The name is absent

Vertical Coordination and Contract Farming

iii. Vertical integration: In this type of
coordination, each individual farm loses its identity and
becomes a company owned farm. The parent company
owns or leases the land, buildings and equipment and
employs its own employees. A firm can be described as
vertically integrated if it encompasses two single-output
production processes in which:

• The entire output of the first process is employed as
part or all of the quantity of one intermediate input into a
second process or,

• The entire quantity of intermediate input into second
stage is obtained from part or all of the output of the first
stage. This can be called as full integration¹.

This description may include more restrictive
criterion where the entire output of upstream process be
employed as the intermediate input into the downstream
process. It can be replaced the case in which most of the
output of upstream process is employed as most of the
input in the downstream process. This case is best
described as “partial vertical integration” (Perry 1989)
or taper integration. Thus, inherent in the notion of
vertical integration is the elimination of contractual or
market exchanges and the substitution of internal
exchange within the boundaries of the firm.

Vertical integration also means the ownership and
complete control over neighboring stages of production
or distribution. Grossman and Hart (1986) have argued
that vertical integration is the ownership and thus
complete control over the assets. But, because of the
different nature of the labor input, it is not relevant for
vertical integration. The workers could be employees or
contractors without altering the degree of vertical
integration.

On the other hand, Williamson (1973) and others
have stated that vertical integration would encompass
the switch from purchasing inputs to producing those
inputs by hiring labor. The required capital for
production, such as building and equipment, could be
owned or leased without altering the degree of vertical
integration. Leasing of capital can allow control of
production without ownership, but this approach is not
enough to explain vertical integration. Vertical
integration is control over the entire production or
distribution process rather than control over any
particular input into that process.

Vertical controls characterize vertical relationships
between the two extremes of vertical integration and

¹ Full integration refers to selling all of the outputs, or
providing all inputs in-house and taper integration refers to
selling some proportion of outputs to or buying some inputs
from outsiders (Harrigan 1986 p.538).

spot market exchange. A vertical control arises from a
contract between two firms at different stages which
transfers control of some, but not all, aspects of
production or distribution. However, vertical control and
quasi integration are intimately related to vertical
integration (Perry 1989).

Vertical integration may arise in a number of ways.
Vertical formation describes vertical integration which
occurs at the time the firm is created. Vertical
expansion describes vertical integration which occurs as
a result of internal growth of the firm creating its own
subsidiaries of the neighboring stages. Vertical merger
describes vertical integration which occurs through the
acquisition of one firm by the existing firm in a
neighboring stage.

iv. Farmer Cooperatives: An agricultural
cooperative is an organization usually incorporated,
owned, and controlled by agricultural producers, which
operates for the mutual benefit of its members as
producers or patrons (Rehber 1984). One world-wide
way of vertical coordination is of course cooperative
organization. Organizing under an agricultural
cooperative or producers’ group is also a type of
ownership integration. By working together in their
cooperatives, farmer-members can better control their
destiny (Ling and Liebrant 1995).

The consequences of farmers’ participation in the
cooperatives would provide them easily access to
available markets, enhanced net returns and
countervailing power when facing anti-competitive
market forces (Petraglia and Rogers 1991). On the other
hand, the possible existence of a competitive yardstick
effect for cooperatives has long been considered
(Cotterill 1987). In cooperative structure, because of the
fact that producers as the supplier of the raw materials
are also the owners of the processing units, it can be
thought that the relationship between the farmers and
processors do not create problems any more. But it is not
a correct approach. In practice this type of coordination
could also be the cause of problems and disputes
especially when the alternative marketing opportunities
are available. To avoid such problems in cooperatives,
contractual relationship with members farmers is
advisable (Royer 1995).

Farmers can also be organized under bargaining
cooperatives to have power at the bargaining table when
setting the terms of contractual relationships. Managing
supply and controlling nonmember free riders are
considered the main problems of such organizations
(Iskow and Sexton 1992). Despite these problems, they
have been a balancing power and a beneficial force in
improving the degree of competition in the many of the
agricultural commodities markets (Cramer et al. 1997)

Food Marketing Policy Center Research Report #52

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