Contract farming has the potential to improve the welfare of smallholders however it is not a sufficient condition for such improvement. Smaller farmers can be excluded from contracts because of selection bias by agribusiness firms awarding contracts to larger farms, be adversely affected by the second-round effects of contracts on incomes and prices and suffer from narrowing of markets that lie outside of contracts.

1. 1
Indian Institute of Plantation Management, Bangalore
CERTIFICATE
This is to certify that the Synthesis Paper titled “Smallholders
participation in contract farming and comparison with global
experiences” by Devesh Shukla submitted for the partial fulfillment of
PGDMABPM 2016-18 is an original work and no part has been submitted or
published for the award of any degree or diploma.
Comments by the Examiner :
Name of the faculty/guide
Mr. K. NARENDRAN
___________________________
Signature of the Examiner
Date: ______________

2. 2
INDEX
Sr. No. Particulars Page no
1. List of tables 02
2. Executive summary 05
3. Introduction 06
4. Advantages of contract farming 07
5. Problems of contract farming 09
6. Suggestion for contract farming model of agriculture
in india
11
7. Reasons why smallholders participate in contracts 13
8. Comparison with global experiences 18
9. Conclusion 25
10. Reference 27
SUB INDEX
1. Introduction 06
2. Advantages and problems of contract farming 07
2.1 Advantages of contract farming 07
2.1.1 Advantages for farmers 07
i. Provision for better inputs and production services 07
ii. Easy access to credit 07
iii. Application of better technology 07
iv. Improvement in skills of the farmers 07
v. Guaranteed pricing system 08
vi. Easy access to reliable market 08

3. 3
2.1.2. Advantages for the sponsors 08
i. Political acceptability 08
ii. Overcoming barriers on land restrictions 08
iii. Production consistency and shared risk 08
iv. Quality assurance 09
2.2 Problems of contract farming 09
2.2.1. Problems faced by the farmers 09
i. Possibility of greater risk 09
ii. Outdated technology and crop incongruity 09
iii. Manoeuvring in quotas and quality specifications 09
iv. Corruption 10
2.2.2. Problems faced by the sponsors 10
i. Limitation on land availability 10
ii. Social and Cultural constraints 10
iii. Farmers disgruntlement 10
iv. Below quality agro-inputs 11
v. Sale of crops by the farmers beyond contractual
agreement
11
3. Suggestion for contract farming model of agriculture in
India
11
4. Reasons why smallholders participate in contract
farming
13
4.1 Adoption of new enterprises 13
4.2 Reasons smallholders enter contracts 15
4.2.1 Access to markets 15
4.2.2 Access to credit 16
4.2.3 Managing risk 17

4. 4
4.2.4 Provision of information 18
5. Comparison with global experiences 18
5.1 National policies 19
5.2 Kenyan tea development authority (KTDA) 19
5.3 Ghana and Ivory Coast 20
5.4 Thailand 21
5.5 Malaysia 22
5.6 India 23
5.7 Mozambique 24
6. Conclusion 25
7. Reference 27

5. 5
EXECUTIVE SUMMARY
An agribusiness firm‟s choice to expand activities through contract
farming rather than plantations, buying directly from open markets or other
means reflects differences in transaction costs found in different types of
procurement systems. Smallholders may enter contracts to reduce
transaction costs of accessing new markets, borrowing, managing risk,
acquiring information or increasing employment opportunities. The success
of contracts reflects both the contracting environment and management
practices. The contracting environment includes the strength of markets for
contracted output, government macro policies, technical sophistication in
production and attenuation of land ownership while important management
elements are farm groups, selection of participants for contracts, managing
contract default and conflict resolution. Direct benefits from contracting
accrue to smallholders from improved access to markets, improved
technology, better management of risk and opportunities for employment of
family members. Indirect benefits occur from empowerment of women and
increased commercial acumen on the part of smallholders. Contract farming
has the potential to improve the welfare of smallholders however it is not a
sufficient condition for such improvement. Smaller farmers can be excluded
from contracts because of selection bias by agribusiness firms awarding
contracts to larger farms, be adversely affected by the second-round effects
of contracts on incomes and prices and suffer from narrowing of markets
that lie outside of contracts. Institutional developments that might
ameliorate this type of exclusion are anti-trust legislation, policies to directly
improve the contracting environment, policies to address specific problems
smallholders face in entering contracts and participation by NGOs in
contract facilitation.

6. 6
1-INTRODUCTION
“Contract farming is defined as an agreement between farmers and
processing and/or marketing firms for the production and supply of
agricultural products under forward agreements, frequently at predetermined
prices”.
The arrangement often involves the purchaser in providing a degree of
production support through, for example, the supply of inputs and the
provision of technical advice. For this arrangement to work the farmer commits
himself to provide a specific commodity in quantities and at quality standards
determined by the purchaser. The company on the other hand agrees to
support the farmer‟s production and to purchase the commodity.
A fundamental feature of contract farming is the shifting of risk from
producers to processors since it is a form of futures market. Production and
price risks are important features of poultry farming. Risk sharing is one of the
widely cited reasons for contracting. Numerous studies of contract farming
emphasize risk reduction as a principal incentive for producers to enter in to
contracts. Much of the price risk is reduced, in contract farming, by the use of
a predetermined price rather than the market price.
The modernization of agricultural value chains – the systems of agreements,
arrangements, and contracts that link farmers to consumers of food,
typically through one or more intermediaries – is both a consequence and
cause of economic development. Commercial demand increases due to
income and population growth, urbanization, and trade liberalization.
Marketed supply rises simultaneously as a result of productivity
improvements in production, post-harvest processing, and distribution
systems.
The combination of increased commercial demand and supply has led to the
emergence of modern marketing channels employing sophisticated
management methods, such as costly grades and standards or vertical
coordination or integration of activities that profitably add value to raw
commodities through transport, storage and/or processing. Participant
farmers – whose comparative advantage allows them to tap the latent
demand of better-off or more distant markets made accessible by emergent
agricultural value chains - typically improve their productivity and
profitability, thereby further stimulating commercial demand and supply.
The emergence and modernization of agricultural value chains (AVCs) thus
result from and contribute to economic development.

