Vertical Coordination and Contract Farming
Rehber
theory of complementarities. They have defined recent
changes in the agro-food system as value differentiation
instead of industrialization (Goodhau and Rausser 1999).
Value differentiation describes the process by which
increasing the value added to agricultural products by
differentiating them to meet consumer requirements. The
theory of complementarities in activities was first
written by Milgrom and Roberts (1992). Essentially, the
theory of complementarities formalizes the notion of
positive feedback effects among a firm’s production,
organization and management choices. A shift in an
exogenous system parameter will have direct effects on
the firm’s activity choices, reinforced by the feedback
effects across activities. Biotechnology, information
technology, and changes in consumer preferences which
are commonly viewed as the driving forces of value
differentiation are not induced by actions of the actors of
agro-food chain but rather are due to changes in the
lifestyles, incomes, and demographics. The value of
differentiation process is driven by complementarities
across activities so that a jump in one variable, such as a
biotechnology-induced change in the production, will
change the marginal value of other activities. This
structure aids firms in identifying desired products and
delivering these products to consumer at the lowest cost.
2.3. Contract Farming
2.3.1. The Concept of Contract Farming
These sort of vertically coordinated production
relations are not new. Contracts were employed by the
Japanese colonial state for sugar production in Taiwan in
the period after 1885 and by the USA banana companies
in central America in the early part of the twentieth
century (Watts 1994). By the late twentieth century,
however, in the Western Europe6, North America and
Japan, contract farming became an integral part of food
and fiber industry. In advanced capitalist states, it seems
that contract farming was widely used by the vegetable
canning industry in North America and by the seed
industry in the Western Europe in the 1930s and 1940s.
Contracts in a general and incomplete sense are
found in agriculture everywhere in extremely
heterogeneous forms. Simple market specification
contracts or future purchase agreements (typically
determine price, quantity, and time of delivery) are
common and labor contracting, supplying labor and
machinery as well as share-cropping contracts have a
wide application in agriculture (Wright 1989; Eswaran
and Kotwal 1985).
Contract farming or contract production, however,
6 Earliest record of forward purchase agreement is dated 1878
(Barker 1972).
must be distinguished from the multiplicity of simple
marketing or share-cropping and labor contracts.
Specifically, contract farming entails relations between
growers and private or state enterprises, that substitute
for spot market transactions between family farms and a
processing, export or purchasing unit. A standard
farming contract includes provisions for price,
production practices, product quality, and credit
facilities, etc.
Arriving at a meaningful definition of contract
farming is rather difficult. The one classic definition
provided by Roy refers to contractual arrangement
between farmers and other firms, whether oral or
written, specifying one or more conditions of production
and/or marketing of an agricultural product (Roy 1963).
Roy's definition is perhaps too broad since it would
include forward contract in which only price and volume
are set. Whether a forward contract can be bought and
sold is not our interest here. In the definition above, even
after excluding marketing arrangements such as forward
contracts, two conditions must be added.
First, contracts should be non-transferable, and
second, the terms "and/or" should be replaced by "and".
Contracts must specify one or more conditions of
production and marketing (Glover 1984).
Contract farming has been promoted over the past 30
years as an institutional innovation to improve
agricultural performance in less developed countries
sometimes as a key element of rural development and/or
settlement projects (Ghee and Dorall 1992).
This system was accepted and used as one of the
promising institutional frameworks for the delivery of
price incentives, technology, and other agricultural
inputs. Local governments, private firms, multinational
companies, international aid and lending agencies like U.S.
Agency for International Development, The World Bank,
Asian Development Bank, and Commonwealth Development
Corporation have been involved in these contract farming
arrangements (Glover 1994). However, world-wide
applications in practice has caused to appear different
terms and connotations regarding contract farming in
related literature (Glover 1992). Hence, contract
farming is used only for a private sector scheme, while
other terms are used for different applications as follows.
Outgrower Scheme: Generally connotes a
government scheme. In this system government usually
has a public enterprise purchasing produce from farmers
on its own or as a part of joint venture with a private
firm. This term is frequently used in Africa and Asia.
Nucleus-Outgrower Scheme: It is a variation of the
outgrower scheme in which there is a project authority
which has or administers a plantation adjacent to the
processing plant. This plant supplements its own
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