Contract Farming and Commodity Market

Contract Farming and Commodity Market have a long legacy to share with. When it is about introducing the local agro commodities to the commodity exchange for the trading and distribution, contract farming has always been taken as one of the effective means to meet the production, demand and supply needs in the modernized and efficient trading system. The days are different in the world now when there used to be spot trading only in the world; for now, the production and sale on a contractual basis is not at all new to the world. Especially when dealt with the perishable agro products, the existence of the contract farming goes long back which holds true for the products like dairy products, fruits, vegetables, etc.

Spurred by changes in (international) competition, consumer demand, technology and governmental policies, agricultural systems are increasingly organized into tightly aligned chains and networks, where coordination among production, processing and distribution activities is closely managed (Zylbersztajn and Farina, 1999). Contracting between producers on the one hand and processing or marketing agribusinesses on the other are viable methods to strengthen vertical coordination in the agri-food chain (Swinnen, 2007). As mentioned by the experts above, there are many forms where the contracting systems have been developed as per the need and demand. One would find it very strange to believe that the food retailing supermarkets are the results of trying to establish the horizontal and vertical coordination in the agro value chain. The procurement practices of the supermarkets support a very centralized purchasing, specialized and dedicated wholesalers, preferred supplier systems and private quality standards which bring the system very close to what would be anticipated for the trading execution through the commodity exchanges. Besides that, the government policies are the determinant factors to establish the value chain in the agricultural commodities. Usually, in the market liberalization policies, the governments do not show much interest over providing inputs, technical assistance and marketing channels for the agro products.

Another advocative measure for the contract farming is to portray the picture for the strengthening of smallholder access to the markets. Increasing the smallholder farmers’ access to the market has been the priority for the Non Governmental Organizations and International Non Governmental Organizations since long in the least developed and developing parts of the world. But, it is frustrating to say that the impacts have not been impressive. These agencies consider CF to be one of the main instruments to link small-scale farmers to domestic and even foreign markets and thereby to reduce poverty (FAO, 2004; IFAD, 2003; World Bank,2007). Since CF arrangements often include the provision of inputs and technical assistance, participating smallholders can benefit from new market opportunities otherwise not available to them.

Going to the history of Contract Farming, one would see that it was highly promoted during the 1960s mainly laying its foundation on the ideological thinking and then a desire to target the rural poor, internationalized agriculture and the rural development strategies dynamism. Green Revolution is one of the major historical events seen in the agricultural paradigm but even during the Green Revolution in 1970s, the smallholder farmers were excluded which definitely invited several critics for the program as the verdict looked very influential by the elite group farmer families in the countries. Due to this reason too, integrating smallholder farmers in the recent strategies counts a lot. Nonetheless, market liberalization and the quick withdrawal of the state poked in big gaps between the smallholder farmers and market.

Contract farming is usuallyportrayed to be an institutional arrangement used for organizing vertical coordination between growers and buyers/processors (Bogetoft andOlesen, 2004). Vertical coordination means that the activities of sellers and buyersare closely aligned. As supply (or value) chains are characterized by sequentialtransactions, vertical coordination implies that the transactions upstream (such asbetween producer and processor) are aligned with transactions downstream (such asbetween processor and distributor). These upstream and downstream transactionsbecome increasingly interdependent when, for example, processors have investedin establishing a consumer brand for their products. In order to protect this brandfrom devaluation by not fulfilling customer expectations, processors try to controlany process that could negatively affect the value of the brand.

The above picture clearly depicts the determinants of the contract farming arrangements. The above picture shows clearly the importance of the institutional arrangements required and then the governance required to monitor and supervise the same. The technology and the techno-economic attributes refer to the necessities required for the commodification of the agricultural products. In order to minimize the risk of complexity and uncertainly, both with the quality and price, the commodification of the products becomes essential. The bargaining power of the farmers (producers) ideologically have to increase but upto now, the bargaining power has been exercised by the intermediaries which do not even appear in the picture, and thus, it happens to be the biggest risk as the intervention measures cannot be planned better. Governance is always necessary to monitor the price and then specify its limits and boundaries; contract farming also requires an efficient governance mechanism. The transaction costs and the marketability costs are the major assessable attributes in the agro-product commodification.


Note: This article is published in the e-newsletter of South Asian Federation of Exchanges.