7. 7
2-ADVANTAGES AND PROBLEMS OF CONTRACT FARMING
2.1ADVANTAGES OF CONTRACT FARMING
2.1.1. ADVANTAGES FOR FARMERS
The main benefit of a contractual agreement for farmers is that the sponsor
will normally undertake to purchase all produce grown, within specified
quality and quantity parameters. Contracts can also provide farmers an
opportunity to access a wide range of managerial, technical and extension
services that otherwise may be unattainable. Farmers can use the contract
agreement as collateral to arrange credit with a commercial bank in order to
fund inputs. Thus, possible advantages of Contract Farming for farmers are
given below –
i. Provision for better inputs and production services: For ensuring a
proper crop husbandry practices in order to achieve projected yields in
required qualities many contractual arrangements involve considerable
production support in addition to the supply of basic inputs such as seed
and fertilizer. Sponsors may also provide land preparation, field cultivation
and harvesting as well as free training and extension.
ii. Easy access to Credit: With the collapse or restructuring of many
agricultural development banks, the majority of small holder producers
experience difficulties in obtaining credit for production inputs. Contract
farming usually allows farmers access to some form of credit to finance
production inputs. Arrangements can also be made with commercial banks
or government agencies through crop liens that are guaranteed by the
sponsor, i.e. where the contract serves as collateral.
iii. Application of better technology: New production techniques are often
necessary to increase productivity as well as to ensure that the commodity
meets market demands. However, small scale farmers are frequently
reluctant to adopt new technologies because of the possible risks and costs
involved. Private agribusiness will usually offer technology more diligently
than government agricultural extension services because it has a direct
economic interest in improving farmers production.
iv. Improvement in skills of the farmers: The skills the farmer learns
through contract farming may include record keeping, the efficient use of
farm resources, improved methods of applying chemicals and fertilizers,
knowledge of the importance of quality and the characteristics and demands
of export markets. Farmers can gain experience in carrying out field
activities following a strict timetable imposed by the extension service. In
addition, spill over effects from contract farming activities could lead to
investment in market infrastructure and human capital, thus improving the
productivity of other farm activities. Farmers often apply techniques
introduced by management (ridging, fertilizing, transplanting, pest control,
etc.) to other cash and subsistence crops.

8. 8
v. Guaranteed Pricing System: The returns farmers receive for their crops
on the open market depend on the prevailing market prices as well as on
their ability to negotiate with buyers. This can create considerable
uncertainty which, to a certain extent, contract farming can overcome.
Frequently, sponsors indicate in advance the prices to be paid and these are
specified in the agreement. Thus Contract Farming ensures guaranteed and
fixed pricing structures.
vi. Easy access to reliable market: Farmers will not cultivate unless they
know they can sell their crop, and traders or processors will not invest in
ventures unless they are assured that the required commodities can be
consistently produced. Contract farming offers a potential solution to this
situation by providing market guarantees to the farmers and assuring
supply to the purchasers. Even where there are existing outlets for the same
crops, contract farming can offer significant advantages to farmers. They do
not have to search for and negotiate with local and international buyers, and
project sponsors usually organize transport for their crops, normally from
the farm gate.
2.1.2. ADVANTAGES FOR THE SPONSORS
The possible advantages for the sponsors are as follows –
i. Political Acceptability: Contract farming, particularly when the farmer is
not a tenant of the sponsor, is less likely to be subject to political criticism.
It can be more politically expedient for a sponsor to involve smallholder
farmers in production rather than to operate plantations. In recent years,
many African governments have promoted contract farming as an
alternative to private, corporate and state owned plantations.
ii. Overcoming barriers on land restrictions: The majority of the world
plantations were established in the colonial era when land was relatively
abundant and the colonial powers had little conscience about either simply
annexing it or paying landowners least compensation. However, in present
days most large tracts of suitable land are either traditionally owned, costly
to purchase or unavailable for commercial development. Contract farming,
therefore, offers access to crop production farm land that would not
otherwise be available to a company, with the additional advantage that it
does not have to purchase it.
iii. Production consistency and shared risk: Working with contracted
farmers facilitates sponsors to share the risk of production failure due to
poor weather, disease, etc. The farmer takes the risk of loss of production
while the company absorbs losses associated with reduced or throughput
non existent for the processing facility. Where production problems are
widespread and no fault of the farmers, sponsors will often defer repayment
of production advances to the following season. Both estate and contract

9. 9
farming methods of obtaining raw materials are considerably more reliable
than making purchases on the open market.
iv. Quality assurance: A steady markets for fresh and processed
agricultural produce require reliable quality standards. Moreover, these
markets are moving increasingly to a situation where the supplier must also
conform to regulatory controls regarding production techniques, particularly
the use of pesticides. Both estate and contracted crop production require
close supervision to control and maintain product quality, especially when
farmers are new with innovative harvesting and grading methods.
2.2 PROBLEMS OF CONTRACT FARMING
2.2.1. PROBLEMS FACED BY THE FARMERS
The potential problems as confronted by the farmers due to Contract
Farming are given below-
i. Possibility of greater risk: Farmers who were entering into a new
contract farming venture should be prepare themselves to assess the
prospect of higher returns against the possibility of greater risk. Such risk is
more expected when the agribusiness venture is introducing a new crop to
the area. There may be production risks, particularly where prior field tests
are inadequate, resulting in lower-than-expected yields for the farmers.
Market risks may occur when the company forecasts of market size or price
levels are not accurate.
ii. Outdated technology and crop incongruity: The introduction of a new
crop to be grown under conditions meticulously controlled by the sponsor
can cause disruption to the existing farming system. Again, the introduction
of sophisticated machines (e.g. for transplanting) may result in a loss of
local employment and overcapitalization of the contracted farmer.
Furthermore, in field activities such as transplanting and weed control,
mechanical methods may produce less effective results than do traditional
cultivation methods. Therefore, Field extension services must always ensure
that the contracted crop fits in with the farmers total cropping regime,
particularly in the areas of pest control and field rotation practices.
iii. Manoeuvring in quotas and quality specifications: Incompetent
management can lead towards production exceeding original targets. For
example, failures of field staff to determine fields following transplanting can
result in gross over planting. Sponsors may also have unrealistic
expectations of the market for their product or the market may crumple
unexpectedly owing to transport problems, civil unrest, change in
government policy or the arrival of competitors. In some situations
management may be tempted to manipulate quality standards in order to
reduce purchases for honouring the contract. Such practices may cause
sponsor-farmer confrontation, especially if farmers have no method to

