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Rationale for Small Farms

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					         UNDERSTANDING
       CONTRACT FARMING IN
        INDIA: MODELS AND
            LEARNINGS

             Sukhpal Singh
                  CMA
                   IIM
               Ahmedabad


10/30/2008      SS/CMA/IIMA   1
             Understanding CF
There is so much diversity in the type of
 firms, farmers, nature of contracts, crops,
 and socio-economic environment that it is
 better to focus on specific situation than
 the generic institution of contract
 farming.
The context of the contract is important
 as many contextual factors and actors
 influence the working and outcome of a
 contract system.
And, there is no single model suitable for
 all conditions but a series of alternatives.
10/30/2008         SS/CMA/IIMA             2
         Indian Experience of CF
• Different Models across regions, agencies
  and crops
• Role of state- direct and indirect




10/30/2008        SS/CMA/IIMA                 3
 Centralised model - private sector
             agencies
         (many-2 examples)
             Company
                                   Supply of
                                   produce



                Supply of inputs         Farmer
                on credit




               Fig.1: Bi-partite CF model




10/30/2008                           SS/CMA/IIMA   4
             Company              Payment
                                                                Bank
                                  Payment for inputs

                                      Supply of
                                      produce

                                                                Credit and
                                                                Payment after
               Supply of inputs
               on credit                    Farmer/AoF          deduction of dues
                                            /Cooperativ         (in some cases)
                                            e




       Fig 2: Tri-partite CF model




10/30/2008                                        SS/CMA/IIMA                       5
         Out-grower scheme/model

Government sponsored/public sector or joint
 venture projects

NDDB’s F&V project (Safal)
Agrocel, Kutch (organic cotton and
 sesame project)



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             Multi-partite arrangement

where      state,    private         firms,   and
  national/international              development
  agencies are involved
 CF in Punjab




10/30/2008             SS/CMA/IIMA              7
                                                                 State
                         Input supply &
                         payment for produce
                                                                 (PAIC)

                                                                               Produce


                                                                           Payment


                                               Produce
                                                                     MoU
                     Farmer
                                                   Payment                               Company
                                                   for service




                                                         Input
                              Extension
                                                         Company/ies




       Fig 3: State-led contract farming system in Punjab
10/30/2008                                        SS/CMA/IIMA                                      8
                              Direct
       Farmer

                                              Extension
                                              co./buying
Machines                                      co./PAFC
and
equipment
            PAFC            Reimbursement of
                            extension fee, waiver
                            of purchase taxes,
                            and approval of CF




            Fig 4: State-led contract farming system in Punjab (revised
            model)




    10/30/2008                                       SS/CMA/IIMA          9
    Nucleus–Out-grower Model
Captive (corporate) farming and contract
  farming both
• Ion exchange, Pune (organic farming)
• Satluj Organics, New Delhi




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            Intermediary model
         (middleman/broker/facilitator)
• Most of the seed companies
• Pepsi in Mah/Kar/MP for potatoes
• Fabindia in textiles and organic food (With
  a Difference: 700 groups (7500 artisans)
  across 20 states in India
• Many companies in Punjab/Haryana
  including organic
• Most predominant model inThailand
10/30/2008         SS/CMA/IIMA             11
                 Farmer selection &
                 documentation               Bank
                                                           Payment for
                                                           produce



             Agri
             input             Payment           P
             Compan            for inputs        a                       Processor/
             y/Broker                            y                       Marketer
                                                 m
                                                 e
                                                 n
             Supply of
             inputs
                                                 t


                                        Farmer         Produce supply under
                                                       agreement




     Fig 5: The Quad-partite CF model



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                      Fig 6: The six-partite (networking) CF model


                             Farmer selection &
                             documentation under              Bank
                                                                         Payment for
c                            agreement
                                                                         produce
  Agri input cos.
o                                                                        under
n                                                                        agreement
t                     Franchisee
r                                              Payment           P
a                                              for inputs
                                                                 a                     Processor/
c                                                                                      Marketer
                                                                 y
t                                       Supply of
                                        inputs/extension         m
                                        for a fee
                                                                 e
                             contract                            n
    Agri input co./                               agreement
      facilitator                                                t
                          agreement
                                         Subfranchisee
                                                                Farmer
agreement

                           Produce supply under
                           agreement
        PAFC




   10/30/2008                                                 SS/CMA/IIMA                           13
                            Fig. 7: Tri-partite (Intermediary) model of contract farming


                                                           Contract production
                                                          organization, supply of       Local
                                                           company seed (with         Middlema
                        Grower                            part advance payment        n/Facilitat
                                                          by grower), extension,
                                      Farmer              and input credit under
                                                                                         or/
                                      selection,            agreement with no         productio
                                      package of           liability on company           n
                                      practices,                                      organiser
                                      payment for                        Farmer
                                      produce (thru                   adoption and
                                      bank* to                          tripartite
        Procurement
                                      farmer and                      agreements,
         at fixed or
                                      facilitator), and               procurement
         mkt. linked
                                      supervision                       , & local
            price,
                                      under                            quality lab    Seed supply, payment of
          grading &
                                      agreement                        mgt. under    commission for extension,
            quality
                                                                       agreement        procurement & seed
          testing of       Supply of produce
         produce by        through facilitator                                       distribution services under
          facilitator      under tripartite                                                  agreement &
                           agreement with no                                              reimbursement of
                           liability on company             Company                   seed/other costs & seed
                           for any loss                                                      replacement
              Company
              Collection
               Centre/
               Factory

       * Bank finances contract production @ Rs. 10,000/acre (NABARD norm is Rs. 13,000/acre for potato) at
       7.5% rate of interest. It receives the money from the company for payment to the farmer for his produce,
       from which it pays the facilitator (as per the authorization given by the grower), deducts its own dues, and
       transfers the remaining amount in the farmer’s bank account.

