Vertical Coordination and Contract Farming
Rehber
value in the production process. For example, pig
farming has usually been integrated within one farm, but
farmers are increasingly specializing in only farrowing,
nursery or finishing. Boon (1999) concluded that
differential capabilities give them a production cost
advantage which may outweigh transaction cost (Boon
1999).
2.2.6. Convention Theory and Contract Economics.
These are the recent theoretical developments
relevant for the study of vertical coordination.
Prices do not constitute a determining variable to
ensure coordination but one of the links of organization
subject to conventional rule. When open market works
properly, quality will be assessed by a given price. But
quality conventions are necessary when the price alone
can not evaluate quality. Eymard-Duvernay
distinguishes four generic forms of coordination (Sauvee
1999). Domestic coordination occurs when uncertainty
about quality is solved through trust. In industrial
coordination, quality is defined by a third party, outside
the market, who determines the common norm and
standards. If prices are sufficient indicators to evaluate
quality, i.e. if there is no uncertainty about quality, then
the market works by itself which is called market
coordination. Civic coordination occurs when there is
a collective commitment to avoid conflicts. In this
theory, a set of mechanisms and rules that involve
private agents as well as public institution exist. The
content of product specification, nature and roles of third
parties involved, strategy of product differentiation or
labeling, or other empirical observations about quality
clarify the convention. Influenced by strategic
management approaches, convention theorist insist that
coordination mechanisms determine the degree of
cooperation or competition between agents. Moreover,
the convention theory approach shows that the definition
of contracts cannot be understood exclusively at the
microeconomic level, i.e. between two partners. A
convention is also a mode of regulation found at a
collective level, for instance a region or an industry.
Unlike the neoclassic economist, convention theorists do
not consider non-price exchange between firms as
market failure or imperfections. Instead, adopting a
positive approach, they integrate the diversity and the
complexity of the quality issue and build their analysis
on it. In spite of methodological incompleteness, this
approach usefully links quality questions with industrial
structure. Convention theory has been used in the study
of quality conventions found in agricultural sub-sectors.
Valceschini demonstrates that in the French vegetable
processing industry, the traditional articulation between
civic and industrial coordination where price discovery
and definition of quality are centralized is no longer
relevant. In this sector, product contracts between
vegetable producers and processors have been
established at a collective level in a national inter-
professional organization (Valceschini 1995). Sylvander
(1995) demonstrates that in the French poultry
processing industry, quality specifications influence the
choice of coordination mechanisms and consequently,
the firms compete and cooperate. This is the emergence
and the strengthening of an industrial convention that
determines the economic behavior of the firms. In this
industrial convention, quality is defined and controlled
by the third party. Each grower is held to a strict set of
standards and requirements about feed, genetic stocks,
housing conditions, etc. Based on the convention theory
assumptions, Valceschini’s and Sylvander’s approaches
have three methodological steps for the study of vertical
coordination.
i. The comprehensiveness of the contract’s
formation can not be understood exclusively at the
microeconomic level. Indeed the content of the
contractual arrangements (micro level) may stem from
institutional arrangements and institutional organizations
(macro level).
ii. These institutional arrangements greatly
contribute to the shape of the competition in the sector.
Contract are not outside the competitive process but are
a part of it.
iii. The formation of these arrangements is itself
dependant upon external and internal factors. Therefore,
a complete vertical coordination analysis should include
the study of interplay between basic conditions and
strategic behaviors and the effect of their consequences
on the institutional environment (Sauvee 1998).
Brousseau’s (1993) contract economics extends the
Williamsonian paradigm but reconsiders some of his
fundamental assumptions. He proposes a general theory
of bilateral economic relations and combines transaction
cost theory and elements of industrial organization.
Although strongly influenced by Williamson, Brousseau
differs from him on several important matters. His
definition of costs is more extensive adding two more
cost categories to the transaction costs: production and
incentive costs. These three categories of costs are the
basic elements for the evaluation of contract efficiency.
He focuses on the comprehension of the decision process
instead of defining a determinist model of governance
structure. For him a redefined notion of contracts
replaces the governance structure (Sauvee 1998).
2.2.7. Value Differentiation and Complementarities.
Goodhau and Rauser tried to explain recent
organizational changes in the food system by using the
Food Marketing Policy Center Research Report #52