10. 10
dispute grading irregularities. Therefore, all contract farming ventures
should have forums where farmers can raise concerns and grievances
relating to such issues.
iv. Corruption: Problems occurs when staff responsible for issuing
contracts and buying crops taking undue advantages of their position.
Such practices result in a collapse of trust and communication between the
contracted parties and soon undermine any contract. In a large contract,
the sponsors can themselves be dishonest or corrupt. Governments have
sometimes fallen victim to dubious or “fly-by-night” companies who have
seen the opportunity for a quick profit. Therefore, in every case farmers
who make investments in production and primary processing facilities run
the risk of losing everything.
2.2.2. PROBLEMS FACED BY THE SPONSORS
The possible problems as confronted by the Contract Farming Developers
are outlined below –
i. Limitation on land availability: Farmers should have a suitable
cultivable land on which they are to cultivate contracted crops. But
problems can arise when farmers have minimal or no security of tenure as
there is a possibility of drainage in sponsorship investment as a result of
farmer - landlord disputes. Difficulties may also arise when sponsors lease
land to farmers. Some contract farming ventures are dominated by
customary land usage arrangements negotiated by landless farmers with
traditional landowners. While such a situation allows the poorest cultivator
to take part in contract farming ventures, discrete management measures
need to be applied to ensure that landless farmers are not exploited by their
landlords. Before signing a contract, the sponsor must ensure that access to
land is secured, at least for the term of the agreement.
ii. Social and Cultural constraints: Promoting Contract Farming is a
cultural, customary beliefs and religious issues. In communities where
custom and tradition play an important role, difficulties may arise when
innovative farming is introduced. Therefore, before introducing new cropping
practices, sponsors must consider the social attitudes and the traditional
farming procedures of the community and decide how a new crop can be
introduced.
iii. Farmers disgruntlement: Sometimes, situations may crop up which
may leads towards farmer discontent; e.g. biased buying, late payments,
incompetent extension services, poor agronomic counsel, undependable
transportation for crops, a mid-season change in pricing or managements
impoliteness to farmers will all normally aggravate the relationship between
sponsors and the farmers. If not readily addressed, such circumstances will
cause antagonism towards the sponsors that may result in farmers
withdrawing from projects.

11. 11
iv. Below quality agro-inputs: Sometimes farmers are forced to use inputs
supplied under contract for the purposes other than those they were
intended for. They may choose to utilise the inputs on their other cash and
subsistence crops or even to sell them. As a result contracted crops yields
were reduced and the quality are affected. Improved monitoring by extension
staff, farmer training and the issuing of realistic quantities of inputs can
resolve the matter successfully. Majority of farmers conform to the
agreement when they have information that the contract has the advantages
of technical inputs, cash advances and a guaranteed market. However, until
a project is very poorly managed, input diversion is usually an infuriation
rather a serious problem.
v. Sale of crops by the farmers beyond contractual agreement: The sale
of produce by farmers to a third party, outside the terms of a contract, can
cause major problem to the sponsors. However, extra-contractual sales are
always possible when there is an alternative market. The outside buyers
offered cash to farmers as opposed to the prolonged and difficult collection
of payments negotiated through the cooperative. Sometimes the Sponsors
may encourage extra-contractual practices as there are several companies
working with the same crop (e.g. cotton in some southern African countries)
and they could collaborate by establishing a register of contracted farmers.
Managers must be aware of the situation when produce were sold outside
the project and also when produce from outside being forced into the buying
system. This happens when non-contracted farmers take advantage of
higher prices paid by a well-known sponsor. Non-contracted crops are
filtered into the buying system by outside farmers through friends and
family who have crop contracts. Such practices make it difficult for the
sponsor to regulate production targets, chemical residues and other quality
aspects.
3-SUGGESTION FOR CONTRACT FARMING MODEL OF
AGRICULTURE IN INDIA
Based on the above study, the following recommendations are made for an
improved Contract Farming Model of agriculture in India –
i. Present provisions of institutional arrangement to record all contractual
arrangements should be made effective. The Panchayat or Gram sabha,
particularly in PESA areas or in case of Forest Right Holder communities,
may be connected with this process. This will promote and strengthen
confidence building between the parties and also help to solve any dispute
arising out of violation of contract.
ii. There should be a contract farmers association or cooperatives at the
plant level which will improve bargaining power of the farmers and the
sponsors and promote equality of partnership. It will also minimise the role
of middlemen or commission agents who are involved in marketing of the
contract commodities on behalf of the company.

12. 12
iii. The selection of appropriate plant genotype is one of the crucial factors
for Contract Farming. Unless the plant material is of good quality and high
yielding and also less prone to pests and diseases, the contract farmers may
lose their confidence and discontinue the cultivation of contracted crop.
iv. Every contract farming agreement should have a provision for both
forward and backward linkages. Unless both input supply and market for
the produce are assured, small farmers are not encouraged to participate in
contract farming.
v. Bank finance to small and marginal farmers should be on easy terms.
vi. A sustainable contract farming requires adequate infrastructure facilities
e.g. roads, public transport, telephones, postal services, stable power and
water supplies, cold storage facilities, etc. Therefore, it is the responsibility
of the governments to provide the minimum necessary infrastructure
facilities like roads, electricity, cold storage, and market yards.
vii. The contracts should be managed in clear and participatory manner so
that there is greater social consensus in handling contract violation from
either side without getting involved in costly and lengthy process of
litigation. Also the terms of contract need to be more comprehensive and
flexible.
viii. In many parts of the country, agricultural tenancy is legally banned,
although concealed tenancy exists. Tenants who do not enjoy security of
tenure are unable to participate in contract farming. Hence, legalisation of
tenancy is a prerequisite for the tenant farmers who will enter into contract
farming. Although different forms of land tenants including share-croppers
can be adopted to maintain the contract farming but security of tenure is a
must.
ix. As assured market of the farm motivates a farmer to enter into contract
with a company, similarly market prospect for the processed products of the
company should exist. Ultimately, it is the success of the company's product
in national or international market, which decides whether contract farming
for any particular crop or commodity would sustain.
x. The government must ensure that contract farming, which is generally a
commodity specific and tends to promote monoculture, does not grow
beyond certain limit which will destroy biodiversity and agricultural ecology.
xi. The Central Warehousing Corporation and the State Warehousing
Corporations should develop commercially acceptable quality standards in
respect of various commodities in order to ensure quality maintenance of
the stored goods over a sufficiently longer period of time.

