Vertical Coordination and Contract Farming
Rehber
system. Recent work on various approaches to provide
performance incentives, as proposed by Casson, may
also be useful (Boehlje and Schrader 1998). The basic
presumption of the Casson’s work is that the overall
economic performance of any system depends on
transaction costs which mainly reflect the level of trust
that exists in the economy. The level of trust in turn
depends upon culture. A key concept in this argument is
that of trust. A crucial question in any economic
transaction, and particularly in those that personnel and
negotiated, is whether either party in the transaction can
be trusted. There are two fundamental approaches to
creating trust;
i. Use of the legal system and penalize those
parties that do not fulfill their negotiated commitments.
ii. Manipulating an intensive structure that
individuals fulfill their commitments based on rewards
they receive rather than penalties they incur.
The impossibility of writing a complete contract and
asset specificity associated with modern agricultural
production strengthen the role of trust in contract
coordination. In a continuing game even the large
contractor who is recognized as being in control must
maintain a reputation for fairness. The contractor needs a
group of contractees as much as the contractees need the
contractor.
Another interesting approach to vertical coordination
is Sporleder’s interpretation of strategic alliances based
on collaboration and the trust as the key features.
Sporleder (1994), in his definition of strategic alliances,
excludes merger and acquisition and other corporate
partnering, and includes only informal vertical
arrangement. In this type of coordination, parties to the
alliance are stakeholders in the object of cooperation but
they are not shareholders. The arrangement is self-
enforcing i.e. in the event of breach of contract, the
arrangement is simply terminated, third party
involvement is not anticipated. The length of this type of
alliance is long-term compared to other classical one-
season or one-year contracts.
2.2.5. The Capabilities Approach
Knowledge-based capabilities was used first by
Richardson linking capabilities with the pattern of
economic organization. He suggested that in an industry
there are an indefinitely large number of activities. These
activities have to be carried out by organizations with
appropriate capabilities i.e. with appropriate knowledge,
experience and skills (Richardson 1972). He discussed
that, coordination among the firms could be
accomplished by consolidation, co-operation and market
transaction. The appropriate way of coordination depend
on the degree of similarity, complementarity between or
among activities.
In the capabilities view, knowledge has a central
explanatory role for understanding economic
organization. Contrary to neoclassical theory, the
capabilities approach assumes that knowledge about
production is neither explicit or freely transferable.
Under full information and no uncertainty, every
organization is as efficient as any other. However, much
of the knowledge is tacit and hard to formalize and
communicate and can be acquired only through learning
processes (Boon 1999). Each firm processes capabilities
differently than other firms and thus, will not incur the
same production costs even though they perform the
same type of productive activity (Foss 1996).
Asymmetries in knowledge: i.e. differential
capabilities result in performance differences between
firms. Knowledge could be transferred through the
market mechanism or through firm organization.
Transfer of tacit knowledge is impossible, only codified
knowledge or explicit knowledge in products can be
transferred across markets. Economic agents may have
substantial differences in initial productive knowledge
for their joint productivity. In that sense, frictions can
occur between economic agents. These frictions are also
called knowledge based transaction costs (Connor and
Prahaland 1996). Integration into many stages would be
costly because other economic agents with superior
capabilities would have a relative production cost
advantage. Hence, firms must rely on market
transactions or cooperation between firms, even when
transaction cost economics would suggest otherwise.
Boon (1999) discussed what determines the choice of
organizational structure in the food system and why the
food system is more tightly integrated. He explained the
capabilities approach using an example in livestock
raising and argued that farrowing, nursery, and finishing
are integrated within the farm firm while slaughtering,
carcass cutting, and processing are integrated in
slaughterhouses. However, farm activities are not similar
to slaughterhouse activities in that they draw on very
different capabilities. Transactions between farms and
slaughterhouses were often market transactions, but
contracting has become more dominant in the animal
production sector. Slaughterhouses produce increasingly
different products with specific quality characteristics
included branded products instead of generic. In order to
establish this production, slaughterhouses need to
developed and transfer the necessary knowledge to the
supplier. This knowledge may be tacit and hence
difficult to be acquired by the farmers. Contracts that
specify particular quality characteristics or even the
specification of production techniques may be an
attempt to codify this knowledge in order to create new
Food Marketing Policy Center Research Report #52