Contract farming

Types

Eaton and Shepherd identify five different contract farming models. Under the centralized model a company provides support to smallholder production, purchases the crop, and then processes or markets it, closely controlling its quality. This model is used for crops such as tobacco, cotton, sugar cane, banana, tea, and rubber. Under the Nucleus Estate model, the company also manages a plantation in order to supplement smallholder production and provide minimum throughput for the processing plant. This approach is mainly used for tree crops such as oil palm and rubber. The Multipartite model usually involves a partnership between government bodies, private companies and farmers. At a lower level of sophistication, the Intermediary model can involve subcontracting by companies to intermediaries, who either have formal arrangements with farmers, such as cooperatives, or less-formal arrangements, such as traders. Finally, the Informal model involves small and medium enterprises who make simple contracts with farmers on a seasonal basis. Although these are usually just seasonal arrangements they are often repeated annually and usually rely for their success on the proximity of the buyer to the seller.

Issues of concern

As with any contract, there are a number of risks associated with contract farming. Common problems include farmers selling to a buyer other than the one with whom they hold a contract (known as side selling, extra-contractual marketing or, in the Philippines, “pole vaulting”), or using inputs supplied by the company for purposes other than intended. From the other side, a company sometimes fails to buy products at the agreed prices or in the agreed quantities, or arbitrarily downgrades produce quality.

The existence of an adequate legal framework is thus crucial for the successful implementation and long-term sustainability of contract farming operations. A system of law is essential to assist farmers and their buyers in the negotiation and drafting of contracts. It is also important to protect them from risks that may occur during contractual execution, such as abuse of power by the stronger bargaining party or breach of contract. Strengthening farmer organizations to improve their contract negotiating skills can redress the potential for subsequent misunderstandings. Different countries have enacted policies and legislation to ensure fair contractual practices and offer remedies for dispute resolution. A “Legal Guide on Contract Farming” was developed in 2013–15 by the International Institute for the Unification of Private Law (UNIDROIT) in partnership with FAO.

Even apparently successful contracts from a legal point of view can face other difficulties. For example, family relationships can be threatened. Work for contracts is often done by women but the contracts are invariably in the name of the man who also receives the payment. Men attend meetings and training courses but women often get no training. Land used by women for food crops or commercial production may be taken over for contract production. This can affect not only food production but also the status of the women. Contracts can break down because of poor management by the company or as a result of unrealistic expectations about the capacity of farmers or about the yields that can be achieved. This has been a particular problem with attempts to promote contract farming for biofuel crops.

Maximising the chances of success

Contract farming has to be commercially viable. To maximise profitability companies need to choose the best available farmers. Once suitable farmers have been identified it is then necessary to develop trust, as contracts will only work when both parties believe they are better off by engaging in them. To achieve this requires a willingness to collaborate and share information. Disagreements over product grading, for example, can be avoided by providing clear, simple specifications in a contract and by ensuring that farmers or their representatives are present when the produce is graded. Late payment can immediately cause a breakdown of trust and must be avoided. Contracts should be flexible to take into account the possibility of extreme events such as high open market prices or bad weather. Finally, however hard the parties try, disagreements are inevitable. Contracts should ideally make provision for arbitration by someone acceptable to both the company and the farmers. FAO's Guiding Principle for Responsible Contract Farming Operations provides concise advice on how to maximise the chances of success for both companies and farmers. Of particular importance here is the role of producer organisations in bargaining for smallholders' interests.

Studies

Numerous studies have been conducted on contract farming ventures and many are listed in the Food and Agriculture Organization's (FAO) Contract Farming Resource Centre. The Asian Development Bank Institute (ADBI) in Tokyo has conducted a series of case studies in selected Asian countries to assess the conditions for benefits to be achieved by marginal rice farmers. In Lao PDR, the research suggested that contracted farmers earned significantly higher profits than non-contracted farmers. This facilitated the transition of subsistence farmers to commercial agriculture, offering potential to reduce rural poverty. A study in Cambodia on organic rice for export assessed the effect of contract farming on farmers’ performance. This suggested that younger and more educated farmers with larger families and fewer assets were more likely to join the contract. However, farmers with access to good road communications often left the contract, indicating that contract farming had helped them to develop into independent farmers. In India, a 2023 study by the Asian Development Bank showed that contract poultry farming boosted the livelihoods of small-scale farmers producing for one of India's largest poultry producers. Contract poultry farming reduced the farmers' exposure to risks associated with price fluctuations, disease outbreaks, and feed price hikes. The study also provided evidence that contract farming with multinational companies could improve the livelihood of low- income segments.

