Vertical Coordination and Contract Farming
Rehber
plantation production by contracting in different
proportions. Satellite farming is used to refer to any of
the variations of the schemes mentioned above. On the
other hand, the term of multipartite arrangement is
used to emphasize the scheme in which several actors
such as private firms, government, and foreign aid
agencies are involved.
Several types of contracts are distinguished
according to the number of decisions influenced, sharing
of the risks, and specifying contract terms. From the
production decisions or management point of view, two
types of contracts are determined.
i. Limited Management Contracts: In this type,
the farmer signs a contract to obtain some production
inputs. There is no real guarantee for price. The farmer’s
responsibility is limited only for the production inputs
which he has obtained under agreement.
ii. Full Management Contracts: In this case the
farmer and the integrator firm have made a contract
based on a certain amount of production. In this type of
contract the farmer has to follow some provisions
specified in the agreement. Here, the producer provides a
certain market for his product and insures himself
against risks.
Kohls and Uhl (1985) has classified contracts into
three broad categories.
i. Market specification contracts: Specify product
quality measures which will be acceptable to the
integrator and restrictions placed regarding the price and
the method of payment. Contracts are generally signed at
planting time and specify how much the integrator will
buy and at what price. Little or none of the farmer's
management decisions are transferred. From the
producer viewpoint, they guarantee a buyer if the
specifications are met.
ii. Resource providing contracts: In this type, the
integrators provide production resources with certain
conditions, managerial help, and supervision. Product
prices are usually based upon the spot markets and
income guarantees to the producers are minimal.
iii. Management and income guaranteeing
contracts: These types of contracts often include the
production and marketing stipulations of the former two
types. In addition, market and price risks are transferred
from farmers to integrators. On the other hand the
integrator takes a substantial part of the managerial
responsibility of the farmers.
Another contract classification identified by
Williamson (1979) based on the transaction economies.
These are, classical, neoclassical and relational
contracting. According to Williamson (1979) three
characteristics of transactions are important in the
determination of the contractual relationship,
uncertainty, frequency of transactions, and the degree to
which investments are idiosyncratic. He described
different governance structures regarding the
characteristics of transactions, excluding uncertainty, as
shown in Table 2.2.
Classical Contracting (Market Governance):
Market governance is the main governance structure for
nonspecific investment characteristic of both occasional
and recurrent transactions. This type of contract is rather
definitive. They are complete and might be traded on the
exchange. In these contracts, third party participation is
discouraged. The emphasis is on legal rules, formal
documents, and self liquidating. Contracts for delivery
of a specific quantity at a specific price, time and place
are considered a part of market consideration (Schrader
1986).
Relational Contracting (Transaction-specific
Governance): This type of structure is used for
recurring, mixed, and highly idiosyncratic transactions
of. In this relational contraction, two main types of
governance structure can be observed. Bilateral
structure (obligational contracting) refers to autonomy
of the parties.
Vertical integration refers to the unified structures
where the transactions are removed from the market and
organized within the firm subject to an authority
relation. When the contractors guarantee is needed to
finance producers facility, production is controlled by
the contractors and the contract is long-term, there would
be significant differences between contracting and
integration.
In the bilateral structure, mixed and idiosyncratic
characters of investment required for production are
extensively specialized so there are no obvious scale
economies to be realized through inter-firm trading that
the contractor or contractee is enable to realize himself
through vertical integration.
Under uncertainty, of course the degree of
uncertainty would affect the degree of integration
depending on the asset specificity and frequency of
transaction.
2.3.2. Reasons for Contract Farming and Disadvantages.
The main reasons behind contract farming could be
summarized as follows:
From the transaction cost framework, the neoclassic
focus on market imperfections is limited because it
ignores the cost of exchanges, i.e. transaction costs. The
main reason for the vertical integration is to decrease
these transaction costs. The degree of integration mainly
depends on the frequency, asset specificity, and
uncertainty regarding transactions. Asset specificity
encourages internal coordination. Large investment in
Food Marketing Policy Center Research Report #52
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