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Contracting out of poverty

Contract farming is a widely used approach for agricultural processing companies (© Bill & Melinda Gates Foundation)
Contract farming is a widely used approach for agricultural processing companies
© Bill & Melinda Gates Foundation

Contract farming - a set agreement between a farmer and a buyer - is a widely used approach for agricultural processing companies and wholesale buyers to efficiently source their produce and for farmers to enter domestic and international markets. However, contracts tend to go to medium-sized and more educated farmers, with smallholders often left out of these lucrative relationships for a number of reasons. In response, the International Food Policy Research Institute's (IFPRI) 'Contracting out of Poverty' project is carrying out experiments in Peru, Vietnam and Tanzania to test if changing the design and implementation of farming contracts can encourage participation by smallholder farmers while also bringing benefits to contracting companies.

For contract farmers, agreeing to provide a set quantity and quality of product offers the reward of a guaranteed market and a reasonable price, and may bring help with agricultural planning, inputs, and technical or financial support. However, despite such incentives, cash-constrained farmers may still be tempted to sell directly to a middleman instead of waiting for the promised payment from their contracted buyer. In an environment of uncertainty and volatile prices, farmers may not be confident that the firm will be able or willing to fulfill its commitment. Smallholders may also not have the resources to produce the high standard of quality required by contracting companies, and bad weather or illness may reduce the farm's promised quantity, making it more advantageous to sell quickly. Farmers who don't trust their buyers may not make needed investments for high quality produce, creating a vicious circle. Firms also report that the cost of monitoring many small farmers is too expensive, making them less keen to make contracts with smallholders.

Improving contracts

Milk production in Tanzania is mainly from indigenous cattle (© FAO/Giuseppe Bizzarri)
Milk production in Tanzania is mainly from indigenous cattle
© FAO/Giuseppe Bizzarri

The 'Contracting out of Poverty' project has tested a number of innovations, including independent verification of quality and incentives for delivering high quality produce. One experiment has been with Maasai women in the Morogoro region of Tanzania, who were in a contract with a local milk processing firm, Shambani Graduates. Milk production in Tanzania is mainly from indigenous cattle that are raised for both milk and meat, and production is seasonal: during the rainy season there is an oversupply of milk and during the dry season it is highly limited and can therefore be sold at triple the price. Shambani Graduates found that they couldn't get a consistent supply of milk and that the farmers often sold to informal traders who offered high prices during the dry season.

The researchers, including IFPRI Senior Research Fellows Ruth Vargas Hill and Maximo Torero, wanted to know if a change in the structure of the contract could make a difference. They started by talking to the women in focus group discussions, and discovered a variety of reasons for the highs and lows in milk production, beyond seasonal availability. If someone in the household was sick, for example, the women had less time to milk. If the weather was rainy and they had a long uncomfortable walk to the cows, that would also affect the amount milked.

The research team decided to test whether adding a clause to the contract that rewarded the farmers for 'loyalty' - sticking to their contract - would increase the consistency and amount of milk produced. They randomly selected farmers who would receive a reward for regularly delivering milk and an additional payment per litre, to reward both loyalty and production.

The big picture

Small adjustments to farming contracts can have a powerful effect (© FAO/Giuseppe Bizzarri)
Small adjustments to farming contracts can have a powerful effect
© FAO/Giuseppe Bizzarri

"The idea is to encourage behaviours that benefit both parties in the long run, and structure the contract so it's better for both the farmers and the firm," explains Ruth Vargas Hill. In the case of the Maasai dairy farmers, it worked. The incentives that rewarded commitment to the contract reduced reneging, and the supply of milk to Shambani Graduates increased. However, Vargas Hill cautions that there are limits to how well this can work. The experiment coincided with a very severe dry season - the same weather pattern that brought the worst drought in 60 years to the Horn of Africa. In the face of such a shock, the incentives lost their effectiveness and some Maasai clans moved their cattle far from collection centres in search of food and water.

Over a longer period, Vargas Hill believes the loyalty clause will have the intended benefits. "These incentives will probably work in 4 out of 5 years, or 9 out of 10. That's still an important effect," she says. Shambani Graduates also recognised the research findings, and have agreed to change their contracts to include incentives for loyalty. Small adjustments to farming contracts such as this can have a powerful effect on smallholders. The researchers hope to disseminate these results so that contract changes such as this can be implemented by firms in other countries and regions, to provide smallholders with access to dynamic markets and, ultimately, improve the welfare of the poor.

Written by: Marcia MacNeil, IFPRI

Date published: January 2013

 

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