Though several varying definitions exist for contract farming, the heart of contract farming is essentially an agreement, typically in written form, between the sellers (farmers and producers) and buyers (agribusiness firms or companies), whereby both agree in advance on the specific terms and conditions for the production and marketing of agricultural and agri-food products.

Terms and conditions written into the agreement typically specify a pricing mechanism and how the producers will be paid, usually based on quantity and quality specifications of the product requested by the buyer, and how the product is delivered from the seller to the buyer.

Majority of contract farming agreements consists of one or more types of agreements (FAO, 2013), for example, an agreement between two parties may specify that the buyer will provide inputs, financing, and technical assistance to producers. By incorporating these components of marketing, providing resources, and production management into the agreement, it creates more value and incentives for both producers and buyers to engage in contract farming

Contract farming has been in existence and practiced for many decades, particularly in South America (e.g. Brazil), Sub-Saharan Africa (Kenya, Ghana, Tanzania and more), East (e.g. China), Southeast (e.g. India, Vietnam, Thailand) and Central Asian (e.g. Afghanistan) regions and for livestock (e.g. poultry and hog production) and commodities such as organic rice, tea, coffee, cocoa, and many others. Its usage has only increased in popularity towards the end of the twentieth century, particularly in developing and emerging countries, and gained appeal as an inclusive business model approach that incorporates more small-scale farmers into the agricultural value chain and to access additional markets. Both demographic changes and technological advances lead to rising living standards and the reshaping of the agri-food systems (FAO, 2005), and along with this, increasing demand for quality and safe agricultural and food products. These changes have contributed to the evolution and dynamics of the agri-food sector. Market liberalization and globalization have profoundly influenced agricultural and food industries in both developed and developing countries, and has led to significant transformations in the agribusiness sector. 

Private sector companies and agribusinesses also realize the benefits of contract farming in that it offers them a sustainable, alternative way to have access to land and a reliable supply of quality raw products. Companies who may have interest to invest in foreign agricultural property face barriers as in many cases, the land is privately owned by small-scale producers. Contract farming would still allow small-scale producers ownership of their land and have the opportunity to grow different crops that they may have been reluctant to grow in the past or have less knowledge of, and to access markets (e.g. international, regional or export markets) that were once not feasible for them. These and many other advantages, as well as disadvantages, are detailed in the next section 1.3.

Many factors combine to increase the conditions and environment that make contract farming a suitable option for developing country contexts. 

Transformation of Global Agrifood Systems

First, the transformation of the global agrifood systems as described earlier has played a key role in the growing interest in contract farming. As value chains become more tightly consolidated, it requires that producers and farmers, towards the beginning of the value chain, become more closely or vertically integrated. Thus, the coordination of value chains in vertical and horizontal dimensions increases their efficiency. Consumers with increased awareness and interest to understand where and how their food is grown, and who is growing their food, are also driving this trend towards sustainable principles, environmental impact as well as social responsibility and health aspects (FAO, 2005). In a competitive food marketplace, consumers have more options and brands to select from because of product differentiation and demand higher quality and safety of agri-food products (FAO, 2005) leading to further development of value addition activities and the expansion of agro-industries. Supermarkets are expanding and consumers, particularly urban consumers, are purchasing and “demanding foods that can be conveniently prepared, such as frozen, pre-cut, pre-cooked and ready-to-eat items” (FAO, 2005). 

This has led to initiatives in traceability and sustainable supply sourcing, and customers in end markets are more informed and knowledgeable about the source and quality of the products. With such vertical coordination, producers must meet higher and stringent quality controls (FAO, 2005; FAO, 2013), even international standards if they are to sell to particular markets, such as for exports. Growing competition in food markets and the need to meet such demands and certain requirements have increased interest in contract farming agreements. Contract farming is a relevant mechanism to efficiently coordinate transactions in modern value chains.

Constraints faced by Smallholder Producers in Market Participation

Second, producers and particularly small-scale farmers in developing countries already face many constraints in accessing and participating in markets. Such challenges will only increase due to the rapidly changing dynamics leaving small-scale farmers behind (FAO, 2005). Many high-end or high value, or cash crops, take a lot of time and resources for investment, and small-scale farmers may be reluctant to invest in new agricultural technologies or to experiment with a different crop in order to reduce their risk (Minot and Sawyer, 2016). They may also lack knowledge related to production and harvesting of certain crops if they have not grown it before, as well as having less access to necessary, quality inputs and fertilizers that would increase their yields. Investing in new or different crops requires financing, such as to purchase the needed inputs and related resources they would need. In addition, knowing market price information is critical for producers to know when to harvest or to sell their crops. Smallholder producers may face additional barriers as changes in consumer demand for safer and higher quality agricultural products and the impact of globalization lead to added costs, increased risks, and technical requirements that may be beyond their existing capacity. Contract farming, however, reduces these constraints and provides opportunities for economic and social development by providing producers with access to market, inputs, credits and other services and support in the form of technology transfer and technical advice and improved infrastructure.

