Like we discussed in one of our previous blogs, contract farming can be viewed as an agreement between farmers and processing or sourcing companies for the production and supply of agricultural products, managed with a contract signed by both parties.
The contract states that the sourcing company is obligated to provide production support to farmers through, for example, the supply of inputs or technical advice. This kind of arrangements usually start with the farmer committing to provide a specific product of a certain quality in specific quantities. On the other hand, the sourcing company commits to support the farmer's production and to purchase the product directly from them.
“Contract farming is an agreement between farmers and processing or sourcing companies for the production and supply of agricultural products.“
Contract farming agreements can work well for both parties, but only if they are fair and have been properly set up. When efficiently organized and managed, contract farming reduces risk and uncertainty for both parties as compared to buying and selling crops on the open market.
Managing Contracts with Growers
When forming a contract, there are three key areas that need to be determined:
- Quantity; specifying the amount of the desired product (crop)
- Quality; agreeing what quality levels and standards the product needs to meet
- Price; stating a specific price for the crops, set by the farmers
Let's take for example a big processing company that sources raw material (potato) for further processing. The company uses potato for production of chips, french fries and other products intended for the food industry.
First of all, the processing company has to find suitable crop growers and create a contract with them, specifying the farmer’s production quota and quality standards the product has to meet. Every season the farmers successfully deliver 500 tonnes of raw potato to the processing company, as previously agreed in the contract.
But this year, the potato beetle infested the entire yield, so the harvest was considerably lower, and the farmers could only deliver 250 tonnes of potato to the processing company.
What does this mean for the processing company? In this scenario both sides suffer great losses—the farmers don't get the financial compensation they had planned, and the processing company faces a shortage of the desired product, what forces them to purchase outside their usual network of growers at a more expensive price, and that can greatly affect the company's budget.
Moreover, if a processing company is unable to meet pre-arranged marketing quotas, future orders could be decreased or canceled.
Monitoring Farmer's Performance Ensures Contract Execution
In real life, this scenario is very often due to various difficulties all contracted farmers face. Both insufficient and excessive production can have serious consequences.
Overproduction can mean unwanted quota reduction and expensive buildup of products that are stored for long periods, that ultimately deteriorate over time.
Underproduction caused by pests or climatic factors could eventually result in losses because processing costs per tonne could rise to very high levels.
Well-managed contract farming is an effective way to coordinate production and marketing in agriculture. Crop production requires close supervision to control and maintain product quality, especially when farmers are unfamiliar with new methods and technologies.
Through the efficient monitoring of crop development, the processing company can usually make yield forecasts based on real-time data. If yield starts to vary, the company can take proper measures to put the production back on track, or in the worst case scenario, react timely if they see that the yield won't fit their desired quota.
“Having a risk mitigation strategy minimizes the impact of identified risks, and allows timely reactions for both, contracted farmers and the sourcing company.“
By having a real-time insight into field operations, the processing company has accurate information about real vs. planned delivery date, which simplifies their further decision making.
So, to sum it up, a clear, transparent contract and compliance with the agreed terms is a precondition for successful contract farming. Also, having a risk mitigation strategy minimizes the impact of identified risks, and allows timely reactions for both, contracted farmers and the sourcing company.
If you want to manage your farmer network and ensure proper contract execution, contact Agrivi Sales team.
Text sources: FAO