Contract Farming Models - Delhi

Sukhpal Singh CMA IIM Ahmedabad

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Input and output market failure for farmers Procurement failure for agro-industry (Cost and Quality Competitiveness reasons) Promoting high-value new crops Lowering cost of production (either by raising productivity or cutting costs directly) Raise returns by value addition Lowering transaction costs

An arrangement for the production and supply of agril./allied produce under advance contracts, with a commitment to provide a commodity of a type, at a time and a price, and in the quantity required by a known buyer. Four major aspects - pre-agreed price, quality, quantity or acreage (mini./maxi.) and time. Three types of contracts: Procurement/marketing, Partial input supply and purchase (resource provision), and Complete - (production mgt.)

Flexible for both parties Less resource demands on integrator Sharing of risk Non-availability/-viability of corporate farming option Access to market/technology/credit by farmers Pressures/opportunities like organic trade, fair trade, ethical trade

supermarket chain growth including FDI in retail international trade and quality issues like SPS measures, organic trade/fair trade/ethical trade banking and input industry push for CF farming crisis failure of traditional cooperatives, and withdrawal of state from agricultural space

! APMC regulation including Gujarat’s tripartite arrangement Improving open market efficiency MSP policy, and Corporate Farming including leasing of wastelands

There is so much diversity in the type of firms, farmers, nature of contracts, crops, and socio-economic environment that it is better to focus on specific situation than the generic institution of contract farming. The context of the contract is important as many contextual factors and actors influence the working and outcome of a contract system. And, there is no single model suitable for all conditions but a series of alternatives.

Reasons for Preference to Large Farmers • • • • •

They produce better quality crops More efficient and business - oriented Large volumes availability (Low collection cost) Provision of services by large farmers, e.g. transport, storage etc. Lower transaction costs

Reasons for Working with Small Farmers • Area dominated by small farmers • Govt. directive or incentive • Nature of crop/commodity (gherkins) • Lower cost small producers • To spread risk of default • To use state support for small farmers • Less organised and easy to ‘manage’ • Image-building exercise

"! Different Models across regions, agencies and crops Role of state- direct and indirect

Centralised model - private sector agencies (many-2 examples) Company Supply of produce

Supply of inputs on credit

Farmer

Fig.1: Bi-partite CF model

Company

Payment

Bank Payment for inputs Supply of produce

Supply of inputs on credit

Fig 2: Tri-partite CF model

Farmer/AoF /Cooperativ e

Credit and Payment after deduction of dues (in some cases)

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Government sponsored/public sector or joint venture projects NDDB’s F&V project (Safal) Agrocel, Kutch (organic cotton and sesame project)

# $! where state, private firms, and national/international development agencies are involved CF in Punjab

State (PAIC)

Input supply & payment for produce

Produce

Payment Produce

MoU

Farmer Payment for service

Extension

Input Company/ies

Fig 3: State-led contract farming system in Punjab

Company

Farmer

Machines and equipment

Direct Extension co./buying co./PAFC

PAFC

Reimbursement of extension fee, waiver of purchase taxes, and approval of CF

Fig 4: State-led contract farming system in Punjab (revised model)

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Captive and contract farming both Ion exchange, Pune (organic farming) Satluj Organics, New Delhi

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Most of the seed companies Pepsi in Mah/Kar/MP for potatoes Food World (Spencer’s)’s Farmer-vendors Fabindia in textiles and organic food (With a Difference: 700 groups (7500 artisans) across 20 states in India Many companies in Punjab/Haryana including organic Most predominant model in India and Thailand

Farmer selection & documentation

Agri input company

Bank

Payment for inputs

Supply of inputs

P a y m e n

Payment for produce

Processor/ Marketer

t Farmer

Fig 5: The Quad-partite CF model

Produce supply under agreement

Fig 6: The six-partite (networking) CF model

c Agri input cos. o n t r a c t

Farmer selection & documentation under agreement

Franchisee

Payment for inputs Supply of inputs/extension for a fee

contract

agreement

Agri input co./ facilitator

Bank

P a y m e n

t

agreement Subfranchisee Farmer

agreement

PAFC

Produce supply under agreement

Payment for produce under agreement

Processor/ Marketer

Fig. 7: Tri-partite (Intermediary) model of contract farming

Grower

Procurement at fixed or mkt. linked price, grading & quality testing of produce by facilitator

Company Collection Centre/ Factory

Farmer selection, package of practices, payment for produce (thru bank* to farmer and facilitator), and supervision under agreement Supply of produce through facilitator under tripartite agreement with no liability on company for any loss

Contract production organization, supply of company seed (with part advance payment by grower), extension, and input credit under agreement with no liability on company Farmer adoption and tripartite agreements, procurement , & local quality lab mgt. under agreement

Company

Local Middleman /Facilitator/ production organiser

Seed supply, payment of commission for extension, procurement & seed distribution services under agreement & reimbursement of seed/other costs & seed replacement

* Bank finances contract production @ Rs. 10,000/acre (NABARD norm is Rs. 13,000/acre for potato) at 7.5% rate of interest. It receives the money from the company for payment to the farmer for his produce, from which it pays the facilitator (as per the authorization given by the grower), deducts its own dues, and transfers the remaining amount in the farmer’s bank account.