13. 13
xii. Updated database of contract farmers along with other relevant details
such as the area & crops under contract, contracting agency, etc. should be
maintained at various state levels and should be available to the public
through an website.
xiii. Agreements written in vernacular language should be given priority so
that the local farmers can understand the terms of contract. To suite the
other party, it can be made bilingual. Standard formats for farmer-friendly
agreement should be designed and mandated by the governments.
xiv. Contract Farming in lands recognized under Forest Rights Act is a
virtual control of a person or agency other than the right-holder
himself/herself and this lead towards violation of the spirit & mandate of the
Act; therefore governments should take protective measures in this context.
xv. Liability of the contractor for any environmental losses should be fixed
by the government, and in case such losses occur, the penalty realized in a
proportionately appropriate amount should be spent for restoring the
concerned area, preferably through the local Palli sabha/Gram sabha.
4-REASONS WHY SMALLHOLDERS PARTICIPATE IN
CONTRACT FARMING
Contracts are initiated by those who write them and, as discussed above,
agribusiness firms write contracts to either increase profits by expanding
operations or reduce profit variability by diversifying supplies. However, if
contracts are to work, they must be attractive to potential contractors.
Hence, contracts struck with smallholders need to increase farm profits or
reduce risk exposure.
4.1 ADOPTION OF NEW ENTERPRISES
A farmer considers three factors prior to undertaking a new enterprise or
substantially changing the way an existing enterprise is pursued. These are
revenue implications, cost implications and any additional exposure to risk
that might arise from the new activity. In principle, a contract does not need
to improve revenues to be attractive if revenue losses are more than fully
offset by cost savings. However, researchers have yet to report examples of
contract farming involving expected reductions in revenue and increasing
revenue is likely to be important.
Two types of farm costs are relevant to adoption opportunity costs and input
costs. Opportunity costs occur with a new activity because other on-farm or
off-farm activities may need to be curtailed. In essence, new enterprises
„crowd out‟ existing activities resulting in lost income (or its equivalent in
utility) from these sources. Hence opportunity costs reflect how resources
such as labour, land, buildings and machinery are used in existing on-farm
and off-farm enterprise or in leisure or community activities. Labour may be
used to generate income or diverted to leisure or community activities. Land

14. 14
is likely to be used for other cropping or livestock purposes or rented out,
sheds may be used for on-farm activities such as grading, processing and
storage or for industrial piece-work and machinery can be used either on
the farm or rented out.
Two considerations are relevant to evaluating opportunity costs. First, it is
important whether the input is constrained in the sense that more of it
cannot be purchased or obtained through negotiation with third parties. For
example, if land can be rented in then the opportunity cost of land used in a
new contractual enterprise equals its rental value. In contrast, if extra land
is not available and the smallholder is „land constrained‟, then the
opportunity cost of land in a new contract equals the gross margin of the
existing on-farm activity that is curtailed to accommodate the contract.
Smallholders may be constrained with other inputs. Hiring in of additional
labour may be impossible because it is unavailable and credit may be
unavailable because the smallholder has no collateral.
The second consideration in evaluating opportunity costs concerns farm
inputs that have zero or very low value for the smallholder. De Janvry ,
Fafchamps and Sadoulet (1991) extend the theory of „shadow pricing‟ to
farm input markets where inputs such as land and labour cannot be used
because of high transaction costs. An example is where a farm family has
surplus labour because it cannot rent in more land to provide employment
for family members and things like travel costs, availability of work, social
factors or cultural beliefs prevent off-farm work. In this situation, even
though the village day rate for labour may be Rs.100,000 the shadow price
for the family‟s labour is zero or very low reflecting only subjective valuation
of leisure time or participation in village activities. In this sense, the family
has a reservation price for its labour, say Rs.50,000 per day, that is never
met by the market after transaction costs are The second type of cost is
expenses incurred in purchasing farm inputs. Such expenses include hired
labour, machinery, seed, chemicals, storage, marketing and rented land. A
new enterprise must increase total farm income if it is to be a candidate for
adoption by the smallholder .subtracted and hence family labour is under-
utilised. Relatively low shadow prices can occur in more subtle ways with
land where social factors prevent certain types of activities. An example of
social transaction costs in land use is wealthy land owners in Pakistan
producing livestock, never crops. Clearly, if a farm contract can provide
employment for resources that have very low shadow prices then it will be
attractive to the smallholder.
Increasing total farm income requires expected revenues to be greater than
purchased input costs plus opportunity costs. Adoption also requires farm
risk remain at acceptable levels hence the effect of the new enterprise on
stability of income is important. How farmers respond to uncertainty is
contentious however elements of the problem are captured in safety-first
theory, where smallholders will not expose themselves to the risk of their
income falling below some minimum threshold level. Farm bankruptcy is
relatively common in developed countries where its consequences are

15. 15
serious though not necessarily dire. In developing countries losing land can
be dire and empirical evidence shows developing country farmers generally
take more conservative account of uncertainty than developed country
farmers.
4.2 REASONS SMALLHOLDERS ENTER CONTRACT FARMING
Agribusiness firms are likely to have four areas of strategic advantage that
allow cost savings to be conferred on smallholders through contracting :
 They may provide services for managing on-farm risk.
 They may have access to product markets where high transactions
costs effectively prevent smallholder access.
 They may have access to relatively inexpensive credit where, for a
range of reasons, smallholders face high interest rates or have no
access.
 They may provide information on extension, logistics and marketing at
relatively low cost.
4.2.1 Access to Markets
Recent expansion of contract farming is often viewed as part of the broader
globalisation phenomenon whereby removal of trade restrictions has led to
increased flows of agricultural products, especially from developing to
developed countries . Runsten (1992) documents a range of contracts since
1989 for HVF crops including strawberries, melons and frozen vegetables
processed in Mexico then exported to the United States by both domestic
and multi-national agribusiness firms. Goodman and Watts (1997)
document the development of contracts, alongside other multi-national
activity, for pineapples and bananas from Central American countries for
export to the United States and Europe. Glover and Kusterer (1990)
document similar activity in Central American countries and Porter and
Phillips-Howard (1997) examine a range of new types of contractual
arrangements involving international trade from Africa.
Agribusiness firms are instrumental in „opening‟ markets for smallholders in
all of these studies. These firms have advantages over smallholders in
market knowledge and experience, information links, legal expertise,
economies to size in processing and transport and have the financial muscle
necessary for sustaining international trade relationships. From a
smallholder perspective, in the absence of contracts these markets are
„missing‟ in the sense that transaction costs of accessing them on a small
scale are effectively infinity.

