Policy-makers in India see
contract farming as an important avenue to bring the producing farmers and the
processors together. The system helps to eliminate the chain of middle-men and
brings the producers and processors face-to-face. For the processing firm, it
is an important step in supply-chain management. Spot market purchases are fraught
with uncertainties with regard to quality, quantity and price. The search and
information costs for the right quality and quantity are high under open market
purchases, whereas contract farming takes care of all these uncertainties and
ensures a steady supply of quality raw material at stable prices. The
advantages to the farmers are in terms of assured market, access to technology,
supply of inputs and extension services.
In India, contract farming is
confined to certain crops in select pockets. However, there is enormous scope
for contract farming. The increasing income has created quality and health
consciousness among consumers who demand food products of certain
specifications; as the economy grows, the number of such discerning consumers
is set to increase. The importance to food safety and the stress on traceability
that is identifying the source in case of any contamination requires greater
control in procurement.
Contract farming allows firms
to have such controls. Despite these advantages, farming under contract has
many constraints. Though contract farming is basically a way of allocating risk
between the firm and its farmers, the distribution of risk depends largely on
such factors as bargaining power, availability of alternatives and access to
information. The advantage ex post that is, after the investment has been made
to one party leads to reneging on contract and exploiting the other party who
ends up with the disadvantage after the investment. Several studies on
different industries have found that when an investment is specific to a transaction
or contract with little possibility of alternative uses, the firm that made the
investment is at a disadvantage as its contracting partner might exploit the
situation.
When, say, the vendor and the
firm are locked in asset-specific investments with no room for either party to
use the resource alternatively, the contract is fairly smooth. Especially in
short-term crops such as vegetables, farmers tend to divert the produce to the
open market rather than supply to the processing firm when the prices are high.
The cost calculations of the firm go haywire, as they are forced to arrange
supply of raw materials from alternative sources with attendant uncertainties
such as not meeting the requirements to maintain safety.
Similarly, in long-duration
crops such as plantation crops, the firms often fail to honour the contract as
they know that farmers have no alternative but to sell the products to them at
lower prices. The latter often succumb to the firms diktats.
The amendments to APMC act
devote lot of attention to contract farming. It mandates registration of
contract with the concerned APMC and any dispute will be referred to the committee
which will arbitrate within 30 days. Even though many states have adopted the
provision with some variation it is hardly in practice. In many states this
provision is not known to the APMC officials even if they know they have no
power to compel the contracting company to register the contracts with them.
Legal action on the defaulting
partner though is possible is impractical. For example, if the company proceeds
against few defaulters who diverted the crop the rest of the farmers in the
area may desert the company feeling that is what would happen to them in the
future. Similarly, when the company behaves opportunistically the small farmer
is hardly in a position to file any case against it.
It was found in crops like
gherkin the contract relationship is functioning without much friction the
reason being both the company and the farmer are locked in an asset specific
relationship. Gherkin has no local market hence farmers necessarily had to
supply to contracting companies similarly the company has to meet their export
obligations and cannot afford to spoil the relationship with the farmers as it
may require time and effort to train new set of farmers in the cultivation
practices.
In other situations such as
when there is advantage to one party because of asset specific investment of
the other party the solution to these problems must be found within the
framework of the contract. The firm can avoid to a great extent the
opportunistic behaviour of the farmers by adopting an innovative pricing
policy. Instead of fixed prices, the firm may adopt flexible prices which are
linked to the market price so that the farmer is always assured of a price
above the market price. It may introduce
bonus schemes to encourage farmers to supply certain quantities, reward the loyal
farmers, and so on. There are also suggestions to make the farmers shareholders
which will ensure continuous supply of raw materials as their welfare in linked
to the health of the firm
In short, farmers must be
convinced that the firm is interested in a long-term relationship with them. Contract
farming is viewed as an important tool to increase private corporate
involvement in agro-processing, and help augment rural employment and income.
However, to ensure the smooth functioning of the contract, innovative features
need to be built in.
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