Managing contract farming in agro industry

Abstract

Although India has made substantial progress in terms of total production in the agricultural sector, the problems of low productivity and poor quality of output remains the major causes for concern. In the era of globalizations as India integrates its agricultural sector with rest of the world, these problems needs to be addressed adequately and urgently in order to improve its price and quality competitiveness in both the domestics and international markets. At the farm level, these problems are caused by many factors such as inadequate knowledge, high risk in input and output markets and low risk bearing ability of farmers. Realizing the need to address these problem some agro based industries have backwardly integrated their operation through contract farming. The other alternative proposed by the agroindustry is corporate farming which is unlikely to take place on a large scale due to restrictive land ceiling regulations. Therefore contract farming is a potential alternative for the agribusiness firms to improve quality and price competitiveness. Recognizing this, both central and state governments have taken steps to encourage contract farming. Though contract farming is practiced extensively in seed industry, however it is yet to be adopted in a large scale by the agro-progressing firms. Therefore there is a need to examine the potential of this approach for the benefit of the agroindustry. So this study is undertaken with the following objectives 1) To understand the critical factors that influence the farmer and firm to go in for contract farming in India context. 2) To develop a decision frame to compare contract crops with the competing non contract crops in order to determine the attractiveness of the cropping options. Identification of the critical factors in contract farming was done through extensive survey of the earlier research studies in this field and also through case studies. Literature review has shown that farmers and firms are influenced by different set of factors to go in for contract farming. Important factors that influence the farmers are missing or imperfect market for inputs, information, insurance and credit. Firms are influenced by the factors like increased control over supply, long run cost reduction and monopolistic privilege. Building reliable case studies on four firms representing four different sections of the agro-based industry helped to cross check on these factors and identify others. The firms that were studied at Pepsi Foods limited (PFL), Godrej Agrovet Limited (GAVL), Namdhari Seeds Private Limited (NSPL) and Agro Biochem Private Limited. Results of the case studies showed that the following factors are considered to be very important in sustaining contract farming operations, 1) The ability of the firm to manage the imperfection in the market for agricultural output, which is accomplished by announcing the price prior to season, providing the market security to the farmer, pricing formula which ensures better revenue for the farmer as compared to that of the competing non-contract crop and prompt payment. Case studies have brought out three different kinds of contractual arrangements which ranged from full contract to partial contract (quantity contract) depending on the availability and functioning of spot market in the locality. Case studies have also brought out three different kinds of pricing formula adopted by the firms based on the nature of marketing arrangements existing for the processed outputs. 2) The ability of the firm to manage the imperfection in the market for production technology by providing extension and research and development support to farmer in order to meet his/her information need. Also a contingency contract in case of natural calamities goes a long way in improving the relationship between the farmer and firm. Case studies have shown that R&D activities of the contracting firms were highly localizes to cater to the precise needs of the farmer and the private extension network of the company effectively transfers technologies developed. 3) The ability of the firm to manage the imperfection in the market for agricultural input by providing the farmer with genetically superior seeds, plant production and protection inputs and credit. Case studies have shown that all the contracting firms supplied seed material which is considered to be the most important input by the farmer whereas the supplying of crop production and protection inputs and facilitation of production credit was varied from firm to firm depending on the need of the farmer and the existing social norms. 4) Also the ability of the firm to market the processed products plays very important role in sustaining contract farming. Companies which could differentiate its products and able to mark up were shown to be more successful in sustaining its contract farming operations. Case studies have brought out clearly the importance of this factor even though it was not very much discussed about in the available literatures. Further, a decision methodology for evaluation of contract farming vis-à-vis conventional agriculture has been developed. The groundnut contract farming project of PFL is analyzed with the decision methodology. Risk analysis of contract crop and the competing non-contract crop was done by obtaining the cumulative distribution function (CDF) of expected net returns, the CDFs were compared using stochastic dominance framework. The analysis has clearly brought out the unattractiveness of contract crop compared to the competing non-contract crops. Using this decision framework, firms can develop an appropriate contract design, which will be attractive to the farmers.