16. 16
4.2.2 Access to Credit
Non-traditional crops are more costly to produce than traditional crops and
cash requirements for farm inputs are usually relatively high. This is
because HVF crops often require specialty inputs and have more exacting
quality requirements requiring sophisticated technology and flexible use of
labour and chemicals. Hence, smallholders need access to credit to
undertake production.
Many smallholders are credit constrained in the sense they have no access
to credit at all. Alternatively, if access is available they face high interest
rates, often three to four times the bank rate, from local moneylenders or
excessive transaction costs if they use bank credit. High interest rates reflect
relatively high costs faced by local moneylenders in sourcing funds and
servicing borrowers who do not have collateral. Titles to land may be
traditional rather than legal and court processes slow, expensive or
ineffective so that small loans are not worth pursuing legally. In this
situation, a moneylender is limited to collateralising the smallholder‟s desire
for future loans and, since they are often part of the same community, may
face social pressure to be benevolent when repayments are delayed by bad
seasons or exigencies such weddings and funerals. These high costs are
passed on to borrowers by moneylenders in the form of high interest rates.
When smallholders seek credit from agricultural banks or micro-lenders,
transaction costs are high. On even small loans they may face forced
purchases, loan delay costs, travel costs, application fees, legal service costs
and collateral titling costs .There are several areas of potential savings for
agribusiness firms in providing credit. If the firm is large and well
established it is likely to obtain funds at normal business rates. A large firm
may also have advantages over moneylenders in management of risk
because of the size and diversity of its loan portfolio. That is, investing in a
large number of small cash advances allows diversification of lending risk
either across participants in a particular contract or across participants in a
number of different commodity contracts or activities. The agribusiness firm
also has lending advantages by virtue of its contract. A contract allows
monitoring of input use, a degree of control over crop management decisions
that might jeopardise repayment and can specify how cash advances are to
be repaid. Also, contracts require delivery to the firm hence cash advances
can be deducted from post-harvest cash settlements. Other loan protection
devices include making future contracts depend on meeting repayment
clauses in current contracts and making loans in the form of specialised
agricultural inputs rather than cash. Finally, there may be no other local
market for the contracted commodity than the agribusiness firm thus
ensuring diversion of collateralised farm output cannot occur. These factors
reduce the need for collateral and mean that agribusiness firms are likely to
incur lower costs than moneylenders which can be passed on to
smallholders through contracting.

17. 17
4.2.3 Managing Risk
Farmers in developed countries have three basic approaches to the
management of risk. First, they can diversify over both on-farm and off-farm
enterprises offsetting losses in one activity against gains from other
activities. Second, they can smooth income over time by adjusting savings
and borrowings to offset low and high income years. Third, they can use
futures or forward markets or crop insurance policies covering price and
yield variability to reduce risk.
In contrast, developing country smallholders have limited strategies for
managing risk. Diversification on the farm offers prospects for income
smoothing however yield risk may be correlated across enterprises if
seasonal conditions are the major determinant of crop yield.
There may be scope for scattering plots across a district to diversify yield
risk or finding off-farm work or entrepreneurial activity when farm returns
are down. Restrictions facing smallholders in credit markets associated with
high interest rates and lack of access, discussed above, limit the scope for
using borrowings to supplement income in bad years and smoothing income
over time. Finally, sophisticated markets for insurance, such as crop
insurance and forward and futures markets, usually do not exist in
developing countries and remain the province of wealthy farmers who can
access international hedge markets. Hence, given the difficulties
smallholders face in shifting risk, it is not surprising risk aversion is central
in smallholder decision making and particularly so in adoption of new crops
and technologies.
Entering a contract may mitigate or exacerbate smallholder risk. If upfront
investment is required then failure of either the crop or the contract results
in loss. Alternatively, if the contract works and becomes integral in the farm
plan then it constitutes a form of diversification and may reduce risk
providing it does not dominate the farm plan.
Agribusiness firms could hedge some price risk for HVF products in options
and futures markets to protect their own forward commitments and provide
upstream protection to smallholders. However, there is not convincing
evidence firms actually do this by putting price guarantees in contracts. We
found from interviews with Indonesian smallholders that contracts for seed
corn, Mangosteens and ginger stipulated prices based on market prices at
time of delivery.
Thus, opportunities for reducing smallholder risk through contracting
include diversification into a new crop with price movements largely
independent of those for traditional products, reduced risk associated with
start-up costs and seasonal operating costs met be the firm through
subsidies at start-up and forward payments and reduced yield risk from the
firm‟s extension activities.

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4.2.4 Provision of Information
Information can be expensive to gather and is not depleted by use. Hence an
agribusiness firm spreading information over many contracts has
advantages in providing crop specific information over smallholders
gathering their own information. Most contracts described in Glover and
Kusterer (1990) included visits by firm extension officers to either individual
farmers or farm groups several times during the first year of the contract
but often less in later years. These visits combined dissemination of
information with suggestions about management as well as providing firms
with feedback on issues between themselves and growers. Most developing
countries have government extension services to disseminate information
about traditional crops however, given the limited nature of developing
country government resources, these agencies are unlikely to provide
specialised information about new crops. Such specialised information may
concern chemical restrictions related to food safety requirements in specific
markets, timing of planting and harvest to meet markets, management of
product quality and other market and technical information.
5-COMPARISION WITH GLOBAL EXPERIENCE
This section will examine some national policies on outgrower schemes
(their possible contradictions) and some case study evidence on successful
schemes. Most contract farming and outgrower schemes have both private
and public sector involvement, although the public sector tends to be more
involved in the latter. It is likely that public sector involvement, whether in
direct management or in supportive policy, will be necessary if outgrower
and/or contract farming schemes are extended to tree farming. For example,
transnationals, as well as „development‟ organisations like CDC are
reluctant to invest in projects that have a slow maturation period or to
finance contract growers themselves. State development banks have taken
on part of this role but for this they need to formulate means of enforcing
loan repayments; appropriate interest rates and compensation for assuming
financial risk. The role the government will play is of course dependent on
the specific configuration of power within the country. Insofar as most
contracts in African agriculture are mediated by state sponsorship – through
actual state investment in processing plants, expropriation of land for use
by transnational corporations, setting of prices, enforcement of contracts,
and recruitment of labour and smallholders or simply by the state‟s agreeing
to provide such basic needs as roads, schools, clinics, and housing in order
to make contracting more attractive – the state becomes enmeshed in the
social relations of production. In so doing, the state becomes more than an
impartial mediator: „it becomes an important battleground for competing
interests in the contracting arrangements‟. It is probable that agribusiness
companies will have greater political influence than growers, and that
governments may not even have much choice in how they deal with the
problem of smallholder welfare. However, there is evidence that some
governments have intervened on behalf of smallholders through for example,

