What is Contract Farming?

Contract farming arrangements of different types have existed in various parts of the country for centuries for both subsistence and commercial crops.  

The commercial crops like sugarcane, cotton, tea, coffee etc. 

Have always involved some forms of contract farming.  Even in the case of some fruit crops and fisheries, contract farming arrangements, involving mainly the forward trading of commodities have been observed.  

However, in the wake of economic liberalization, the concept of contract farming in which national or multinational companies enter into contracts for marketing of the horticultural produce and also provide technologies and capital to contract farmers has gained importance. 

According to this, bipartie agreements are made between the farmer and the company and the latter contributes directly to the management of the farm through input supply as well as technical guidance and also markets the produce.  

The main features of this type of contract farming are that selected crops are grown by farmers under a buy back agreement with an agency engaged in trading or processing.  

In such cases, the centralized processing and marketing agencies supply technology and resources, including planting materials and occasional crop supervision.  

Under such contracts, the farmer assumes the production related risks, which the price risk is transferred to the company.  

In some cases, the company also bears the production risk, depending on the stage of crop growth at which the contract is made.  

If the contract is made at flowering or fruiting stage, the company bears the production risks also.  

In any case, the company bears the entire costs of transaction and marketing.  

It is this variant of contract farming which is said to be one of the ways by which small farmers can participate in the production of high value crops like fruits, vegetables, flowers etc. and benefit from market led growth. 

How can small farmers benefit from contract farming?

  • Small farmers in India are generally capital starved and cannot make major investment in land improvement and modern inputs. 
  • Contract farming can fill up this gap by providing the farmers with quality inputs, technical guidance and management skills.  
  • Although the company deals only with the contract crop, the farmers’ overall management skill may improve, thereby helping him to raise the yields of both contract and non-contract crops.  
  • From the standpoint of corporate bodies, farming reduces the supply risk, while the farmers enter into contractual arrangements with companies in order to minimize price risks.  
  • The company and the farmers enter into contracts to supply or purchase a specified quantum of the commodity at agreed prices.  
  • The agreed contract may be either formal or informal and may cover supply of inputs and marketing of output.  
  • By entering into contract, the company reduces the risk of non-availability of raw material and the farmer reduces the risk of market demand and prices of his produce.  
  • The inputs and services supplied by firms may include seeds, fertilizers, pesticides, credit, farm machinery, technical advice, extension etc., or may involve only the supply of hybrid seeds and marketing of produce.

APMC Act and Contract farming?

  • The Model Agricultural Produce Marketing (Regulation) Act circulated by the Central Government to the States in 2003 for implementing marketing reforms has provisions for the registration of contract farming sponsors and recording of contract farming agreements with the Agricultural Produce Marketing Committee (APMC) or a prescribed authority under the Act, protection of title or rights of the farmers over the land under such contracts, dispute settlement mechanism and a model draft agreement suggesting various terms and conditions. To help States in the formulation of Rules in this regard, the Ministry of Agriculture has also circulated a set of Model APMC Rules to them for adoption. 

By now, relevant provisions have been made by several State Governments/ UTs in their respective APMC Acts for providing a legal framework to contract farming.

Success stories of Contract farming in India?

Contract farming is becoming an increasingly important aspect of agribusiness, whether products are purchased by multinationals or by smaller companies.

  • There are few success stories on contract farming such as  Pepsico India in respect of potato, tomato, groundnut and chili in Punjab, Safflower in Madhya Pradesh, oil palm in Andhra Pradesh, seed production contracts for hybrids seed companies etc. which helped the growers in realization of better returns for their produce.  
  • Other success stories of contract farming are Amul and NDDB for milk procurement, sugarcane cooperative in Maharashtra, and prawn-acqua culture in Andhra Pradesh. 

