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
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
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
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
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
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
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
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)
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
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
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
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
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
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
Commodity Characteristics
For 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
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
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
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
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
What Needs To Be Done To
Make Contract Farming Work?
• Be sure that conditions exist that give return
to CF—no 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
Thank You