19. 19
price stabilisation, guaranteeing debts or trying to obtain better contract
conditions and services for smallholders.
5.1 NATIONAL POLICIES
Smallholder schemes are attractive to many governments because it
appears to provide an avenue whereby small farmers can enter commodity
production on favourable financial terms. It also provides a useful
mechanism for a variety of explicit and implicit political objectives such as
earning foreign exchange, moving populations to new settlements,
redistributing land and gaining the political support of the middle
peasantry. Most national governments became involved in smallholder
schemes and/or in taking over plantations after Independence. In almost all
countries where there had been plantations, governments are using tax
incentives and credit facilities to influence the plantation sector in line with
development objectives. The most common form of public sector support for
contract farming manifests itself in a „nucleus estate‟ which encourages the
expansion of smallholders around it. In some cases, the plantation itself
provides finance training and technology. For example, the United Planters
Association of India has a joint program with the Tea Board of India to assist
smallholders. In Indonesia, the Nucleus Estates Smallholders Program has
made the market for palm oil and tea accessible to smallholders. In the Ivory
Coast, smallholdings – called „Plantations Villageoises‟ – are expanding
around the large industrial complexes created by government for the
exploitation of rubber and palm oil. National policies have also tried to
diversify, at a national level, in order to break monocrop dependence and to
make contract crops less risk intensive for smallholders. The Philippines, for
example, introduced more crops such as coffee, banana, and pineapple to
break dependence on sugar. In Malaysia during the 1960–70s there was a
shift from rubber towards palm-oil, although rubber recovered its leading
role in the 1980s when it was decided the competitive position of synthetic
rubber would not decline. Most smallholder programs have government
support the case studies below will examine different policy approaches and
the reasons for their success and failure.
5.2 THE KENYAN TEA DEVELOPMENT AUTHORITY (KTDA)
Kenya has a large plantation sector co-existing with the largest and most
effective smallholder sector in Africa. The Kenyan example is interesting to
consider for this reason. It has an extremely high rate of population growth
(over 4% a year) and is fast approaching a land frontier with alarming levels
of poverty, underemployment and malnutrition. Labour is in surplus and
will continue to increase with population growth in the absence of
alternative sources of non-agricultural employment. By the mid-1980s more
than 230,000 households were involved in the contract production of tea,
sugar, oilseeds, tobacco and horticulture. About 15.5% of all Kenyan
smallholders produce under contract accounting for 40% of tea, 50% of
sugarcane, and 80% of tobacco production. The centre of the contract
system, and the most renowned part of it is the sugar and tea sectors, both

20. 20
dominated by large parastatals. Tea was first planted in the 1920s on
plantations. Since then the tea output has increased by 700% with a large
part of it smallholder contribution. For the last three decades this growth
has been steered by KTDA which was established in 1964.
The development of contract farming, and the implications for the
replication of this development have to be understood in the political history
of Kenya. The white settler class which ruled the Kenyan colony, had
secured the legislative right to ban peasant production of export crops and
to confine Kenyan peasants to crown reserves. The imposition of regulations
on production and the expulsion of tenants led to the Mau rebellion in the
early 1950s. This was in effect a political emergency and the colonial state
targeted tea and pineapple as peasant crops, and after Independence in
1963, the expansion of peasant commodity production. The expansion of
tea, coffee, sugar and tobacco was overseen by the state, and later CDC and
the World Bank. Watts (1990) argues that the expansion of smallholder tea
production is best understood by examining the political motives that
underscored it. „In this sense, it is no surprise that in the case of tea, the
contract crop par excellence, more than half of smallholder production was
located in the Central Province, the overcrowded reserve that both spawned
the nationalist revolt against the British and provided the political bedrock
of the Kenyatta regime in the postcolonial era‟.
More serious than the above is the claim that KTDA has concentrated
resources in one area and concentrated on relatively prosperous
smallholders. The income effects for the Kenyan tea smallholder are positive
with above average standards of living in a normal year. The KTDA has
drawn heavily on government resources and imposes direct costs on the
government for salaries, which are not recovered from the tea growers. They
are also able to draw on the best extension staff. Further, smallholder cash
crop production may not be the best option for the rural poor. First, they
cannot join if they do not have enough resources of land and secondly, the
wages paid by smallholders are amongst the lowest in Kenya. Some
commentators have pointed out that plantations are actually better for the
rural poor because they are more productive and therefore more labour
intensive.
5.3 GHANA AND IVORY COAST
Contract farming of oil palm in the Ivory Coast and Ghana provides an
interesting comparative study. Both the Ivory Coast and Ghana had a
tradition of oil palm production and a growing gap between internal demand
and supply at the time of Independence. The two countries both had an
interest in the potential contribution of the projects to their post-
Independence import-substitution. Both states have a political agenda with
smallholders and both brokered the relationship between agribusiness and
smallholders. In both states, the organisational model chosen was the
nucleus-estate smallholder combination. However, the comparison reveals