In our country this approach has considerable potential where small and marginal farmers can no longer be competitive without access to modern technologies and support. The contractual agreement with the farmer provides access to production services and credit as well as knowledge of new technology.  Pricing arrangements can significantly reduce the risk and uncertainty of market place

  • Studies have highlighted a significant problem in some cases wherein : both firms and farmers breached contracts when market conditions provided arbitrage opportunities. Firms rejected more contracted produce on quality grounds when market prices dipped below contracted prices and farmers engaged in side-selling in open markets when market prices rose higher than contract prices.
  • Companies prefer medium and large farmers because of transaction costs. They want farmers to dedicate a minimum acreage, say, five acres [one acre is 0.4 hectare] of land, to the contract crop. In India, 85 per cent of the farmers are marginal or small, operating less than two acres. In fact, 66 per cent operate less than one acre each. How many will have such land to give for contract crops?
  • Contract farming can work if there is a collectivisation of small farmers. For instance, 10 to 15 farmers get together, form a group, and sign a group contract. It brings down the transaction costs, the farmers are better protected, and it is essentially a win-win situation for both the farmer and the corporate. It has been successful in Thailand. In fact, the Thai government planned it out and made it a part of the country’s national development plans.

How can contract farming be successful?

  • It will work if the farmers have better bargaining power. 
  • They have to be legally protected. 
  • Furthermore, in contract farming, it is extremely important to understand the contracting operations. 
  • The terms and conditions of the contract are crucial. 
  • It has been  found that quite often the farmer had not even seen the contract and did not know what the terms and conditions were. 
  • The contracts need to be more transparent.

When and how did this form of farming evolve in India, where agriculture practices have largely been traditional?

  • Contract farming has been there since the 1960s in seed production, in both private and public sectors. 
  • Also, since the Land Ceiling Act does not permit non-farmers to own land, there is no other way to get specified produce than through contract farming. 
  • So as market demand changed in the 1980s and 1990s, contract farming became more common, starting with Pepsi in Punjab in tomatoes and potatoes in the mid-1990s as a first case of perishable-produce contract farming, other than a few other cases in some other crops elsewhere in India. 
  • Further, the amendments to the APMC [Agricultural Produce Marketing Committee] Act at the State levels in the last decade, which made contract farming legal, led to its widespread adoption across crops and regions and companies.

What are the risks and benefits the farmer faces in contract farming?

There are different types of contract farming, and each type of contract farming will have its own set of pros and cons. 

  1. One is simple procurement; 
  2. In the second, the buyer provides some inputs and takes the crop according to the terms and conditions of the contract; and 
  3. In the third, the buyer provides inputs and planting schedules and is more involved in the agricultural process. The last one carries the most liability for the company.

The pros are the high yields and fixed prices. The cons, however, are there as both production risk and market risk. Production costs in contract farming are higher as the standard expected is higher. No company offers protection for crop failure. No crop insurance is given and thus production risk is not covered most of the time. As said earlier, many companies take advantage of the clauses in the contract in case the harvest does not meet their requirement; they tend to buy it at a lower price or reject it altogether. Thus, market risk is also not covered fully, especially when the contract prices are based on market prices, as we know that the market prices vary substantially during the season or even during the day. If your contract document is not fair, how can your practice be fair?

Can CORPORATE farming be a reality in India ?

  • Legally, corporate farming cannot exist in India. 
  • A non-farming entity is not allowed to own land. 
  • The Land Ceiling Act does not permit it. 
  • It has not been viable most of the time. 
  • There have been some companies that have attempted to lease land and cultivate crops but have not met with as great a reward as expected. 
  • Some States have leased out so-called wastelands to some companies for corporate farming but owing to local opposition, this has stopped now.

Contract farming can help curb inflation: RBI

The Reserve Bank of India (RBI) wants the government to facilitate contract farming in India and to exempt fruits and vegetables from agri procurement laws to improve food productivity. The central bank has also called for better supply chain logistics by setting up cold chains and processing facilities to reduce wastage. 
Highlighting data that show rising incomes affecting consumption patterns, Deepak Mohanty, executive director at RBI, said that increased consumption of proteins and vegetables was one of the factors driving up costs of these items. Mohanty was delivering the annual Lalit Doshi Memorial Lecture at St Xavier’s College here on Monday. 
“Another factor is the cost of cultivation. The dominant part of the cost of cultivation is labour. This is particularly so in our set-up with the preponderance of small holdings, which are less amenable to mechanization. There are several explanations why rural wages have increased. One explanation is that socially inclusive public policy such as Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) has set a floor to rural wages and increased the bargaining power of the work force,” said Mohanty, adding that even after factoring inflation real wages have grown. 

