CF – How does contract farming work?

How Does Contract Farming Work?

As a joint endeavour Contract Farming combines the buyers’ business model with the producers’ business model. It gives small-scale farmers a more durable position within value chains specifying the obligations of farmers and buyers as partners in business.

What is the immediate benefit of Contract Farming?

Market access — Contract Farming has enormous potential to substantially improve farmers’ integration into regional, national and even international markets.
Food safety — Contract Farming has shown to have an impact on the quality of produce and the raising of food safety levels, also contributing to increases in farmer incomes and overall value addition along agribusiness value chains in rural areas.

A promising option — though no silver bullet

In itself Contract Farming is neither a new concept nor a panacea for poverty and food insecurity. However, there is a wide range of long-known examples which demonstrate the positive contribution Contract Farming can have on reaching the fundamental goals of development cooperation:

Positive effects of informal or formal agreements between producers and traders or processors who supply local or regional markets with staple food or higher-end market products
Positive effects of formal or informal agreements between producers and exporters of fresh produce or processors in developing countries who export to international markets
Global players who engage in contracting producers in developing countries for providing to the local or regional markets, for example baby food or milk, or who export internationally, for example cocoa or cashew

Improving livelihoods

By raising incomes inclusive contract farming can lead to improved livelihoods of rural communities, provided the business models are viable and sustainable, which in itself depends on a number of external factors.

The comparative advantage

Producers’ main motivation is to get better selling prices, but the real benefit of being contracted is typically an increase in productivity – given that relevant buyers provide embedded services – as well as reliable access to inputs, advisory services and markets.

Ideally, contracting is beneficial for both business partners – a typical win-win situation. Prices that fluctuate with the market and more importantly harvest losses or lesser quantities are dealt with in the contracts beforehand. The buyers benefit from a guaranteed quantity or quality; producers and aggregators gain from guaranteed sales.

Performance enhancer

Farmer-based organisations can play a decisive role in improving the performance of contract farming schemes. Where they are capable of providing needs-oriented services to their members and buyers in a business-minded way, they reduce transaction costs by economies of scale effects.

Contract constellations including other actors related to post-harvest management, aggregation or the like tend to be more stable, thanks to a more inclusive approach. It is an advantage that the responsibility for handling produce and to assure quality aspects is given to experienced actors.

Key component — trust

The main challenge of Contract Farming is not the drafting of contracts but the building of trusted, stable relations. Issues jeopardizing the relationship must be avoided from the onset, especially issues that can lead to contract defaults.
This can happen on both sides. The producer can for example be involved in side-selling or a deviation of inputs. The buyer delivers inputs late or delays payments. Contract Farming business models therefore need to be well planned and well managed.