Statements from the evolving industry of contract farming

Contract farming is a recognized mechanism for coordinating agricultural production and trade. The analysis of the size and market share of global contract farming demand in 2022 was valued at approximately $58.75 billion, and it is predicted that the size of the contract farming market will increase to $78.42 billion by 2030, with an average growth rate of 3.73%.

News ID: ۸۲۶۳۲۴

22 February 2024

EghtesadOnline: Increased demand for agricultural products and food security are expected to likely drive the trends in the global contract farming market. Contract farming plays a vital role in meeting demand by providing the necessary agricultural infrastructure. Agricultural trading companies such as Olam, Nestlé SA, Tyson Foods, JBS SA, Bunge, Wilmar International, Louis Dreyfus Company (LDC), Archer Daniels Midland (ADM), and COFCO enable processors and retailers to offer sustainable and reliable agricultural products. It encourages farmers to adopt better farming practices, including the use of modern technology, efficient products, and production methods. Contract farming is a common agricultural trading method among multinational meat processing companies and accounts for the majority of industrial poultry production. Firstly, it leads to increased production and ensures the availability of food. Secondly, contract farming often focuses on specific high-demand products or livestock. Farmers, by signing contracts, are guided by market signals to produce the products they need. For example, in March 2023, the multinational food company Cargill acquired a Canadian agricultural company, Protera, in the United States. This acquisition allows Cargill to expand its portfolio of sustainable protein products. Protera is a leading developer of plant-based proteins made from non-GMO ingredients. On the one hand, this acquisition provides Cargill access to Protera's technology and expertise in developing plant-based proteins, as well as its portfolio of brands, including "Puris" and "SoyaPro."

In recent decades, contract farming has become increasingly popular in developed countries. Over 60% of large farms in the United States have used contracts, covering almost 40% of the annual value of agricultural products. In North America, the contract farming market is at the forefront of agricultural innovation, guided by advanced technological solutions and evolving customer preferences and legal relationships. Commercial agricultural companies and farmers collaborate using advanced technologies such as unmanned aerial vehicles (UAVs), satellite imagery, and data analysis to optimize crop management through strong implementation of contract farming. These innovations enhance production efficiency, resource utilization, and sustainability, meeting the growing demand for traceable and high-quality products. As consumers prioritize transparency in production processes and environmentally friendly practices, contract farming in North America is emerging as a model for utilizing technology to meet market demands while ensuring more efficient and responsive agricultural supply chains. Europe also has a significant contract farming industry. The European market is guided by commitments to sustainable agriculture and food security. Collaboration between agricultural commercial holdings and farmers focuses on adopting environmentally friendly practices, reducing chemical usage, and enhancing responsible land and resource management. This growth momentum resonates with consumers who value sustainability and steer towards environmentally friendly products. Contract farming offers several advantages. It can help reduce supply chain risks, increase farmers' productivity, stimulate companies' marketing activities, facilitate farmers' access to higher-level markets, and increase overall profits for both companies and farmers. Evidence of improved production efficiency among farmers adopting contract farming has been observed in the value chain in the United States, Japan, France, Belgium, Canada, and Britain. Contract farming is pivotal in India and accounts for approximately 17 to 18 percent of the Indian economy. It refers to an agreement between farmers and agricultural companies whereby the companies agree to purchase agricultural products at a pre-determined price from the outset. Contract farming is not new to India. During British colonial rule, cash crops such as indigo, opium, tobacco, and cotton were procured through the CF system. After independence, CF was utilized in commercial seed production and sugarcane (from the 1960s), dairy (from the 1970s), tomato and pine plantation farming (in the 1980s). In 1988, despite some opposition, India allowed PepsiCo to procure and process some horticultural products in Punjab through joint investment with a state-owned Punjab Agro Industries Corporation. This investment later expanded to tomato production under the CF system. Following PepsiCo's entry, several other commercial brands also engaged in CF in some states for the production of red chili, basmati rice, peanuts, sorghum, oil palm, potatoes, and chrysanthemum. This scattered expansion of CF occurred in response to structural changes in India's food economy after the reforms of 1991. These changes include increased domestic demand for high-value agricultural products, increased entry of private sector companies into food processing, and the rapid growth of supermarkets and modern retail chains. These developments necessitated the continuous and timely supply of fresh and high-quality agricultural products, thus contract farming emerged as a possible solution to meet this demand gradually. In this regard, India's first national agricultural policy, published in 2000, supported increased private sector participation in agriculture through contract farming. In India, contract farming has gained popularity as an effective way to bridge the gap between farmers and markets, increase productivity, and improve the livelihoods of small and marginalized farmers.

