contract farming models - delhi

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Sukhpal Singh CMA IIM Ahmedabad

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Page 1: Contract Farming Models - Delhi

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CMAIIM

Ahmedabad

Page 2: Contract Farming Models - Delhi

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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

Page 3: Contract Farming Models - Delhi

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����������������� 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.)

Page 4: Contract Farming Models - Delhi

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��������������� 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

Page 5: Contract Farming Models - Delhi

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� 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

Page 6: Contract Farming Models - Delhi

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� APMC regulation including Gujarat’s tri-partite arrangement

� Improving open market efficiency� MSP policy, and� Corporate Farming including leasing of

wastelands

Page 7: Contract Farming Models - Delhi

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� 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.

Page 8: Contract Farming Models - Delhi

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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

Page 9: Contract Farming Models - Delhi

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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

Page 10: Contract Farming Models - Delhi

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� Different Models across regions, agencies and crops

� Role of state- direct and indirect

Page 11: Contract Farming Models - Delhi

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Company

Farmer

Supply of produce

Supply of inputs on credit

Fig.1: Bi-partite CF model

Centralised model - private sector agencies

(many-2 examples)

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CompanyBank

Farmer/AoF/Cooperative

Supply of produce

Supply of inputs on credit

Payment

Credit andPayment after deduction of dues(in some cases)

Payment for inputs

Fig 2: Tri-partite CF model

Page 13: Contract Farming Models - Delhi

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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)

Page 14: Contract Farming Models - Delhi

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where state, private firms, and national/international development agencies are involved

� CF in Punjab

Page 15: Contract Farming Models - Delhi

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Farmer

State (PAIC)

Company

Input Company/ies

Payment for service

Extension

Input supply & payment for produce

Produce

Payment

Produce

MoU

Fig 3: State-led contract farming system in Punjab

Page 16: Contract Farming Models - Delhi

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Farmer

PAFC

Extension co./buying co./PAFC

Direct

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

Machines and equipment

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

Page 17: Contract Farming Models - Delhi

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

Page 18: Contract Farming Models - 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

Page 19: Contract Farming Models - Delhi

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Agri inputcompany

Bank

Processor/Marketer

Farmer Produce supply under agreement

Payment for inputs

Payment for produce

Paymen

tSupply of inputs

Farmer selection & documentation

Fig 5: The Quad-partite CF model

Page 20: Contract Farming Models - Delhi

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Franchisee

Bank

Processor/Marketer

Farmer

Produce supply under agreement

Payment for inputs

Payment for produce under agreement

Supply of inputs/extension for a fee

Farmer selection & documentation under agreement

Agri input co./facilitator

P

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m

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Agri input cos.

PAFC

agreement

Subfranchisee

agreement

agreement

contract

contract

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

Page 21: Contract Farming Models - Delhi

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Company

Grower

Local Middleman/Facilitator/ production organiser

Supply of produce through facilitator under tripartite agreement with no liability on company for any loss

Seed supply, payment of commission for extension,

procurement & seed distribution services under

agreement & reimbursement of

seed/other costs & seed replacement

Farmer adoption and

tripartite agreements, procurement

, & local quality lab mgt. under agreement

Contract production organization, supply of company seed (with

part advance payment by grower), extension, and input credit under

agreement with no liability on company

Company Collection Centre/Factory

Procurement at fixed or mkt. linked

price, grading &

quality testing of

produce by facilitator

Farmer selection, package of practices, payment for produce (thru bank* to farmer and facilitator), and supervision under agreement

* 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.

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

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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

Page 23: Contract Farming Models - Delhi

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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.

Page 24: Contract Farming Models - Delhi

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Broker/Collector/Cooperative (PGC/LSC)

/Local Co.

(Direct)

Company

Seed/Inputs/Payments

Seed / Inputs/ Payments/ Commission

Produce Produce

State (BAAC & DOAE)

Credit & Extension Coordination &

Facilitation

Farmer/FarmerGroup

Contract Farming System in Thailand

verbalformal

Page 25: Contract Farming Models - Delhi

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� 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

Page 26: Contract Farming Models - Delhi

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� 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

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� 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’

Page 28: Contract Farming Models - Delhi

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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)

Page 29: Contract Farming Models - Delhi

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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

Page 30: Contract Farming Models - Delhi

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� 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

Page 31: Contract Farming Models - Delhi

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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 labourinterest.

Page 34: Contract Farming Models - Delhi

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���������������� 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?

Page 35: Contract Farming Models - Delhi

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Designing a Workable ContractCo-ordination, Motivation and Transaction costsare 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

Page 36: Contract Farming Models - Delhi

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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; Groupcontracts, and Individual risk rating/information collection before contract is signed

� (vi) Do Not Kill Co-operation: encouraging group or co-operative 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

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� 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

Page 38: Contract Farming Models - Delhi

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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

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Thanks