Contractual Relations

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Contractual Relations in Agricultural
Markets Mohammad A. Jabbar, ILRI Christopher
Delgado, ILRI and IFPRI Nicholas Minot ,
IFPRI Paper presented at the workshop on
Unleasing markets for agricultural growth in
Ethiopia MoARD-IFPRI, Addis Ababa, May 18-20,
2005
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Presentation outline

• Commodity characteristics that determine forms of
  marketing
• Changing conditions that need new institutions
• Producer coops, marketing coops and contract
  farming as marketing institutions
• Potential and constraints for smallholder
  participation in contract farming

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Institutions Dictated by Specific Needs

• Form of marketing depends on needs for exchange,
  different for different commodities and
  situations
• Spot market (cash and carry)
• Forward purchase of specific lots (futures
• markets, where risk is greater and quality can
  easily be specified in a contract)
• Contract sales on a regular basis (including
  coops)where both buyer and seller benefit from
  assured market

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Concerns Production Risk

• Seasonality and culture in production and
  consumption, e.g. milk
• Production risk due to weather, disease outbreak
  and mortality
• Variations in quality outcomes

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Concerns Market Risks

• Price volatility/sharp seasonality
• Market events abroad beyond local control
• Unequal market power among participants
• Sellers of perishables subject to extortion
• Buyers of perishables subject to fraud

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Information The Key to Contractual Forms

• If buyer can know everything about what is being
  sold, little need for contracting in most cases
• But can be hard to predict future when one will
  need to buy
• Quality issues may be important but not easily
  observable at sale
• Trust and reputation of product is key to what
  buyer will pay

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Different Commodities Have Different
Institutional Needs for Marketing

• Milk highly perishable, hard to know bacterial,
  fat content at sale, need to mix many batches in
  one cooler with associated risks for all, but
  still possible to take small destructive samples
  for testing at sale
• Fruits and vegetables similar to milk, but less
  perishables and bulking is less of a risk
  quality easier to observe at sale time

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Other Commodities

• Meats Quality (fat, flavors, tenderness) harder
  to observe at live sale, especially for pigs and
  poultry destructive sampling usually not
  possible except at great cost
• Grains Quality fairly easy to observe at sale
  except where specialty traits like lysine are an
  issue (exception may be seed, where certification
  is necessary)

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Also Changing Situations Market Chains Become
Longer

• Quality grades and standards harder to maintain
  across several spot markets in chain
• Capital and input supply harder to link to final
  sale (e.g. credit becomes more necessary while
  repayment is harder to enforce)
• Marketing/price risks grow relative to production
  risks

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Producers Coops The Usual Form of Milk Marketing
to Cities

• Invented in Denmark in 19th century
• Producers get higher prices and buyers lower
  prices for a given quality than in spot markets
• Sellers less subject to extortion and get better
  markets in flush period
• Buyers less likely to get adulterated milk and
  get lower prices in dry period
• Everyone wins and net gain finances coop

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Marketing Coops frequent for fruits and
vegetables

• Gets economies of scale in input supply and
  shipments of perishables
• Helps brand output
• Helps handle characteristic of market being
  flooded at harvest through sharing cold storage
• Not very helpful for credit
• Net gains to buyers and sellers together over
  spot markets are modest, so not as prevalent as
  coops for dairy

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Contract Farming (CF) Common for Poultry and
Pigs, Sometimes Veg

• Livestock has very high capital requirements
  pig, broiler and egg prices very volatile
• Quality requires hard to monitor labor and input
  use over long cycle
• CF supplies capital and extension in mode where
  repayment is easier to enforce shares production
  risks, and reduces price risks
• Only schemes that work over time have balance of
  power between buyers and sellers

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Spot Markets Work Well for Grains, Veg if No
Processing

• Usually not enough gains in contracting to
  compensate both buyers and sellers for extra cost
  (except for seed)
• Same is true for veg unless presence of a
  processing industry means some buyers will pay in
  order to guarantee their supply lines and to
  improve uniformity of inputs to their industrial
  plants

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What Does Contract Farming Do?

• CF is one type of vertical coordination or
  farmer-buyer linkage in the market
• The mechanism usually allows
• Transmission of market information to farmers
• Facilitation of technical assistance to farmers
• Provision of inputs, credit and other services to
  farmers
• Verification of production methods and quality
  assurance to consumers
• Lower market volatility to all

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Commodity CharacteristicsFor Which CF Works Best

• Perishable, subject to high price volatility and
  market risk, e.g milk, poultry, vegetables,
  fruits
• New crops destined for new markets so require
  good technical and market information, e.g.
  vegetable and fruits for niche markets, new seeds
• High costs of monitoring intensive production
  methods and quality, e.g. poultry, vegetables
• Purchased input cost a high share of output value
  and high investment cost, e.g poultry, milk,
  vegetables

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Criteria For Defining Forms Of Contract Farming

• Types of partners involved farmers, private
  investors, intermediaries, credit agencies,
  public sector organisations
• How risks, benefits and obligations are shared
• How contract agreements are made, enforced,
  monitored, and how disputes are settled

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Cooperatives vs. Private Integrators?

• Coops work well when farmer buy-in is key, credit
  is not a big issue, but capital investment in
  infrastructure (such as cooling) is too large for
  local farms
• CF with private integrators works well when
  technical assistance throughout each production
  batch is important, quality and uniformity is
  key, suppliers credits are a binding constraint,
  and price volatility is a problem for BOTH buyers
  and sellers

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Potential Smallholder Benefits From Contract
Farming

• Access to better inputs, technology and advisory
  services to produce better quality outputs
• Access to capital and credit to overcome
  financial and liquidity constraints
• Quality assurance for inputs and products and
  better health control
• Reliability of market outlet and prices

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Potential Problems/Cost To Smallholders From CF

• Inequitable share of risk mortality, production
  loss
• Loss of earning potential when market price rise
  above contract price
• Loss of autonomy and inability to diversify
  production when opportunity may come
• Absence of regulatory support to resolve disputes

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What Needs To Be Done To Make Contract Farming
Work?

• Be sure that conditions exist that give return to
  CFno point in trying in net gain to buyers and
  sellers combined is not enough to finance the
  high cost of CF
• Create regulatory environment to encourage
  practice of CF, especially
• So that contracts are transparent and assure
  equitable sharing of risks and benefits
• So that contracts provide adequate incentive and
  safeguard to all parties not to default
• To support proper contract enforcement and
  resolution of disputes due to contract violation

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Thank You