A set of papers on the role of contract farming in promoting inclusive market access, published by FAO in 2013, coverrd contractual arrangements in Argentina, Bangladesh, Brazil, China, Honduras, South Africa, Tanzania and Thailand. The editors concluded that despite a preference for procurement from large farmers, factors other than farm size contribute to a company's decision and that contract farming would not, therefore, necessarily lead to the exclusion of small farmers from supply chains. Geographical factors were important, both in terms of how they impacted on production and in terms of factors such as land rights, gender and ethnic relationships. The editors identified a gradual convergence in clauses and conditions used in contracts and noted that the two most common contract provisions, those involving technical assistance and pre-financing of inputs, may be essential for small farmer inclusion. The publication considered the role of third parties, such as NGOs, in coordinating farmers. The editors also identifed potential roles for third parties in providing independent quality certification and in certifying contracting companies in order to reduce the risk for farmers.

In considering the subject of “side selling” the FAO publication advocated a combination of favourable incentives and explicit penalties for farmers. It also noted that in some circumstances the costs of full avoidance of contractual breaches caould be much greater than losses from side-selling, and that companies may therefore learn to live with side-selling. This would depend on the size of the firm and the amount invested in farmers. Drawing in detail from the case studies, the publication reiterated the importance of a suitable enabling environment. However, it also concluded that in certain cases the lack of such an environment is not necessarily a binding constraint to contract farming, particularly where flexibility and non-conventional contractual clauses can be used. Although an enabling environment is important, the editors cautioned against government incentives and subsidies to promote inclusion as these could give a misleading impression of profitability and jeopardize sustainability. They also noted that the costs to the firm of pursuing an inclusive strategy were rarely considered by proponents of the concept.

Prowse (2012) provided a comprehensive review of issues in contract farming in developing countries. Several studies offered a positive message on the inclusion of smallholders and the benefits they accrued from participation. For example, in a study published in 2014, Wang, Wang and Delgado review a large number of empirical studies of contract farming. They concluded that contract farming had had a significant impact on improving farm efficiency and productivity, and farmer incomes. In a synthetic review of econometric studies, Minot and Ronchi (2015) suggested that participants’ incomes increased by 25-75%. A more measured approach was taken in Ton et al.'s (2017) systematic review of contract farming. Although their study found that contract farming could substantially increase farmer income, Ton et al. argued that such figures needed to take publication and survivor bias into account. In other words, studies that showed negative or no 'impact' were less likely to be published, and the calculation of the impact of contract farming may neglect schemes that do not improve incomes for smallholders or that collapsed and were thus are not available for evaluation.

Alternative contractual models

To avoid making large investments in farm equipment, farmers often hire the services of contractors to carry out activities such as land preparation, seeding, fertilization and harvesting. An alternative approach involves an agreement, or joint venture, between a landowner or tenant and a contractor to farm an area of land. As implemented in the United Kingdom, this model is based on a contractor carrying out all farming activities, receiving a fixed fee to cover its costs, together with a share of the eventual profits. The advantages of this arrangement for farmers should include lower labour and machinery costs, as contractors working on several farms can benefit from economies of scale denied to individual farmers. The profit-sharing nature of the agreement should also incentivise the contractor to be as efficient as possible. For contractors, the advantages are that they can farm large areas of land without having to buy it or enter into tenancy agreements. Contractors should also benefit from economies of scale by spreading machinery and labour over a larger area of land.

Popular culture

A 2015 episode of the US television show Last Week Tonight with John Oliver documented contract farming for poultry in the US, arguing that many of the farmers were below the poverty line.