CONTRACT farming (CF) is central to the ‘linking farmers with markets’ policy thrust in developing world agriculture/agribusiness as it brings private corporate agribusiness entities in direct contact with the primary producers. In simple terms, CF is a system for production and supply of agricultural products by farmers to a buyer under advance contracts. There is a commitment by the farmer to produce and provide the specified commodity, at a specified time and location, price, and in specified quantity to a known committed buyer. The contracts could be only procurement agreements, input supply and purchase contracts or could control the entire production process on the farm. But, the exact nature of CF varies depending on the nature and type of contracting agency, technology, nature of crop/produce, and the local/national context. Also, different types of production contracts allocate production and market risks differently between the producer and the buyer.

Due to the efficiency and equity (smallholder inclusion) benefits (compared with corporate farming), CF has been aggressively promoted in the developing world by various agencies. In India, food supermarket chain growth; international trade aspects like sanitary and phyto-sanitary measures, and organic/fair/ethical trade; state promotion of CF; banking and input industry push for CF; farming crisis and reverse tenancy; and the failure of traditional cooperatives, will help spread of CF as they provide new space to CF in the context of withdrawal of state from agricultural sector especially procurement, extension, credit, and insurance.

The government has been promoting CF at various levels (Union and state) with recent policy changes (amendment of the Agricultural Produce Marketing Committee – APMC – Act) and fiscal incentives. But, it is known from experience elsewhere that CF has implications for larger developmental goals like equity, environment, gender, and labour, both positive and negative, depending on the context.

CF gives access to additional sources of capital (credit), and a more certain price to farmers by shifting a part of the risk of adverse price movement to the buyer. Farmers also get access to new technology and inputs. In fact, CF is seen as an institutional innovation for agricultural development. For agribusiness, CF is also an alternative to corporate farming which may be costly, risky, non-available, difficult to manage, and not viable in competitive markets. Contract farming lowers transaction costs for the farmers as well as the buyers as many of the transactions are internalized.

 

Given the predominance of small producers in economies like India, small producer participation in CF has been an important issue as their inclusion is rather an exception. The factors which result in CF excluding small producers are: enforcement of contracts, high transaction costs, quality standards, business attitudes and ethics like non/delayed/reduced payment and high rate of product rejection, and weak bargaining power of the small growers. On the other hand, the organizers of CF find it costly to work with them due to their scattered location and smaller volumes.

Contracting agencies impose eligibility conditions for contract production like certain land size, irrigated land, literacy level of the farmer, no non-contract crop production in the neighbouring fields, and certification which are discriminatory in terms of who can be a contract grower. In fact, several studies have shown that in CF, private agribusiness firms have less interest and ability to deal with small farmers on an individual basis and tend to prefer larger farmers for CF which leads to lower cost procurement for the firm.

 

Contract farming has various models/variants being practiced in India at present like bi-partite model, tri-partite model involving a bank or a facilitator or a subcontractor, quad-partite model involving bank, processor, CF organizer, and the farmer and even a multi-partite model involving franchisees besides the above said players. Various studies have shown that contract production of tomato gave much higher gross returns compared with that from the traditional crops of wheat, paddy and potato in Punjab as well as net higher returns compared with those under non-contract situations. The cases of cucumber CF in Andhra Pradesh and cotton CF in Tamil Nadu were similar. This was due to higher yield and assured price under contracts. However, the cost of production is generally higher under the contract system.

A study on poultry CF revealed that the cost of production of contract growers was higher and the net income of contract growers not much different from that of non-contract growers because processors chose only those contract growers whose skills, experience and access to credit were relatively poor and the processors captured most of the surplus from contract production. The contracting agencies also manipulated provisions of the contracts in practice like picking up birds before due date or delaying it which meant losses for contract growers. But, growers were locked into these contracts due to the buyer specific fixed investments they had made.

Across crops and regions, studies have shown that most firms worked with large and medium farmers with the exception of firms in Karnataka, Tamil Nadu, and Andhra Pradesh where small and marginal farmers were also included due the nature of the crops (cucumber/gherkin, and broiler chicken). Even a state sponsored cooperative (Markfed) in Punjab did not entertain farmers who could not spare at least three acres for its basmati paddy CF programme. In mint CF in Punjab, contract farmers were found to own holdings ranging from 5 to 30 acres with the average being over 17 acres and operated land holding, including leased in land, around 57 acres. This bias in favour of large/medium farmers is perpetuating the practice of reverse tenancy in regions like Punjab where these farmers lease in land from marginal and small farmers for contract production.

