Vertical Coordination and Contract Farming
Rehber
1. Introduction
Major structural changes have been occurring in the
agricultural-food system (agro-food). The advanced
agro-food sector is considered as a chain of interrelated
activities from input suppliers to consumers while the
traditional view of agribusiness considered only
activities beyond the farm-gate. These changes are
driven by changes in food consumer preferences and
attitudes, technological improvements, food safety issues
and related regulations, and changes in the farming
structure.
In developed countries, it is observed that while the
importance of agriculture in population, national income,
export and employment has been decreasing, the share of
the processed food supply to the consumer is increasing
estimated to be about 60% of consumption on average.
In such a system, of course, the agro-food industry is
based on market oriented intensive agricultural
production and well coordinated and organized market
structure.
Vertical coordination has gained attention in the
food system as a device for providing both cost and
product quality advantages (Roy 1963). The agro-food
sector can be conceptualized as a system of vertically
interrelated stages. These stages are tied together
through a variety of activities and institutions ranging
from the sale of intermediate goods via arms length
transaction agreements to consolidation of two or more
stages under the common management of single firm
i.e., vertical integration. Briefly vertical coordination
encompasses all means of harmonizing vertically
interdependent production and distribution activities
ranging from spot markets through various types of
contracts to complete integration (Frank and Henderson
1992). Between these extremes, the one which entails the
most direct relationship between large corporations and
small farmers is contract farming.
This system is widely used in developed countries
where it accounts for about 15% of agricultural output
(Glover 1990). For instance, in the U.S., 32% of the total
value of agricultural production was produced under
contract arrangements (Perry et al. 1996). In Japan, 75%
of broiler output was produced under contracts in 1989
(Yi et al.) In the EU, the production aid system has been
encouraging contract farming (Anonymous 1984). For
example, in Germany, vertical integration through
contract production is already common in dairy, poultry
and sugar processing accounting for approximately 38%
of the agricultural production (Grosskopf 1994).
Economies of the developing countries are mostly
agricultural based. Development of agriculture from a
traditional structure to a market oriented structure is the
major challenge for them. The main struggle is to
decrease the rate of population engaged in agriculture to
a certain amount through creating new employment
opportunities either in non-agricultural sectors; such as
textile industry, services sector etc., or agricultural based
industries such as food processing. For developing
countries, it is generally agreed that food processing is a
key industry which should receive high priority both at
national and international levels (Anonymous 1981).
Moreover, food industry development promotes
development in other sectors through forward and
backward linkages. In these countries, the food-
processing industry is important to economic growth and
to the health of people. Many food raw materials in these
countries are not fully utilized, foods are imported, food
shortages exist and diets are inadequate. Developing
countries such as Turkey must develop their food
resources more extensively (Anonymous 1969). The
development of the food industry not only provides new
job opportunities and increase national income via
accruing value added but it also is the way to supply safe
and adequate processed food to consumers.
One of the important pre-conditions for the
development of the food industry is the availability of
processed food demand in both domestic and foreign
markets. On one hand, the existence of plants which
have modern technology and are economically viable to
process agricultural produce is important. On the other
hand, providing continuous, safe and ample raw
materials is vital for the establishment of a sound food
industry. That is why the vertical relationship between
farm firms (i.e. growers and producers) and processors
or traders of agricultural commodities is very important.
Current efforts to improve agricultural performance
in developing countries tend to emphasize two
instruments: technological innovation and alteration of
macro policy framework (Glover 1987). Although both
are usually necessary conditions, institutional innovation
also has an important role to play. Acting in an
organized manner in agricultural production and
marketing will serve to create an efficient coordination
among the chains in the food system from producers to
consumers.
As a means of coordination; contract production has
traditionally been considered a feature of an advanced
capitalist agricultural structure but it also represents an
expanding and much suggested method of agro-
industrial integration for developing economies.
Contract farming has also been promoted over the last
three decades as an institutional innovation to improve
agricultural performance in less developed countries
sometimes as a key element of rural development and/or
Food Marketing Policy Center Research Report #52