Contract farming is a system in which agricultural commodities are produced and supplied mostly to processors and exporters under pre-negotiated management. Such farming helps bring producers and processors close on mutuality terms. In contract farming, the processors get assured supply of quality materials on mutually beneficial terms. The producers also get ready market and remunerative prices under the arrangement. Generally, there are two types of contracts: marketing and production. Marketing contract refers to a verbal or written agreement between a contractor and a grower. Such agreement sets a price and an outlet for a commodity prior to the harvest or before the commodity is ready to be marketed.
In fact, production contract specifies in detail the quality and quantity of a commodity to be produced and the type of compensation the producer would receive for his/her endeavour. The contractor may furnish all the necessary inputs. In contract farming, most management decisions remain with the growers because they retain ownership till the final disposal of the commodity. Despite bearing all the production risks, the producers share the price risk of the contractors.
Production methods Since the contractors monitor the production methods used and the quantity produced, the nature of contract relies on the type of the crop and the company's objective area of cooperation. Actually, contracting out production is a commercial decision to facilitate adequate supply within a specified period and at a reasonable price. Farmers under contract production can derive some advantages. They are insulated against the vagaries of the market and are assured of a fixed income. Apart from having access to the latest technology, agricultural inputs such as seeds are supplied by the agricultural processing firms, and contractors for raising the crops. Since one constantly monitors the crop product, there is no doubt that the risks are maintained by and by.
The processing firms also accrue benefits from contract farming and are assured of the steady supply of quality raw materials for their operation at a fixed price. This reduces the transition cost, especially the search cost and the information cost about the availability of necessary raw materials, thereby saving the procurement costs of the processing firms. Not only this, the steady supply of raw materials helps schedule processing operations, resulting in saving to the firms.
Contract farming enables processing firms to have control over agricultural production, thereby making in possible to maintain the standard of food safety. However time and again it has been criticised as a tool for agricultural business firms to exploit an unequal power nexus with growers. Such farming secures the farmers, land and labour. The control made by the processing firms is indirect but effective.
Contract farming is exploitative when it involves a highly unequal power relationship because contract farmers are relegated to the status of hired labor. Despite the fact that contracts are superficially equitable, it is usually the farmers who sustain serve penalty for deviations. But if the firms fail to honor their commitment, they are not penalised. This has been a problem since time immemorial.
There are some instances where farmers divert their products to open market when the prices are high, leaving the firms in a lurch. Such cases usually occur in vegetables and other short-term crops. The advantage after the investment made to one firm leads to reneging on contract and exploiting the other firm. Unanticipated non-fulfillment of contract is usually prevalent when the value of a given use is higher than the value of its next maximum use.
Sometime, when the firms and the farmers are blocked in asset specific investment with no chance for either of them to use the resource alternatively, the contract is fairly successful. Actually, it is arduous to foresee all the processes while entering into contract. For this reason, the exposit advantage of the firm is often exploited. For example, a farmer may fail to deliver agricultural products in accordance with the contract due to the loss of crops, resulting from the vagaries of weather and pests.
Flexible price In some countries, though agricultural processing firms would like to deal with small number of farmers, they may have to be satisfied with a large number of small farmers. What is more, legislation in many countries does not allow the direct purchase from the farmers; consequently, there is an additional cost on market fee and cost on logistics. In these countries, some legislative measures should be introduced to enable the agricultural processing firms to purchase directly from the farmers. However, such measures have not been taken in these countries yet.
The agricultural processing firms can reduce the opportunistic behaviour of the farmers by adopting flexible pricing policy. In this context, they may introduce bonus schemes to encourage market prices in order to supply certain quantities and reward the loyal farmers. At the time of contracts non-governmental or local community organisations would help alleviate farmers' exploitation. Such organisations can monitor the enforcement of the contract by the agricultural processing firms and notify the concerned authorities of any violation. Contract farming is considered an important tool in the supply management of agricultural materials to the processing firm. However, in order to ensure its smooth functioning, timely reforms should be made while entering into the contract.