Contract Farming: Pros and Cons

Contract farming is an institutional arrangement widely adopted in agricultural production (see Roy, 1963; Glover and Kusterer, 1990; and Glover and Ghee, 1992). Contract farming represents an agreement between farmers and contractors (mostly processing and/or marketing firms) for the production and supply of agricultural products. Under contract farming, farmers usually agree to deliver specific commodities in predetermined quantities and to meet predetermined quality standards, while contractors agree to provide production support (e.g., supply of input and provision of technologies) and accept products at predetermined prices (Eaton and Shepherd, 2001).

Contract farming is beneficial to farmers because it opens up otherwise unavailable markets (especially to smallholder farmers), providing materials, technological and financial support, and reducing farmers' costs and the risks involved in selling products. It also benefits contractors by allowing them to establish close relationships with farmers and by reducing uncertainties in purchases through predetermined timing, prices, and quality standards (see Glover, 1984; Key and Runsten, 1999; Singh, 2002; and Setboonsarng, 2008).

While contract farming is a conceptually sound institutional arrangement, lack of flexibility is one of its main liabilities, and coordination problems are faced during its implementation (see Glover and Kusterer, 1990; and Little and Watts, 1994).

As contract farmers are often required to grow new crops or adopt unfamiliar farming techniques, they tend to encounter greater production risks (Key and Runsten, 1999). They are also likely to face greater credit risks because of excessive advances, which tend to jeopardize the sustainability of their operations in the long run (see Glover, 1984; and Glover and Kusterer, 1990).

Supports from contractors can help reduce these risks. However, overdependence on a contractor not only makes farmers less adaptive and hence more vulnerable to economic shocks, but also tends to reduce their bargaining power in contract negotiations (see Key and Runsten, 1999; and MacDonald et al., 2004). Contract farming may also be biased against poor farmers in remote areas while favoring better-off farmers with extensive land who are living in areas with good infrastructure (Setboonsarng, 2008).

Contract enforcement is another major issue. Farmers may breach the contract by diverting inputs supplied on credit to other purposes or selling outside the contract for higher prices, while contractors may breach the contract (e.g. with unfair quality standards, low quality inputs, poor technical assistance, incomplete purchases, delayed payments, etc.) because of inefficient management or marketing problems (see Glover, 1984, 1987; and Singh, 2002).1

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1. Anthony M. Zola
   (posted 02 July 2008 / 12:54:22 AM)
   
   This is an excellent contribution to the current debate about contract farming in mainland Southeast Asia.
   
   I have conducted research for the ADB, much less sophisticated than this study, and had similar results. Smallholder farmers were better off if they were engaged in contract farming than when they sold daily labor to local concessions / nucleus estates.
   
   My congratulations to the research team. It is not an easy topic on which to conduct research.
   
   Anthony Zola
   Bangkok, Thailand
   & Vientiane, Lao PDR