10/30/2008                                            SS/CMA/IIMA                                                     14
             Is it Contract Farming?
• Bharti’s Fieldfresh model
• Satluj Agriculture
• Nijjer,
• Potato Kings in Jalandhar, and even
• State’s Council for Agro and Fruit Juicing- on
  leased land
(CAJP Leases land @8-12,000/ acre for 12 years
  from farmers under two options (20% increase in
  rent every 3 years OR 2% increase for 6 years
  and then 50:50 sharing of fruit profits), minimum
  10 acres)

10/30/2008            SS/CMA/IIMA                15
    Emerging Model of CF in India
Intermediary model due to the transactions cost
  logic    and   competitive     national   and
  international food/fibre markets where cost
  and quality will determine success. It is
  already being practiced in different forms by
  many CF agencies.
But, the exclusion of small farmers will remain
  an issue.
Movement from acreage to quantity contracts


10/30/2008          SS/CMA/IIMA              16
             Indian Experience of CF
• Default by companies and farmers (Moral
  Hazard problem)
• High transaction cost of dealing with small
  farmers
• Farmer level performance – higher returns
  but also higher cost, undue quality cuts,
  delayed deliveries and payments, low
  price (‘agribusiness normalisation‘), poor
  extension, and seed/crop failures
10/30/2008            SS/CMA/IIMA           17
          Indian Experience of CF
• Farmer’s production risk not shared
• Prices based on open market prices, including for
  organic produce (even market risk not shared!).
  Issue of what is fair price for the primary grower
  remains as there is little transparency in pricing
  and costing of operations
• Monopsonistic situation faced by the growers
• Biased contracts
• Penalties for failure to meet contract terms
• Business ethics/commitment - withdraw/ move
  away after exhausting potential
 10/30/2008            SS/CMA/IIMA                18
             Larger Impacts of CF
• Small farmer exclusion (due to admission criteria)
  e.g. MARKFED, and NESTLE
• Nestle follows two types of contracts- direct legal
  with large farmers with more than 25 animals and
  indirect (through agents with legal contracts) for
  small farmers with a few cattle/buffalo only. The
  latter mode dominates procurement.
• Employment        increase      but     sustainability
  (mechanisation) and gender and child labour issues
• Ecological sustainability – perpetuation of chemical
  input intensity, except when organic/export market
  driven
• Socio-economic differentiation – perpetuation of
  ‘reverse tenancy’
10/30/2008             SS/CMA/IIMA                 19
 Contract farmed mint being harvested
 with hired labour in a Punjab village for
 delivery to A M Todd & Co’s extraction
 unit nearby




10/30/2008        SS/CMA/IIMA                20
An infant in a cradle and another
child on watch while the mother
attends tomato harvesting in a
contract farm




10/30/2008      SS/CMA/IIMA         21
        Lessons for CF Agencies
• Is there enough rationale (market failure)?
• Crops suitable for small farmer CF - short duration, labour
  intensive, not high cost
• Fixed price or Pricing options, not market price based price
• Marketing extension: Market information, Product planning,
  Accessing markets, Alternative markets, Market orientation
• Better co-operation/co-ordination between companies and co-
  operatives




 10/30/2008               SS/CMA/IIMA                    22
       Lessons for CF Agencies
• Transfer some of the operational or functional
  responsibilities like distribution of inputs, equipment
  orders, and credit repayment management, to the
  grower bodies (Spencers’ example)
• Build trust by: Fair contracts, crop insurance (Pepsi with
  Agril Insurance Co and Gherkin firms with New India
  Assurance Co), and remunerative prices or lower costs.
  Equity Shares to contract growers?




10/30/2008                SS/CMA/IIMA                      23
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10/30/2008   SS/CMA/IIMA   25
       Designing a Workable Contract
        Co-ordination, Motivation and Transaction
       costs are three pillars of a contract arrangement
•      (i) co-ordinating to minimize production costs
       which means using price signals or instructions or
       both,
•      (ii) balancing decentralization and
       centralisation in farm decisions which impacts
       problems like moral hazard and hold up,
•      (iii) minimizing or sharing risk and uncertainty,
•      (iv) reducing the costs of         post contractual
       opportunism      (Moral     hazard)     by   various
       mechanisms of monitoring contracts like other
       party bears part of the cost, Social pressure,
       Incentive structure, and Group contract/incentives
    10/30/2008             SS/CMA/IIMA                  26
 Designing a Workable Contract
• (V) Reducing the cost of pre-contractual opportunism
  (Adverse selection) by Rationing i.e. offer a contract
  suited only for some ‘good’ farmers; ‘Menu of contracts’
  for screening farmers so that they reveal their true type
  by choosing certain contracts; Group contracts, and
  Individual risk rating/information collection before
  contract is signed
• (vi) Do Not Kill Co-operation: encouraging group or co-
  operative action among producers to lower costs and
  ensure better compliance,
• (vii) Motivate Long term Contracts to reduce hold up
  problem
• (viii) balancing pros and cons of renegotiation of
  contracts over time,
• (ix) reducing direct costs of contracting, and
• (X) using transparent contracts
10/30/2008               SS/CMA/IIMA                     27
             THANKS




10/30/2008    SS/CMA/IIMA   28

				
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