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UNDERSTANDING CONTRACT FARMING IN

INDIA: MODELS AND LEARNINGS

Sukhpal SinghCMAIIM

Ahmedabad

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Understanding CFThere is so much diversity in the type of

firms, farmers, nature of contracts, crops,and socio-economic environment that it isbetter to focus on specific situation thanthe generic institution of contractfarming.The context of the contract is important

as many contextual factors and actorsinfluence the working and outcome of acontract system.And, there is no single model suitable for

all conditions but a series of alternatives.

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Indian Experience of CF

• Different Models across regions, agencies and crops

• Role of state- direct and indirect

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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

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Out-grower scheme/model

Government sponsored/public sector or joint venture projects

NDDB’s F&V project (Safal)Agrocel, Kutch (organic cotton and

sesame project)

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Multi-partite arrangement

where state, private firms, andnational/international developmentagencies are involved CF in Punjab

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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

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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 (revisedmodel)

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Nucleus–Out-grower Model

Captive (corporate) farming and contract farming both

• Ion exchange, Pune (organic farming)• Satluj Organics, New Delhi

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Intermediary model(middleman/broker/facilitator)

• Most of the seed companies• Pepsi in Mah/Kar/MP for potatoes• 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 inThailand

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Agri inputCompany/Broker

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

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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

a

y

m

e

n

t

Agri input cos.

PAFC

agreement

Subfranchisee

agreement

agreement

contract

contract

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

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Company

GrowerLocal

Middleman/Facilitat

or/ productio

n 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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Is it Contract Farming?• Bharti’s Fieldfresh model • Satluj Agriculture • Nijjer, • Potato Kings in Jalandhar, and even • State’s Council for Agro and Fruit Juicing- on

leased land(CAJP Leases land @8-12,000/ acre for 12 years

from farmers under two options (20% increase in rent every 3 years OR 2% increase for 6 years and then 50:50 sharing of fruit profits), minimum 10 acres)

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Emerging Model of CF in IndiaIntermediary model due to the transactions cost

logic and competitive national andinternational food/fibre markets where costand quality will determine success. It isalready being practiced in different forms bymany CF agencies.

But, the exclusion of small farmers will remainan issue.

Movement from acreage to quantity contracts

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Indian Experience of CF

• 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

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Indian Experience of CF• 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 growerremains as there is little transparency in pricingand 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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Larger Impacts of CF• 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 andindirect (through agents with legal contracts) forsmall farmers with a few cattle/buffalo only. Thelatter mode dominates procurement.

• Employment increase but sustainability(mechanisation) and gender and child labour issues

• Ecological sustainability – perpetuation of chemicalinput intensity, except when organic/export marketdriven

• Socio-economic differentiation – perpetuation of ‘reverse tenancy’

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Contract farmed mint being harvested with hired labour in a Punjab village for delivery to A M Todd & Co’s extraction unit nearby

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An infant in a cradle and another child on watch while the mother attends tomato harvesting in a contract farm

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Lessons for CF Agencies • Is there enough rationale (market failure)?• Crops suitable for small farmer CF - short duration, labour

intensive, not high cost• Fixed price or Pricing options, not market price based price• Marketing extension: Market information, Product planning,

Accessing markets, Alternative markets, Market orientation• Better co-operation/co-ordination between companies and co-

operatives

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Lessons for CF Agencies• Transfer some of the operational or functional

responsibilities like distribution of inputs, equipment orders, and credit repayment management, to the grower bodies (Spencers’ example)

• 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 to contract growers?

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Designing a Workable ContractCo-ordination, Motivation and Transaction costs are three pillars of a contract arrangement

• (i) co-ordinating to minimize production costswhich 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 variousmechanisms of monitoring contracts like otherparty bears part of the cost, Social pressure,Incentive structure, and Group contract/incentives

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Designing a Workable Contract• (V) Reducing the cost of pre-contractual opportunism

(Adverse selection) by Rationing i.e. offer a contractsuited only for some ‘good’ farmers; ‘Menu of contracts’for screening farmers so that they reveal their true typeby choosing certain contracts; Group contracts, andIndividual risk rating/information collection beforecontract 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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THANKS