Alternative Business Model and Development Approach

Third, and furthermore, contract farming has gained prominence as an alternative business model and as a development approach to alternative large-scale foreign land investments in the commercial sector that can cause controversy and adversely affect producers’ livelihoods. Contract farming is seen to be a “win-win” approach for private and public sectors (Murekezi, Menezes and Ridler, 2018) as well as for its inclusivity of small-scale producers and to improve farmers’ livelihoods through access to stable markets and long-term partnerships. It has the potential to reduce poverty and promote sustainable growth.

In addition, agribusinesses have the financial resources and capacity to extensively study the end markets of their products and have detailed information and research to understand consumer behavior and demand (e.g. from customers such as supermarkets, restaurants, hotels, schools, hospitals, etc.). They have this advantage on the other end of the value chain. Small-scale producers, on the other hand, cannot afford nor have the time to invest more resources into this level of research into their markets. Agribusinesses may also be able to supply the critical technical assistance and inputs to obtain specific quality attributes or requirements to meet demand as discovered through their market research.

According to Murekezi, Menezes and Ridler (2018), the “reduction of structural adjustment programs” can also attribute to the growing interest in contract farming. The public sector has been gradually moving away from providing agricultural extension services and increasingly, this has been taken up more by the private sector and agri-food companies who want to have more direct access and influence on the production and supply side (FAO, 2001). Further, the private sector is increasingly involved in monitoring procedures in food safety as well as traceability (Murekezi, Menezes and Ridler, 2018). Contract farming arrangements with production and technical support components allow farmers to adopt new technologies and techniques for increased yields and achieve higher-quality products. On the other hand, agribusiness firms and agro-processors are particularly interested in developing long-term partnerships with suppliers and to have more direct contact with farmers in the process of securing a sufficient, consistent supply of raw materials that meet buyers’ needs in terms of quality and quantity.

In light of all the above, and due to improving competitiveness and efficiency in response to transformations driven largely by globalization, the promise of contract farming for poverty reduction and consequent economic growth is gaining increased recognition and growing interest among donors, governments and policy makers.

Contract farming is increasingly seen as an effective alternative to traditional market channels that can dramatically reduce barriers and constraints for smallholders and provide a way for them to participate successfully in markets. As poverty is more prevalent in rural areas and smallholder farming is central to food security, contract farming is seen as a potential tool, if used correctly, to increase food security, reduce poverty, contribute to rural employment and development.

The usage of contract farming continues to expand in developing countries. It is widely acknowledged as a sound mechanism for promoting the access of smallholder farmers to markets and governing transactions in agri-food supply chains.

Though contract farming has many benefits for both parties, it presents advantages and disadvantages for both producers and buyers as outlined and described further. It is important to establish and maintain a fair, balanced relationship between the two parties and to reduce risks and disadvantages as much as possible within the terms of the agreement.

Risks with growing new crops, monocropping, or environmental impact

Though growing crops new to farmers can open more opportunities for farmers, they can also face risks during the production cycle, such as encounter with new pests or plant diseases that are unfamiliar to them. Environmental risks may also exist if the crop is uncommon to the local environment or even invasive, or brings in other diseases and pests, leading to loss of biodiversity. Monocropping may increase their susceptibility to such risks.

Financial and other risks

Producers may face other risks due to inefficiencies in management, lack of transparency, unequal bargaining powers and risk allocation, or power imbalances between producers and buyers. Delays such as in the delivery of inputs or payments can cause problems in production and procurement.

Market price fluctuations

Farmers usually cannot benefit from increases in the market price as they are locked in the contract and are not permitted to sell to alternative buyers leading to reduced selling options. If they should sell to alternative buyers, they risk breaching the contract which may lead to costly legal disputes.

Susceptible to indebtedness and dependency

Farmers are also susceptible to indebtedness caused by production risks or excessive loans from their buyers. This is particularly problematic if buyers are less reliable and exploit farmers’ increased dependency, or even due to unfair terms of the contractual arrangement.

Loss of former market and traditional linkages

Before entering contractual agreements, producers may previously have participated in traditional and spot markets, and have long established linkages. They may lose these former linkages to traditional markets as well as losing traditional farming practices.

Side-selling or contract breach by producers

Although trust is central in contract farming agreements between the two parties, it can happen that farmers may break the contract and sell to other buyers, misuse inputs on credit such as seeds and fertilizers, or not comply with indicated production practices or delivery schedule. These can affect the yield, quality and reliable supply of the product.

Less flexibility and reputational risks

Once bound to the contract, buyers have less flexibility to switch to alternate suppliers should difficulties arise with production or if production results in substandard quality of agricultural products, and can result in reputational risks for the buyer.

High transaction costs

Buyers may have less capacity to deal with a large number of producers, especially if they are small-scale or have small farms, compared to working with larger farms or a smaller number of producers. Working with a large number of farmers increases their transaction costs.

Constrained land use

Buyers may still face constraints related to the land use and agricultural production. Regulations and rules may constrain land use of contracted farmers, and therefore may jeopardize long-term sustainability of contract farming operations.

