Income Risk and Efficiency

Contract farming provided growers with an assured market, stable income, access to firms' services, ease of credit and technical knowledge, and it provides agro-industrial firms with an assured supply of good quality raw material at less fixed investment and low cost. Specific outcomes of contract farming on these aspects are discussed below and are based on Wiboonpongse et al., (1998) except where indicated otherwise.

In the case of Northern Thailand in the late 1980s and early 1990s, half of the farmers earned off-farm income before and after starting contract farming. After starting a contract, 74% of the respondents enjoyed higher household income while 5% reported reduced incomes. Despite the higher incomes, some farmers (26%) incurred losses due to production and quality risk (all contract crops) and market risk (tomatoes). The major problem was crop damage due to flood and diseases (Sriboonchitta et al. 1996).

A more specific comparison was limited to potatoes and tomatoes, which had dual markets. Table 1 [ PDF 12.7KB | 1 page ] shows net returns and variations per rai, (1600 sq. meters or 6.25 rai = 1 ha) of contract and non-contract crops. On average, non-contract crops provided slightly higher incomes (2.5%–10%). Price instability on open markets for potatoes averaged 185% over that of contract prices.

Income discrepancies from the open market reflected price risk and production risk for both crops since the prices were determined by varying market supply-and-demand. However, contract tomato farmers had higher income variations than their counterparts due to the informality of contract agreements and uncommitted responsibility of the processing firm. Potato prices were more under control, even though they varied. In the end, income variation came mainly from yield risk since prices were guaranteed and made known to the farmers in advance.

Economic efficiency here refers to the combined effects of production and allocated efficiencies in order to minimize unit cost. (Production cost comparisons between contract and non-contract were not available in other studies, so the conclusion should not be over generalized.) Unit costs for contract potatoes and tomatoes were lower than those of noncontract farms. Contract farmers outperformed the non-contract farmers. Farmers of both types proved to be profit maximizers under their different production conditions.

Sukasem (1992) found that in contract soybean, non-contract soybean, and both types of tomatoes and potatoes, farmers applied economic rationales. They allocated their main resources optimally in response to output-input prices.

Contributions from agro-processing firms in productivity and quality improvement were significant. The frozen food firm's new variety of soybean raised yields from 800 kg/rai 1991–1992) to 1,300–1,700 kg/rai (1993). For informal contracts like tomatoes, varieties used by farmers in the open market were those once introduced by contract firms. Therefore, fresh tomatoes available in the market were processing types and consumers could hardly find table tomatoes.

A contract system can boost farmers' production efficiency. Wongwiwat et al. (2007) reported in their analysis that potato yields of Chiang Mai growers could significantly increase yields by 43% compared to those of non-contract growers. The know-how followed by education is a dominant attribute of efficiency, while diseconomy of scale was observed for potato production size rising beyond 1.4 ha. (Wongwiwat et al. 2007).

Both farmers and processing firms have had a long process of learning and adjusting to produce raw materials of a standard quality. Contract farmers have learned to accept criteria for "quality,” while farmers in general, who sold their ungraded produce in the open markets, were less familiar with the concept. In rigid contracts such as soybean and Japanese cucumbers, contract farmers realized that their income depended on the quality of grades they produced. Fifty percent of new farmers, after training, can deliver high-grade produce. Presently, experienced farmers and additional new farmers, who grasp the concept quickly, understand the value of quality.

Agro-processing firms have been careful in screening farmers they contract. Diligent and honest farmers received first priority, which is still practiced. Farmers' production of contract crops was limited to ensure quality. Field supervision helped monitor production for quality produce and provide regular checks of predicted total production. However, the latter practice did not ensure supply of raw materials. The firms, through middlemen, terminated a contract if a farmer was found to secretly sell his/her produce on the open market or to other firms.

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