Vertical Coordination and Contract Farming
Rehber
concept of vertical integration will be discussed later in
this chapter.
Horizontal integration occurs when a firm gains
control over the firms performing similar activities at the
same level in the production and marketing sequence.
Firms often expand both vertically and horizontally.
If both vertical and horizontal operations are tied
together this is called circular integration. Local dairy
cooperatives which are brought under a regional union
illustrate this. When organizing dairy farmers under a
dairy cooperative, vertical integration has occurred. At
the same time, if dairy cooperatives are organized under
a regional cooperative union, a horizontal integration has
occurred.
Another type of organizational expansion which
occurs when agencies or activities that do not have any
direct relation among them are brought under a unified
management, this is called conglomeration.
The terms vertical coordination, vertical integration
and contract production are often used interchangeably
(Cramer and Jensen 1988; Paarlberg 1995; Cramer et
al.1997). Of course vertical coordination is a rather
broad term which encompasses all means of
harmonizing vertically interdependent production and
marketing activities ranging from spot markets through
various types of contracts to complete integration (Frank
and Henderson 1992).
An efficient way to review vertical coordination in
one industry is by studying the extent of the transfer of
decision and the ownership of the firm assets. When all
the decisions and assets of the firms are taken under a
single firm’s control, that ownership is called ownership
integration or merger. Vertical integration is best
reserved for ownership integration where two or more
stages in the process of production and marketing are
effectively controlled by a single management. This
term also refers to a technological rather than an
institutional development (Trifon 1959).
In contrast, when each firm retains its separate
identity but leaves one or more decisions of production
and/or marketing under the control of another firm, that
is called quasi integration or contract integration.
Sometimes it is called vertical restrictions. “A non-
integrated firm may write long-term, binding contracts
with the firms which it deals, in which it specifies price
and other terms. Such contractual restraints are called
vertical restrictions“ (Carlton and Perloff 1990, p. 502).
An agricultural production and marketing system
includes different stages or sectors: suppliers of input
items, farm operator, processor of farm products,
distributor, and final consumer. In the Western World,
the relationships and transactions between these sectors
could be realized in different manners (Allen 1972). In
agriculture, four types of vertical coordination between
farmers and off-farm businesses are generally
recognized (Berkama and Drabenstott 1995).
i. Coordination without any contract (market
coordination): The prevalent existence of spot market
or open market transactions is known as market
coordination. Spot market or traditional free marketing
system still accounts for the lion’s share of the present
world marketing system.
In this relationship there is no written or oral
contract between firm and the farmer for both buying or
selling. Here, the farmer buys supplies from whom he
chooses and sells his products to whoever will pay the
best price. This type of vertical relationship provides
freedom to farmers but uncertainties both in buying
supplies and selling produce are the main drawback. In a
competitive open (free) market system, price signals
control the market mechanism. The message reflected in
price would be passed back to the processor from the
final supply points (super markets or groceries ), to the
farmer and then to the supplier of input items. This
system may work very slowly.
This traditional form of market organization and
price determination will remain the appropriate means of
coordinating the links in the system if certain conditions
are available;
• Production occurs close to the points of final
consumption.
• Control over short term variation in prices and sale
volumes exist either through government or producer
organizations.
• Imprecise grading is acceptable for the purchaser.
• Agricultural extension and advisory services as
government functions are sound and effective.
For instance, contract farming rarely exists in grain,
oilseeds and cotton production which have been subject
to government price and/or income support programs.
Farmer contracts for delivery of a specific quantity at a
specific price, time, and place (ordinary forward and
futures contracts) are considered a part of market
coordination (Schrader 1986).
ii. Contract farming: This contract/integration
system is described as the most profound system
(Paarlberg 1995). Contract farming is sometimes called
quasi integration. British and American approaches are
different in this subject. British literature has drawn a
sharp distinction between contract farming and vertical
integration and regard one as an alternative of the other
(Barker 1972), preferring to restrict the meaning of
vertical integration to what has been called “ownership
integration”. American practice, in particular, has been
to regard contract farming as a form of vertical
integration (Allen 1972).
Food Marketing Policy Center Research Report #52