21. 21
the extent to which the terms of the contract and smallholder collective
action are dependent on the political space given by the state.
The development of the modern oil palm industry in the Ivory Coast started
in 1963. The Plan Palmier outlined a program for the establishment of state
owned nucleus estates (plantations agroindustrielles) and land belonging to
contracted smallholders (plantations villageoises). Funds provided by the
World Bank and the European Development Fund played an important role
in enabling the implementation of the plan. The state released forest
reserves established by the colonial estate for the new plantations and
created a land tenure system whereby anyone working the land could have
title to it. This land tenure system was enforced by traditional elites and
government institutions. By 1984 the estates, operated by the parastatal
Palm industrie, constituted 60.3% of the area devoted to oil palm production
and 39.7% was constituted by contracted smallholders. Intercropping was
prohibited. Peasant producers were offered government subsidies, cash
advances and good prices, which reflected the high prices for palm oil in the
world market during the 1960s and 1970s. Contracted smallholders were
also given a six-year grace period before they had to begin repayment of
their debts so participation in the scheme did not require a cash outlay. The
average size of smallholding is 4.41 hectares and smallholders must be able
to show that the land is commensurate with their labour power and
management skills. Security against smallholder default and continuity in
oil palm production, are secured through a provision which ties heirs to the
loan obligations of the contracted farmer. This was made possible for many
by the government policy on immigration that ensured a flow of cheap
labour from the Sahel in particular.
The development of the contract and the reaction of the contracted
smallholders in both countries to deteriorating terms of trade. In the Ivory
Coast, peasant resistance took highly individual forms, the diversion of palm
nuts to the open market, neglecting trees and not replanting which has led
to the under utilisation of plant capacity. These individual responses have
not been effective in changing the producer price structure. In Ghana, the
smallholders have formed an association known as SHAK which has
emerged as a voice for the smallholders dealing with a number of issues
including production related matters such as the need for seedlings, timely
collection and proper weighing. The issue of food availability and services
such as methods of transporting food has also been successfully taken up
by SHAK.
5.4 THAILAND
Thailand has extensive experience of contract farming with the highest
degree of private sector involvement and foreign direct investment. Contract
farming has been a central component of the government development plan
and its strategy of integrated agricultural development generated through
the private sector. The contract farming model used, is one in which private
firms supply farmers with inputs, credit and technical assistance and

22. 22
purchase the farmers outputs. The major role played by private firms in
contract farming, is largely due to a credit extension policy that requires
commercial banks to extend 20% of their total deposits in rural credits.
Commercial banks have preferred to do this through contract farming as
opposed to direct loans to smallholders as this reduces the credit risk.
The proliferation of contract farming is part of a larger national agrarian
restructuring which has shifted Thai agriculture from its traditional
dependence upon primary commodities to an integrated agro-food system.
However, contract farming has not done very well in Thailand. Public
outgrower schemes have never been attempted which reflects Thai
agricultural policy of introducing policies that affect the agricultural sector
(such as the rule on credit) without intervening directly. Most private
contract farming schemes have failed. In some cases early successes in
contract forestry were not sustained as firms switched from artificially
supported terms designed to attract growers to more realistic terms. But the
failure of contract farming in Thailand is better explained by the competitive
market. The growers and contractors both have multiple potential business
partners, products and non agricultural income sources. These do not meet
the condition of quasi-monopsony which appears crucial for contract
farming. Contractors fear that growers will apply inputs supplied for
contract crops to non-contract crops and contract defaults are the rule
rather than the exception. Growers can survive in fluctuating markets by
shifting to new buyers or products and capitalising on short term export
opportunities. Farmers invest revenue from boom periods in new crops or
non-agricultural activities, including real estate, and are able to survive in
this way. The preferred mechanism for both Thai contractors and growers to
cope in this fast market is the quotaman. This is an intermediary who is
able, through personal contacts, to provide access to small producers when
necessary without the formality of a contract. Companies can diversify their
sources of supply and rely on several quotamen to spread their risks.
Quotamen are also better able to judge a growers creditworthiness and their
margins are not cut by tax. Contract farming in Thailand has failed because
the success of the agricultural sector in Thailand.
5.5 MALAYSIA
The Malaysian experience of contract farming is characterised by heavy
public sector involvement in land settlement-outgrower schemes and
reliance on traditional tree crop exports like rubber and palm oil. The
responsible public sector body is the Malaysian Federal Land Development
Authority (FELDA), established in 1956. The Malaysian case is interesting
because it has had a long experience with outgrower schemes; many
schemes are now in the second crop cycle and second generation of farmers.
FELDA has set up 442 schemes, covering 714,945 hectares and involving
more than 100,000 families. The schemes were designed to settle new lands
and to produce a prosperous export-oriented Malay peasantry. Ghee and
Dorral (1992) have evaluated the schemes as successful, with a notable
success in increasing farmer incomes, long waiting lists of applicants, and

23. 23
an annual economic return of 20%. The yields which have been achieved on
FELDA schemes are impressive, they match those of plantations for rubber
and in the case of oil palm exceed those of outgrowers by 30–300% . The
contract system itself is very complex and still in a state of development. The
settlers are allocated 4 hectares of land to manage which are situated in a
larger management block. The system in the 1960s was that settlers were
given title to land but a minimum of institutional support and inputs. This
system led to poor husbandry and was changed a decade later to a system
whereby settlers were assigned to blocks for cooperative work. The settlers
arrive 18 months after planting and are allocated 4 hectares each, arranged
in blocks of 100 for cooperative work. These plots are managed under the
supervision of a field assistant and are worked in a regimented way under
his control. On maturity, the holdings become the responsibility of
individuals and the field assistant becomes an extension worker. The
growers receive title to the land once they have repaid their debt. It was
thought that peer pressure would induce the settlers to work, but
absenteeism and subcontracting to illegal Indonesian workers became a
problem. The latest system under consideration is one of share ownership
instead of land ownership.
5.6 INDIA
The Indian data come from a survey of 825 farmers covering five commodity
sectors: cotton, gherkins, marigold, papaya, and broiler chickens. The study
area – nine administrative districts in the southern state of Tamil Nadu – is
heterogeneous in its agro-ecological conditions, physical features, and levels
of socioeconomic development, spanning districts that are among the richest
as well as the poorest in India. The survey was conducted in two phases
between 2007 and 2010. The list of contracting farmers for the year of the
survey was obtained from one contracting firm in each of the commodities
studied. Based on this list, all the villages in the sample area were divided
into contracting villages or non-contracting villages. A similar exercise was
carried out for the larger administrative units, blocks and districts. Starting
from the largest administrative unit for the study area, contracting districts
were sampled, within which contract and non-contract blocks were
randomly sampled and then further on, within sampled blocks, contract and
non-contract villages were sampled. In the villages sampled, a census house
listing identified four key types of farmers: those currently contracting; those
who grew the contract crop but for the open market or for other firms; those
who had given up contracting and those who had never contracted. The
sample respondents were randomly selected from each type. Gherkins are a
nontraditional export crop with no domestic markets. The crop is procured
from farmers and processed at small-scale plants by washing, rinsing, and
preserving in brine, acetic acid, or vinegar. Gherkins are then either bottled
and labeled for international clients or shipped in barrels for bottling. Cotton
is a traditional cash crop in parts of the study area, with established local
markets and networks. Recent years have seen mills integrating along the
garment chain and extending backward to contract with farmers for good
quality, long staple cotton for milling. Papaya was introduced in the region