India Journal: The Rise of Contract Farming

The last generation of significant improvements in agricultural yields in India — the famous “Green Revolution” — was achieved in the 1960s and 1970s through government investments, institutions and interventions.

But success stories from public action since then have been rare and Indian agriculture is widely seen to be in crisis today.

Contract farming — businesses signing contracts with farmers to grow a specific crop, even a specific seed variety, and guaranteeing buy-back of the produce at an agreed price or price range — holds the promise that the next generation of yield improvements could come through efforts from the private sector.

There has been a long history of regulation limiting private investment and trade in various aspects of agriculture in India, which is only now being slowly removed.

Until 2003, when reforms of the Agricultural Produce Market Committee Act was initiated in many states, it was illegal in most states for businesses to purchase agricultural produce directly from farmers rather than from government-regulated local markets called mandis.

Today, contract farming is emerging as a preferred mechanism through which agri-businesses can directly engage with farmers. An expanding urban middle class and increasing commercial investment in agricultural retailing and processing are creating demand for more standardized, higher-quality agricultural produce. But underdeveloped supply chains and small farm sizes make sourcing such produce difficult.

PepsiCo was one of the earliest promoters of the contract-farming model in India. In 1997, it set up a tomato processing plant in Punjab, not a traditional tomato growing area, and started tying up with local farmers to grow tomato varieties needed for ketchup.

Although PepsiCo has since exited tomato processing, it still works with 12,000 farmers, primarily to procure potatoes for potato chips.

Independent studies confirmed increased yields and incomes for farmers partnering with PepsiCo. Interestingly, studies also found that once better seed varieties, new technology and growing practices were introduced to a select group of farmers through contract farming, such practices spread to other farmers who were not directly involved in such efforts.

The PepsiCo intervention, and subsequent similar interventions by Hindustan Lever and Niger Agro Foods, are credited with transforming tomato cultivation in Punjab.

However, studies also highlighted a significant problem: both firms and farmers breached contracts when market conditions provided arbitrage opportunities. Firms rejected more contracted produce on quality grounds when market prices dipped below contracted prices and farmers engaged in side-selling in open markets when market prices rose higher than contract prices.

More recently, SAB Miller’s ongoing work with barley farmers represents a variant of the contract-farming model and highlights the benefits of such efforts for both big businesses and farmers.

SAB Miller India — an Indian subsidiary of the global beer group — required 75,000 tons of barley last year for its brewing operations. But, in India, barley is mainly grown as animal feed and the local variety is not suited for extracting malt, a key intermediate step in brewing beer.

While procuring from local mandis in the main barley producing regions — Rajasthan, Uttar Pradesh, Haryana and Uttarakhand — SAB Miller found that a lack of uniformity in grain size and mixing of different varieties of barley increased processing costs and resulted in lower quality beer.

In response, SAB Miller launched an initiative to provide higher-quality certified seeds, training and extension services to teach farmers best practices in growing barley.

SAB Miller does not enter into contracts for purchasing the crop but has created local outreach and procurement centers through which it commits to procuring first from farmers that are part of the initiative.

Currently, SAB Miller has 15 outreach and procurement centers throughout Rajasthan covering 5,600 farmers. Farmers participating in the initiative report an impressive increase in yields from 1.9 tons a hectare to 3.84 tons a hectare within the space of one year.

United Breweries, the biggest Indian beer company, is also scaling up similar contract farming efforts in Punjab and Rajasthan and has tied up with PepsiCo to manage outreach to farmers.

Together, such efforts by UB and SAB Miller could eventually reach a tipping point, where barley farmers across the country start adopting the better seeds and growing practices introduced by these companies and are able to raise their yields and incomes.

Experience so far shows that contract farming provides opportunities for farmers to access information, new technology, better inputs and assured links to market.

However, it should not be thought of as a panacea to the web of problems facing the Indian agricultural sector. Private initiative cannot be expected to fix basic, widespread problems including groundwater depletion, excessive fertilizer use and farmer suicides due to indebtedness; those still require policy reforms and concerted public interventions. Perhaps most importantly, in the context of declining public investments, the government needs to speed up liberalization measures to attract greater private investment into the agricultural sector.

This is the fourth in a series of India Journals looking at the intersection of business and the poor in India. His next India Journal will look at the community model of corporate ownership.