Reducing Price Risk: Contract Farming Conditions for Success Edition
This post links discussions going on under the enabling environment blog series as well as the ongoing price and production risk blog series.
Contract farming can be a win-win across agricultural market actors under the right conditions and where there is an enabling environment that supports contract enforcement as well as other critical legal and regulatory elements. The various structured producer-buyer relationship models that make up contract farming include effective strategies for smallholders looking for more certainty in the market and for agri-enterprises looking to secure a pipeline of product at a pre-negotiated price, quantity, and source origin. The predictability of these arrangements can reduce price risk and facilitate an increase in smallholder incomes.
In many cases, these contracts also facilitate the transfer of knowledge and technology across smallholder farmers. However, whether contract farming is an appropriate business model ultimately depends on the structure of the market, the capabilities of the farmers, the practical logistics of the setting, and importantly a legal, regulatory, and institutional framework that facilitates accountability and fosters transparency. When tensions do arise, they are often around side-selling (FAO Working Paper, 2014), which generates challenges for agri-enterprises and opportunities for smallholders. Broken contracts are also however a shared risk by smallholders since either party can break agreements. Herein lies the importance of the enabling environment and an example of why engaging at the broader systems level is important to understand what drives behaviors and decision-making by actors on the farm and across the market.
Local government, private sector actors and donor partners often have shared goals motivating their engagement in contract farming. Governments have a unique and critical role to play and are an essential partner for success. Their policies and actions in support of contract farming should promote a clear and predictable contractual environment that encourages the development of market-driven contracts between well-informed parties with an eye towards the long-term sustainability and viability of these commercial relationships. Governments that seek to build or strengthen an enabling environment for contract farming success can do so by:
- Establishing a strong legal, regulatory, and institutional framework for agricultural contracting;
- Providing public goods and services that lower transaction costs for farms and buyers;
- Ensuring government incentive programs that promote contract farming are carefully weighed against the prospects for long-term commercial sustainability of the contractual relationship; and/or
- Bringing attention to positive social and cultural norms that support transparency and accountability as well as working with diverse actors to address norms that present barriers to achieving inclusive results through contract farming.
What does it mean to invest in a better enabling environment for contract farming? There are several concrete strategies, noted below, that governments can take to strengthen the conditions for success on behalf of smallholders, agri-enterprises, and others that benefit from more productive and stronger market systems. You can learn more about these strategies in the context of the contract farming policy brief “Building an Enabling Environment for Contract Farming Success”:
- Ensure contract laws establish accountability and provide clear rights and remedies
- Strengthen the judicial and alternative dispute resolution systems at all levels of government
- Remove or address marketing restrictions that distort relationships and efficiency in the value chain
- Facilitate the use of intermediaries to encourage contract compliance
- Provide stable trade policies for input and output markets
- Establish public grades and standards for contracted crops
- Support diverse lending structures
- Facilitate access to information on contracting partners and market conditions
- Provide extension services to contract farmers to address knowledge gaps
- Prioritize strategic transportation infrastructure investments that are beneficial for contract farming
- Ensure subsidies and investment incentives have a clear short-term goal and exit strategy
- Limit monopsony power as a means of controlling side-selling
- Avoid undue government or donor interference in setting the terms of the agreement
Private and public sector partners also have important roles to play in helping inform and advocating to their governments as well as assisting them in prioritizing the most important strategies or reforms needed to address gaps in their specific contract farming commodity, market and/or geographic context. Additionally, how partners engage through existing social and cultural norms can positively influence and shape how these practices evolve in the future, as discussed in this recent post on norm shifting in Bangladesh here.
Stay tuned for a future post which will dive deeper into warehouse receipts, another strategy for buying down risk where a supportive enabling environment is key to success.