24. 24
in the 1990s for extracting papain, an enzyme whose industrial uses range
from making meat tenderizer to treating insect bites and other wounds. The
variety is not ideal for table consumption, and the fruit is used to make
candied fruit or puree. Marigold contracting was initiated by firms for
oleoresin extraction for export, mainly as colouring agent for poultry feed.
Marigold, however, has a thriving local market as a flower used for a
number of ceremonial occasions, religious and otherwise. The broiler
chicken industry is almost completely vertically integrated in the study
region, a process that began in the mid-1990s. In this case, day-old chicks
are provided by the firm and bought back. The firm acts as an aggregator
but also has its own brand of chicken in various processed forms.
5.7 MOZAMBIQUE
The Mozambican data come from the official agricultural household survey
produced by the Mozambican Ministry of Agriculture with the assistance of
Michigan State University . The balanced panel for 2002 and 2005 consists
of 3480 households. The sample is based on the Agricultural and Livestock
Census from 2000, using the standards of the National Statistics Institute.
The sampling design aimed at evaluating rural production and incomes
representative of rural small- and medium-holders at the provincial and
national level. The survey collected detailed information on household
characteristics welfare indicators landholdings, employment types, and
remittances as well as detailed information regarding farming practices,
crops grown, harvested and sold, and livestock, assets, and incomes. In
addition, a community level survey for both years collected information on
marketing, prices, and infrastructure. The focus of on which this paper
draws, is on the impact of farmer groups on smallholder marketing
behaviour and welfare, although only a limited share of agricultural
marketing in Mozambique during this period was through CFAs. Because of
the perceived importance of farmer groups for connecting smallholders to
CFAs, the insights of this study contribute directly to the broader meta-
narrative.

25. 25
6-CONCLUSION
The rapid transformation of agricultural value chains and spread of CFAs
with the rapid rise of Super markets, fast-food chains, and other retailers
with downstream market power, along with a more prominent role for global
agro-exporters, is one of the more important and fascinating agricultural
development phenomena of the past few decades. The relatively high upfront
investment required to participate in modern markets is a challenge to
participation of smallholders, however. In the same way that much of the
early Green Revolution literature focused on limited small farmer uptake of
improved seeds, fertilizer and other components of “modern” production
systems, a large share of the emerging literature on modern value chains
has been concerned with smallholder participation in CFAs and with
whether these same value chains might be leaving many poorer farmers
behind.
This is perhaps unsurprising given that, historically, market sales of food
have been heavily concentrated in the hands of a small number of
producers, even in regions and countries with broad-based market
participation. Although most of the evidence comes from staple grain
markets, a relatively small group (i.e. less than 10 percent) of relatively well-
capitalized farmers located in more favorable agroecological zones accounts
for a significant majority of market sales throughout the world (Barrett
2008). This suggests that gains from agrifood value chain transformation
accruing to net sellers in the form of higher profits will likely concentrate in
the hands of a relatively modest share of the farm population in the
developing world, although there is presently scant hard evidence on this
important point.
Most empirical studies of the welfare effects of CFA transformation and
participation have struggled to establish causality, i.e. to ensure that the
estimated impacts on welfare can truly be ascribed to CFAs rather than to
unobserved factors. To be sure, most such studies suggest that participating
farm households enjoy higher levels of welfare. Few studies, however, have
credible controls for the nonrandom pattern of geographic placement of firm
contracting and of firm selection of individual suppliers into specific
commodity value chains, raising serious questions as to whether the
observed associations between farmer income and participation, for
example, reflect the welfare effects actually caused by the value chain
transformation or merely placement and selection effects.
The good news is that some progress is being made in this area as
researchers have begun exploiting panel data designs, credible instrumental
variables for participation in CFAs, and randomization of interventions to
properly control for exogenous drivers of both welfare changes and CFA
participation.

26. 26
Yet much more remains to be explored. In particular, we know little about
the effects of participation on potentially more durable and transformative
gains associated with improved nutritional status and educational
attainment by smallholders children and smallholder households
accumulation of productive assets. Likewise, more needs to be done to
determine whether the emergence of modern value chains shifts power
within the household, for example whether men take over crops traditionally
cultivated by women once they become profitable, or grab wives land as it
becomes more valuable for cash cropping, although Raynolds (2002) shows
that in the Dominican Republic, CFAs for tomatoes increase the demand for
women‟s paid labor.
This paper has synthesized the findings from some countries – Ghana,
India, Malaysia, Thailand and Mozambique – to inform a conceptual work of
the determinants and dynamics of smallholder participation in CFAs and to
begin to tease out a meta-narrative describing and explaining patterns of
participation and effects that are too often elusive in a literature heavily
dependent on smallscale, one-off case study evidence. I hope that this
synthesis paper helps spur further integrative modeling and analysis of the
distributional implications of accelerating structural transformation in the
agricultural marketing channels of the low-income world.

27. 27
7-REFERENCE
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2.Asokan, S. R. (2005), “A perspective of contract farming with special
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3.Kumar J. and Kumar P.K. (2008), “Contract Farming: Problems, Prospects
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7. Bijman, J. (2008). “Contract Farming in Developing Countries: An
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8. Kirk, C. (1987), Contracting out: plantations, smallholders and
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11. http://www.icar.org.in
12. https://en.wikipedia.org/wiki/contract farming
Prospects of Contract Farming in India

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5.2. Problems of Contract Farming5.2. Problems of Contract Farming
5.2. Problems of Contract Farming
5.2. Problems of Contract