Economics Assignment 2

According to Vidit A., Technology Specialist at Infosys Technologies Limited, Contract Farming is a system for the production and supply of agricultural produce under forward contracts between farmer (i.e. supplier, seller) and buyer based on the agreement of producer (i.e. seller) to supply an agricultural products of a certain type and quality at a predetermined price and quantity.

The conditions of price, quantity and quality of goods and delivery time are decided in advance. Based on the contract farmers need to do plantation of crops of contractor, harvest and deliver these produce to him. The buyer may give all necessary inputs like seeds, tools, fertilizers, insecticides to yield desired type of produce. (msm.org.in)
Because of advantages of contract farming it is favourable option to contract with cultivators by food processing companies. On the other side there are also difficulties if one choose to buy raw materials from open market or proceed to take up and operate a large farm. Advantage to Sponsors from Contract Farming

1. Overcoming land constraints According to Shoja Rani B N, Contract Forming solves the problem of land for cultivation. The farmers produce the crops as per contractors choice. Contractors need not to purchase whole land. They can hire land and can pay agreed contract price for the consideration for use of land. If any organization involved in agrofood processing business found difficult in searching of new land or they may find it out of their pocket then they can easily occupy such kind of farm by entering in contract farming. 2. Terms fixed in advance: Contract farming is kind of forward contract under which all of the terms are decided in well advance. The price, quantity, quality, type of the product is prefixed. So in the future change in market behavior may not affect in all terms. So even if there is higher price prevailing in

the market at the time of harvesting, sponsor company only pay agreed price decided at the time of contract.

3. Production reliability Contractor companies can rely on farmers for their raw materials. The farmers can rely on contractors because they may provide inputs, tools, fertilizers, pesticides and other things which are required for the production. So both parties can rely on each other for their businesses. 4. Risk allocation : In such kind of contract both of the parties share the risk. Farmers and the sponsoring company both, generally, bear the risk of failure of production. If crop fails than it is the risk of sponsors for not having enough supply of raw materials for the production. Farmers also abide by the risk to pay to labourers and also not income from the contractor company for not supplying the produce if crops fail. The risk of failure of crops or lower production due to poor weather or disease is allocated to both farmers and sponsors. 5. Uniformity in Quality The ultimate supplier companies of consumer goods in market have to confront with the regulatory standards to maintain quality. They have to also apply to quality controls as tool to stick with those standards. By providing inputs and tools to the farmers they can get same kind of quality output from their various farmers. 6. No intermediary Cost: Sponsor Company can get their desired crops directly from farmers. They can process on these inputs and make products by processing on them to produce consumer goods and put it on the market. In such a case there is no media or agent between contractor and farmers. So there will be no intermediary cost involved in arranging raw materials through method of contract farming.

7. Low survey cost: The buyer of the farm produce need not to spend more on survey like which land is better in fertility, which crop will be suitable for the land, which fertilizers should be used and so on. These are the concerns of the farmers so sponsors need not to bother for that. They can also save time and money in survey from which provider of input in open market they should buy their raw materials in cheaper price and desired quality and quantity. 8. Technological Advance: Under the contract farming, the price for the agricultural produce is fixed in advance. Because of productive techniques the supply is increased rapidly. According to Jackson et al., the electrification and mechanization of farms, improved techniques of land management, soil conservation, irrigation, use of hybrid crops, etc -such advancements lead to increase in production of agricultural output. These will also reduce the cost of production. So contractor also can benefit from augmented output at better quality and they may be charged lower prices.

9. Productive efficiency and Allocative Efficiency: In the contract farming productive efficiency is possible. It occurs when the all of the factors of production brought by farmers as well as by sponsors are used in optimum manner. Under the contract farming there is scope of allocative efficiency when there is an optimal distribution of inputs for the desired output (Jackson, McIver, Bajada and Hettihewa).

Because of following demerits, large agribusiness firms may not prefer owning and operating farms or acquire raw materials from open market. Drawback of owning and operating farm: 1. Problem in occupying land: It may be difficult for the companies to purchase land, to cultivate, to harvest the crops and to bring those to factory premises for the further processing. Buying a land for farming could be unviable to the companies because of their limited budget. 2. Lack of agricultural knowledge: The workforce of the sponsor company may not be conversant enough for the farming matters. So it may not be practically sound project to operate farms without that much of knowledge and techniques.

Problems in buying inputs from open market: 1. Intermediary cost involved: In open market, the price of raw materials may involve cost of previous buyers and sellers who had already transacted before. It may be more problematic for companies having numbers of processes. When every new seller adds his profit and every new buyer adds his all additional costs, the price of last product available for the food processing companies tend to be higher because of assorted intermediary costs. 2. Survey Cost and time involved: If the companies choose to purchase their input stuffs from open market, than it may incorporate the expenditure in finding out which type of products can be used, which seller is giving the cheapest price, where can it find best quality and quantity, how

much cost would be involved in transportation, etc. It may also consider substitutes available in market, at which price. Thus, buying inputs from open market may involve sufficient survey cost and also occupy that much of time.

3. Variation of market behavior: In open market, prices change as the factors of demand and supply vary. It might be unpredictable to have consistency in price of agro based raw materials. The prices may tend to fall in case if weather condition favors and productivity increases. However, the supply may be lower because of poor weather condition which may lead to shoot up in price level. According to factors such as weather, diseases, irrigation supplies, the crops production may fluctuates and show a discrepancy. Consequently, the market behavior cannot be determined and companies may have to compromise with higher prices. 4. Hidden cost: On the spot purchase from market may be inclusive of certain hidden costs. It may involve transportation cost, preservation cost, taxes involved in it, additional labour charges, commission, etc. Hence, the cost to food processing companies in purchasing agricultural products as an input may be higher.

5. Price and income instability for short-run: In open market, the price of the agro based items may vary because of several factors. As to which the cost and returns would be fluctuate. In short run, there would be great income volatility if food processing companies opt to purchase stuff from the open market. Because of that the profit-estimation may not be possible for them. 6. Price of products in Monopoly:

If the firm involved in agribusiness get its input raw materials from the seller or firm who enjoys monopoly in producing or supplying that product than it may have to suffer the higher cost of that monopolist firm. As suggested by Jackson et al., monopolist firm is price maker. It controls the volume of output as well as determine price. So in such a situation food processing company may have to pay price decided by it which would be higher than actual.

It is the choice of agro based food processing companies from which sources to obtain raw materials for their manufacturing processes. The contract farming also have some of the evils such as it is time consuming because of long harvesting period, lack of options for quality, legal constraints. Sometimes demand and supply can not be varied because of pre-decided contracts and also risk factor of failure of crops may lead to problem in contract farming. However considering positive points of contract farming, it is more feasible option even after open market offers good bargain power, more options and substitutes and operating own large farm offers no reliance on others.

List of References: 1. Definition adapted from http://nsm.org.in/2008/07/20/contract-and-corporatefarming. Data retrieved on 2-1-2010.

2. Shoja Rani B N, Globalization and Contract Farming in India-Advantages and

Problems data retrieved from http://dspace.iimk.ac.in/bitstream/2259/520/1/637-647+.pdf retrieved on 2-5-2010

3.

Jackson, J., McIver, R., Bajada, C., Hettihewa, S., Economics Principles, McGraw Hill, page 207

3. ckson, J., McIver, R., Bajada, C., Hettihewa, S., Economics Principles, McGraw Hill, page 197, 198
4. Jackson, J., McIver, R., Bajada, C., Hettihewa, S., Economics Principles, McGraw Hill, page 221, 222