Intermediary model due to the transactions cost logic and competitive national and international food/fibre markets where cost and quality will determine success. It is already being practiced in different forms by many CF agencies. But, the exclusion of small farmers will remain an issue and their deprivation is likely to increase in the absence of more competitive open markets

Co-operative-Corporate Alignment Thai PGC with Frito-Lay Thailand (Pepsico) Bimandiri model in Indonesia It works with farmer groups on the basis of agreed quantities for supply only to Carrefour. Prices are either fixed in advance or related to returns within a floor/ceiling price range. The company’s margins are said to be fully transparent.

Contract Farming System in Thailand Seed / Inputs/ Payments/ Commission

Seed/Inputs/ Payments Farmer/Farmer Group

Broker/Collector/ Cooperative (PGC/LSC) formal verbal /Local Co. Produce

(Direct)

Company

Produce

Credit & Extension

Coordination & Facilitation State (BAAC & DOAE)

"! Default by companies and farmers (Moral Hazard problem) High transaction cost of dealing with small farmers Farmer level performance – higher returns but also higher cost, undue quality cuts, delayed deliveries and payments, low price (‘agribusiness normalisation‘), poor extension, and seed/crop failures

"! Farmer’s production risk not shared Prices based on open market prices, including for organic produce (even market risk not shared!). Issue of what is fair price for the primary grower remains as there is little transparency in pricing and costing of operations Monopsonistic situation faced by the growers Biased contracts Penalties for failure to meet contract terms Business ethics/commitment - withdraw/ move away after exhausting potential

! Small farmer exclusion (due to admission criteria) e.g. MARKFED, and NESTLE Nestle follows two types of contracts- direct legal with large farmers with more than 25 animals and indirect (through agents with legal contracts) for small farmers with a few cattle/buffalo only. The latter mode dominates procurement. Employment increase but sustainability (mechanisation) and gender and child labour issues Ecological sustainability – perpetuation of chemical input intensity, except when organic/export market driven Socio-economic differentiation – perpetuation of ‘reverse tenancy’

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Mandatory and optional provisions Mandatory (who can do CF, contract specifications, liabilities, farmer asset indemnity, and dispute resolution) Optional (farm practices, insurance, monitoring, farmer body, and support)

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Registration with the local authority Quite fair contract in terms of sharing of costs and risks but silent on delayed payments and deliveries, contract cancellation damages, production risk sharing, tournaments, and forbidden acts Gujarat APMC Act amendment

*$ Scrutiny of contracts, public contract terms, and competition in procurement (monopsony) Legal protection to growers like in Japan/USA (clear written terms contract, and forbidden acts like advance payments, compulsory purchase of inputs, forced price reduction, and refusal to buy; monitoring by FTC in Japan) Fixed price or Pricing options, not market price based price

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Requires contracts to be: in plain language and disclose material risks, provides a three days cancellation period for the producer to review and discuss production contracts with their advisors, provides for producers to be first priority lien for payments due under a contract in case of contracting company bankruptcy, protects against undue cancellation of contracts by companies, and prohibits ‘tournaments’ (contracts where compensation to grower is determined by his performance relative to others)

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Encourage group contracting – lowers transaction cost, ensure better compliance, and builds local capability Link credit to CF, though not mandatory or exclusive (lower interest rates for CF (Thai model)?) Remove policy indifference to small farmers (MFPI and Punjab schemes)

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Strong producer organisations/groups to negotiate (the Thai potato groups and the PGC) Institutional innovations like the NGCs for input and output, Franchising, Producer companies, Co-operatives as contractors (marriage of Co-operation and CF) Encourage use of fair trade, SA 8000, and ethical trade standards in dealing with growers to protect the grower and the labour interest.

Is there enough rationale for CF (market failure)? Crops suitable for small farmer CF - short duration, labour intensive, not high cost Marketing extension: Market information, Product planning, Accessing markets, Alternative markets, Market orientation Build trust by: Fair contracts, crop insurance (Pepsi with Agril Insurance Co and Gherkin firms with New India Assurance Co), and remunerative prices or lower costs. EQUITY Shares?

Designing a Workable Contract Co-ordination, Motivation and Transaction costs are three pillars of a contract arrangement (i) co-ordinating to minimize production costs which means using price signals or instructions or both, (ii) balancing decentralization and centralisation in farm decisions which impacts problems like moral hazard and hold up, (iii) minimizing or sharing risk and uncertainty, (iv) reducing the costs of post contractual opportunism (Moral hazard) by various mechanisms of monitoring contracts like other party bears part of the cost, Social pressure, Incentive structure, and Group contract/incentives

Designing a Workable Contract (V) Reducing the cost of pre-contractual opportunism (Adverse selection) by Rationing i.e. offer a contract suited only for some ‘good’ farmers; ‘Menu of contracts’ for screening farmers so that they reveal their true type by choosing certain contracts; Group contracts, and Individual risk rating/information collection before contract is signed (vi) Do Not Kill Co-operation: encouraging group or cooperative action among producers to lower costs and ensure better compliance, (vii) Motivate Long term Contracts to reduce hold up problem (viii) balancing pros and cons of renegotiation of contracts over time, (ix) reducing direct costs of contracting, and (X) using transparent contracts

# Competition in CF Let CF whither away? But, it may not Small farmer upgradation /organisation/incentives for inclusion Too many hopes from CF? Regulation must - not more, but better

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Target Educated small farmers only? Needed and Relevant for south Asia? Niche markets- product differentiation and branding e.g. fair trade, organic, place of origin, poor producer concern, co-op. products Domestic markets – supermarkets and fresh/processed markets Large scale Corporate farming- poverty reduction through wage linkage? Bharti’s Fieldfresh model in Punjab

Thanks