two or more players, with banks, state corporations and franchisees being involved as well, in some cases.

In India, studies on the impact of contract farming have concentrated only on the economics of the system for special crops. Studies on tomato contract production in Punjab and Haryana, and of gherkins in Andhra Pradesh, found the net returns from these crops under contract were much higher than for those under non-contract situations, though production costs were also higher.

However, contract growers in Punjab and Haryana face many problems like undue quality cuts on produce by firms, delayed deliveries at the factory, delayed payments, low prices and pest attacks on crops. Contract tree farming schemes also did not do well for reasons mainly related to the design of the contract and the management of projects by companies.

THE CONSORTIUM APPROACH

Where agribusiness companies have played the role of facilitator in the contract farming system, the scheme has worked well. One such model is that of Mahindra Shubhlabh Services Ltd (MSSL), which has an agreement with the Government of Punjab to facilitate contract farming of maize over 1 lakh acres for export. It plans to capture 16% of the agri-input market by 2005, and increase farmer profitability by 35-60% through better input supply and better markets.

The company offers extension services to farmers for a fee, but assures a certain level of yield. If farmers get lower than the assured level of yield, they need not pay the fee. In Madurai, in Tamil Nadu, farmers paid Rs 500 per acre and achieved assured yields in 75% of the cases in the first year. This increased to 80% in the second year despite drought conditions.

Similarly, in its projects in Madhya Pradesh, Maharashtra, Karnataka and Haryana, Rallis India provides all the inputs, technical support and finance to registered growers of a specific crop. The company also facilitates the sale of produce at a reasonable price. Farmers are taught how to improve yields and are paid the prevailing market price after deducting input costs.

Conclusion AND suggestions

The contract farming system per se is acceptable. In order to make it an effective development tool, however, strong mechanisms must be in place to monitor contracts and ensure that growers -- the more vulnerable partners -- are not exploited.

One way of doing this is to encourage vigorous bargaining cooperatives or other agricultural producer organisations that can negotiate equitable contracts. In developed countries, the state can intervene to regulate contracts. Producer bargaining units and farmers' markets are additional tools the farmer should be able to use. Non-government organisations can be involved, both to ensure that the contracts are fair and to provide knowledge inputs.

Though the amended Agricultural Produce Marketing Committees (APMC) Act contains some provisions to regulate contract farming, legal protection for contract growers as a group is essential. This would include setting out clearly what the parties must do and what they cannot do in the areas of delivery, payment, returning goods, price-fixing, etc.