Charoen Pokphand Foods Public Company Limited (CP Foods) is also one of the first and most successful Asian companies to introduce the contract farming model in 1975 to promote employment and sustainable income among Thai livestock farmers, covering poultry, swine, and egg businesses. Currently, the company has a network of over 5,900 farmers participating in these projects, with nearly 2,000 farmers involved for over 10 years. The company provides "trainers" to assist in advising and sharing new knowledge related to livestock farming methods and technologies. To respond to global trends, the company has supported contract farmers in using automation and technology to increase efficiency. Contract farming can reduce the uncertainty of crop performance, facilitate the adoption of new production technologies, and increase production efficiency with lower production costs. Another significant items of the growth of the contract farming market is the increasing market demand for traceable and high-quality agricultural products. Nowadays, consumers are becoming more aware and sensitive about the origin, quality, and safety of the food they consume. This trend has prompted agricultural companies and retailers to seek reliable sources of products that can meet stringent quality standards and provide traceability throughout the supply chain.

One of the primary benefits of contract farming is guaranteeing a market for farmers' produce. This reduces the risks of price fluctuations and market uncertainties, which are significant challenges for small-scale farmers. Furthermore, contract farming promotes modern technology, improved seeds, and better agricultural practices, leading to increased productivity and reduced production costs. This, in turn, results in higher profits for farmers.Another advantage of contract farming is that it enables farmers to access credits and inputs that they may not be able to afford without contracts. Agricultural companies often provide inputs such as seeds, fertilizers, pesticides, and credit in exchange for the farmers' commitment to supply products to the company. This allows farmers to improve their performance and enhance their bargaining power with input suppliers. In developing economies, smallholders are among the poorest sectors because they face recurrent price fluctuations and natural disasters. However, the emergence of contract farming has transformed the lives of millions of farmers. Contract farming in developing countries has become an increasingly prevalent method for protecting farmers' interests. Due to the benefits of guaranteeing farmers' profits, contract farming has garnered considerable attention.Companies such as Wens, Starbucks, and Biocoop, which are active in contract farming, not only enter into bulk purchase contracts with farmers but also share market demand information with them. Contract farming can be defined as an industry that provides specific "inputs" such as seeds, fertilizers, credit, and legal and technical advice to farmers in exchange for exclusive purchasing rights over a particular product. This form of vertical integration in agricultural supply chains has attracted significant policy attention. For example, contract farming initiatives like "Company + Farmer" by Wens in China or Walmart's "Direct Farm" program and Starbucks' Coffee and Farmer Equity (CAFE) practices.

Contract farming can reduce farmers' price risks and provide long-term sustainable supply for companies. In agricultural contracts, both farmers' actual production and downstream market demand limit the quantity of orders for the company. Market demand information at the downstream level is crucial for farmers because demand information may impact farmers' production decisions and profits through company order quantities. For example, a lack of market demand information is likely to result in farmers' products not meeting the company's order quantity. This leads to farmers being unable to earn higher profits, while the company may face losses due to insufficient supply. Moreover, in contract farming, influenced by market demand, the company may not order all of the farmers' produce. If farmers overestimate market demand, most of them can only sell the remaining products at a price lower than the contracted price. Understanding the challenges that farmers and companies face in contract farming, some companies also invest in predicting market demand and share information with farmers. For example, Biocoop, a network of organic chain stores in France, announces its investment in predicting market demand for the next three years to farmers. Each Biocoop store signs a contract with local farmers to ensure a sustainable supply and also shares market demand information with farmers throughout the season. Starbucks also provides information and support packages to cooperative farmers to ensure that farmers can produce high-quality coffee beans and earn higher profit margins. Market demand information is vital for small and poor farmers as it can help them make more informed decisions in production and prevent overproduction or shortages. However, profit-oriented companies operating in contract farming differ from various government organizations because their main objective is to maximize profit rather than improving social welfare.

