Vertical Coordination and Contract Farming
Rehber
disagreements and disputes over quality standards,
delays in delivery and payments, and default on loans
through the court systems creates long delays. An
arbitration and/or a conciliation system would be useful
by involving government and non-governmental
organizations (Spolter 1992). In arbitration, an arbitrator
renders a decision and third party imposes it taking all
the control away from the parties. In a conciliation or
mediation process, the parties retain control of the
process and the outcome.
5. Conclusions and Suggestions for Marketing
Efficiency
The agro-food sector from producer to consumer
involves a range of discrete and complementary
activities changing from farm input procurement to
consumption. The vertical relationships between these
activities range from open market transactions to vertical
integration. Over time impersonal and open-market
transactions between activities in traditional agro-food
systems based on price signals are replaced by rather
controlled, impersonal vertical coordination mechanisms
such as organizing cooperatives, short and long-term
contractual relationships, and ownership integration in
the advanced and industrialized systems. Changes in
food consumer preferences, attitudes, technological
improvements, food safety issues and related regulations
are main forces behind industrialization
In light of investigated theories, one of the main
reasons for vertical integration is transaction costs.
Vertical coordination through ownership integration
decreases transaction costs but creates its own costs.
Some distinctive features inherent in production of
agricultural commodities and markets favored the use of
contractual relationships in agriculture versus full-
integration (ownership integration). However, even in
ownership integration, internalizing all transactions in a
firm does not preclude the use of contracts, i.e. a firm
can have all production assets or have complete control
of them but need to hire labor and use labor contracts. In
the cooperative structure, the relationship between
member producers and their own organization
(cooperatives) often requires formal linkages more
constitutive than contractual relationships. On the other
hand, specialization in one of the stages of the agro-food
chain can provide cost advantages. Therefore,
coordination among the specialized firms through
contractual arrangements or even open-market
relationships may be more efficient versus ownership
integration.
In practice it is not possible to have a complete
contract because it is not possible to foresee all
contingencies in advance (bounded rationality), it is
difficult to describe and write these contingencies
accurately and there will be a cost for writing down such
a plan and realizing it and solving disputes. In practice,
contingencies inevitably arise that have not been
planned. In this case, parties must find ways to adopt.
These adaptations introduce the possibility of
opportunism. In general terms, incomplete
characteristics of the contracts lead to problems of
imperfect commitment. Under information asymmetry,
there will be a moral hazard problem which limits the
contracts that can be written and enforced.
Asset specificity, task programmability and
separability are primary determinants of the degree and
type of vertical coordination (governance structure). In
the contractual relationship, the length and the
comprehensiveness of contracts are dependant on the
above features. In the case of high asset specificity that
cause sunk cost may create a hold-up problem. Another
important determinant is uncertainty regarding
production and marketing.
It is a fact that the role of successful management
(strategic management) is very important for efficiency
in every kind of vertical coordination. Improvements in
managerial approaches in relationships for both intra-
firm and inter-firm transactions based on trust,
confidence and mutual understanding could be
interpreted critical issues in financial and economic
efficiency. Legal and/or incentive systems based on
reward and penalties can be used creating trust and
mutual confidence. Desired method is availability of
coordination consciousness that the processor (principal)
needs a group of producers (agents) as much as the
producer needs the processor as explained in our
cooperative model.
Quality and quality control is one of the important
issues in every stage of the agro-food chain. A quality
convention is required among the transaction parties in
these stages. Quality requirements can be best defined
and controlled by a third party, government and/or
independent organizations along with the internal
convention in the food chain.
In general, both for farmers and integrators, one of
the significant reasons for contract production is to
decrease uncertainties (risks). Under contract integration,
producers bear some of the production risks, but price
risks for the contracted commodity and most variable
inputs are transferred to the integrator. A guaranteed
market, easy access to credit facilities, and information
are among the reasons for contracting for producers. For
integrators the main reason is to provide a steady input
supply with a certain quality and quantity.
In addition to the reasons mentioned above, recent
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