Breach of contracts by farmers as well as firms has also been reported. Even the state sponsored programme of CF did not deliver in Punjab. Further, most of the contracts protected company interest passing all costs to the farmer and did not cover farmer’s production risk, e.g. crop failure, and generally offered open market price based contract prices. Even organic produce buyers offered conventional produce market price based prices to their growers. This is a serious issue as even a significant premium over market price may not help a farmer if open market prices go down significantly, which is not uncommon in India. CF can also hurt the interests of non-CF growers as it can result in lower buyer competition in spot markets for a (contract) crop where non-contract growers sell.

 

By determining the crop to be grown and the husbandry practices, the contracting agency influences the impact CF will have on the environment. The environmental implications of CF include depletion of soil quality, exploitation of groundwater, salination of soils, decline in soil fertility, pollution of soil and water due to excessive use of chemical inputs and their impact on environment, humans and animals. CF tends to aggravate the environmental crisis as contracts are short term and the firms tend to move on to new growers/lands after exhausting the natural potential of the local resources, particularly land and water. In Punjab, the contract farmers were practicing more intensive agriculture than the non-contract farmers and were growing basmati and maize (new crops promoted under CF for diversification) more water intensively than that by non-contract farmers across all crops. The contracting agencies do not pay any heed as such cost effects are externalised for them.

 

However, it is not that CF always leads to negative impacts on the local resource base. A Canadian MNC subsidiary into potato CF with growers in Gujarat made it compulsory for the contract growers to go in for micro irrigation, given the low groundwater table in the area. This condition about micro-irrigation was not even mentioned in the contract, but all the contract farmers had sprinkler systems. Most of the organic production takes place under CF and promotes more ecofriendly and sustainable practices. What comes out from the above analysis is that environmental concerns are increasingly dictated by market demand, e.g. in the case of chemical residues or organic practices.

But, markets may not signal the importance of ecological concerns in all situations and at all times due to various imperfections in the market and externalities in the presence of weak monitoring. For example, in Kenya, soil erosion was not attended to by the contracting agencies as that was not reflected in the product quality and was an externality of contract production. Similarly, price premiums for environment friendly food may not encourage genuineness due to incentive to cheat and mislabel because of information asymmetry. Therefore, it is important to proactively provide mechanisms in CF policies to ensure environmental compliance. This can be done by way of land use planning based on soil depth, soil quality, land slope, land use pattern and water availability.

 

Though it may not be possible to police contracts, but the state/government can still play both a regulatory and an enabling/developmental role in CF. Legal protection to contract growers as a group must be considered to protect them from the ill-effects of CF. There are cases of legal protection given to subcontracting industries in Japan in their relations with large firms and in some provinces of the USA for contract growers. If CF is nothing but a flexible production system prevalent in industry applied to farm production, then it is only logical to extend such legal provisions with necessary modifications to CF.

The model CF agreement under the amended APMC Act leaves out many aspects of farmer interest protection like delayed payments and deliveries, contract cancellation damages if producer made buyer specific heavy investments, inducement/force/intimidation to enter a contract, disclosure of material risks, competitive performance based payments, and sharing production risks, though it provides the producer asset indemnity in case of default by contract grower.

Collective action by producers’ organizations may encourage firms to seek alternative non-organized growers by relocating their operations to new areas or to integrate backwards vertically. On the other hand, organizing cooperatives can help lower transaction cost for firms and small growers. In CF with small producers in West African countries, the cotton companies transferred many operational or functional responsibilities like distribution of inputs, equipment orders, and credit repayment management, to the village associations and provided them with management skills for these tasks which led to successful CF. In India, Spencer’s Retail procures ‘ready-to-retail’ products from the contract growers.

The amended Companies Act in India provides for registering producer companies since 2003 and many such companies have already been set up. Contracting agencies should encourage such initiatives. Giving farmers equity shares can make them feel that they are a part of the arrangement and realise that failing the firm would be failing themselves. In fact, in Karnataka, a public limited sugar company had mobilized 30 per cent of its equity from more than 9,000 sugarcane contract growers as its shareholders. Earning the farmer’s trust is fundamental to success. This comes from mutuality of benefits.

 

Finally, there is no need to look for permanence in CF, though short or medium term sustainability is desirable to ensure its beneficial effects on growers and local economy. CF is only an instrument/means to agricultural development, not an end in itself. CF can wither away as a commodity market becomes efficient because it is only a response to a situation of market failure and depends on commodity/crop/sector dynamics which are liable to change, especially in a globalized and liberalized world. But, there are many indications that CF can continue even in the presence of competitive markets as in the developed countries or even developing countries like Thailand.