The Walmart business in developing countries increasingly favors purchasing from small-scale farmers using contract farming. Whether farmers are close to the supply chain or not is an important benchmark for Walmart. In the "company + farmers" contract farming model, Wens also preferably selected farmers with easier transportation access to join the contractual farm because Wens had to judge whether the farmers met the conditions for cultivation and transportation or not. Additionally, farmers who were distant from Wens' service areas could incur increased costs. Farmers and the company form a sustainable two-way cooperative relationship with contract farming. They are upstream producers and downstream retailers in the contract farming supply chain. They sign forward contracts and agree on delivery criteria and contract prices.

Despite its advantages, contract farming also has numerous drawbacks. Firstly, because farmers overlook their right to price their products, they are likely to fall under the dominance of monopolistic companies. Secondly, small-scale farmers may be subjected to "unfair" contracts when dealing with powerful companies, burdening them with significant financial pressures. Ultimately, a poorly performing contract farming system may allow companies to reap more profits and benefits while small-scale farmers bear all the costs. To address this ultimate limitation and consequently increase farmers' motivation to enter into contract farming agreements, many companies decide to share expenses by providing necessary materials such as seeds, livestock, chemicals, day-old chicks, feed, fertilizers, and machinery. For instance, Dongfanghong, one of the largest green onion packaging holdings in China, supplies 60% of the required pesticides for its contract farmers. Similarly, it offers technical assistance to farmers to comply with quality and food safety standards set by supermarkets and importers.

Despite these incentives, not all farmers are willing to share such costs with companies. In practice, many farmers prefer to bear all these expenses alone and sell their products to companies at wholesale prices, known as Wholesale Price (WP) contracts. Potential reasons for their decisions include: (1) farmers may doubt the quality of materials provided by companies; (2) materials supplied by companies may be delayed without reason, reducing farmers' annual production cycles and income; (3) companies may procure machinery that farmers do not know how to operate. Additionally, farmers may refrain from entering into Cost Sharing (CS) contracts due to their profit incentives. Farmers' returns may significantly decrease under a CS, so it is necessary to develop a model that makes the type of contract and key parameters such as purchase price, retail price, and farmers' profits more attractive for their participation. In addition to direct relationships in the farmer-company structure, some farmers may protect their interests by joining an agricultural cooperative and establishing a Company-Cooperative-Farmer (FCF) structure. Such cooperatives act as representatives negotiating with powerful companies on behalf of farmers based on their greater bargaining power. Therefore, the existence of agricultural cooperatives is also valuable for companies. Exchange transaction costs with individual farmers can be reduced, and mechanisms for contract compliance can be improved.

As a result, the number of agricultural cooperatives involved in contract farming has significantly increased over the past 20 years, reaching nearly 600,000 in China by 2012, including 46 million members and accounting for 18.6% of all farmers. Another typical example of a cooperative is the California Cling Peach Association (CCPA), which negotiates with canning factories on behalf of its member producers for a certain percentage of the gross value of sold products. Another prominent example is the European Olive Oil Farmers Cooperative, which provides marketing and processing services to its members and helps them negotiate with downstream channel members (bottlers and oil retailers) and receive part of the net income of farmers.In European countries such as Portugal, Malta, Slovakia, Sweden, Denmark, and Finland, farmers need to invest in infrastructure, equipment, and skills necessary for fresh milk production. Introducing contract farming in this environment reduces the investment risk portfolio and consequently increases their production efficiency. Ultimately, contract farming in the world is developing and evolving. Prices in this industry are not dictated; governments or state-owned companies do not intervene in this industry. Holdings, commercial companies, complementary industry factories, unions, associations, and private sector entities dominate this field. This industry requires institutionalization and the enactment of strong laws in parliament. In conclusion, the government is only a regulator.

*PhD in Agricultural Development