Generally, there are two types of contract farming contracts: production contracts and marketing contracts. A marketing contract focuses on the sales of the agricultural commodity. The buyer and the producer agree on the sales of the product before planting or even before harvest. In the production contract, the buyer is more involved in the production and has more process-related obligations compared with the marketing contract. Production contracts might outline inputs to be supplied and used, production processes to be followed, financing options, or training and technical assistance to be provided. More specifically, the types of contract farming agreements can be described as below:

1. Production-management contract , Outlines detailed information and instructions on production measures, techniques and/or methods to be carried out by the producer to ensure a quality product and the quantity demanded by the buyer. This may also entail technical assistance provided by the buyer or intermediary third parties such as governmental agencies, producer organizations, and/or NGOs.
2. Market-specification (or marketing) contract , Emphasizes the terms related to the sales and marketing of the agricultural or livestock-related product in which the buyer will oversee that aspect of the value chain for end markets and the buyer’s customers. Producers must still meet quality and product specifications.
3. Resource-providing contract , Buyer agrees to provide necessary resources, such as seeds and fertilizers, financing options (e.g. credits, insurance, risk reduction measures), to the sellers

In general, there are five different contract farming models that can be implemented. Their common foundation, regardless of their form and actors involved, is the contract between the buyer and the farmer(s):

1. The centralized model is best used for large volume crops that require a high level of processing. It usually involves a centralized processor or packer, vertical coordination and tight quality control with farmers stretching from small to large. The buyer’s engagement within this model can range from minimal input provision to predominant control of most production aspects.
2. The nucleus estate model, also known as the outgrower model, is similar to the centralized model but is often used with resettlement or transmigration mechanisms. Within this model, the company also manages a central estate or plantation, but usually provides the majority of material and management inputs to assure cost-efficient implementation of installed processing capacities. This model is typically used for perennials.
3. The multipartite model can consist of various organizations or statutory bodies. Through the formation of farmers into cooperatives or the integration of a financial institution, this model can develop from the centralized or nucleus estate model.
4. The informal model usually involves individual entrepreneurs or small companies acting on a seasonal basis and frequently requires governmental support services. Despite being known as a temporary and speculative model, long-term trustful relationships can reduce the danger of opportunistic behaviour. Provided services are often basic and typical products can be fresh fruit, vegetables, staple crops or other produce that do not require much processing and packaging.
5. The intermediary model is based on subcontracting linkages of farmers to intermediaries. However, it involves the risk of price distortions and reduced incomes for farmers as well as the possibility that the company’s control over quality and production might get compromised.

Generally, the benefits of contract farming and its advantages for both producers and buyers outweighs any disadvantages. In order for contract farming schemes to succeed and be sustainable for the long-term, both parties must come to the agreement with mutual trust, fairness, transparency and respect.

In the context of contract farming, the contractual arrangement should also be established within an enabling regulatory environment to ensure its success and long-term sustainability. The outcome of contract farming arrangements will depend on a variety of economic, social, institutional and legal factors among others. Country-specific and local conditions, policy environment, functioning of the market mechanism or the availability of services are also instrumental to the success of these agreements.

No successful contract farming scheme can exist nor remain sustainable if the institutional, legal, regulatory, and political setting are not conducive for it.

Public and government support has proven to be key (FAO, 2001). FAO (2001) recommends that “governments need to be aware of the implications of all laws and policy decisions on agribusiness development and how those policies influence contract farming.” In addition, related infrastructure is also critical to ensure the success of contract farming operations and it can work both ways, as the establishment of contract farming operations may also promote further economic and social development as well as infrastructural investment.

Appropriate legal and regulatory frameworks governing contract farming, while protecting rights and balancing contractual power of involved parties, leads to increased benefits and minimizes the risks of contract farming. There are ways to counter uneven balances of power, for example, by promoting producers’ associations, providing third-party mediation support and services, and through legal and regulatory provisions. An enabling environment can help overcome challenges and curtail potential disadvantages, and hence is key to the success of contract farming. The concept of an enabling regulatory environment is further discussed in Module 5.

Besides public and government support and an enabling regulatory environment, there are other factors to encourage sustainable contract farming from a broader perspective. Contractual agreements should be designed to reduce transaction costs, increasing scale by working with producer groups, and reducing any foreseen risks. For farmers, it could mean to enhance their bargaining power through organization, cooperatives, collective actions and understanding their legal rights. For buyers, it could be improved communication with producers, providing group lending options, increasing quality and scope of service provision, enforcing terms for defaulters, extending contracts and through building long-term relationships with their suppliers. Environmental responsibility and social inclusion, such as with women and youth, should also be considered. Contract farming seems to work best for high-value commodities, which will be further discussed and covered in Module 2, that often must comply with stringent quality, safety, and process requirements.

Contract farming is often a multi-stakeholder effort requiring engagement and collaboration, involving incentivizing the private sector, organizing producers, and building public support. In Beegle and Christiaensen (2019), the authors indicate there is much evidence to show the impact of contract farming and how it has boost “farmgate prices, farm productivity, and farm household income.” Contract farming has great potential to in addressing many of the Sustainable Development Goals (SDGs) by promoting sustainable impact and development through economic growth, social progress, and environmental sustainability; all three dimensions of the triple bottom line of sustainable agri-food value chain development