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Chapter 2

Key preconditions
for successful contract farming

No contract farming venture should be initiated
unless some basic preconditions are met.
This chapter reviews these preconditions under the headings
of profitability, the physical and social environments
and government support.


The sponsor

  • Must have identified a market for the planned production
  • Must be sure that such a market can be supplied profitably on a long-term basis

The farmer

  • Must find potential returns more attractive than returns from alternative activities and must find the level of risk acceptable
  • Must have potential returns demonstrated on the basis of realistic yield estimates


Main factors

  • The physical environment must be suitable in general, and in particular for the product to be produced
  • Utilities and communications must be suitable for both farming, e.g. feeder roads, and for agro-processing, e.g. water and electricity
  • Land availability and tenure - contracted farmers require unrestricted access to the land they farm
  • Input availability - sources of inputs need to be assured
  • Social considerations - cultural attitudes and practices should not conflict with farmers' obligations under the contract and managers must develop a full understanding of local practices


The enabling and regulatory role

  • Suitable laws of contract and other laws are required as well as an efficient legal system
  • Governments need to be aware of the possible unintended consequences of regulations and should avoid the tendency to overregulate
  • Governments should provide services such as research and, sometimes, extension

The developmental role

  • Governments can take steps to bring together agribusiness and suitable farmers


The primary precondition for any investment in contract farming must be that it is likely to be profitable. Having identified a potentially profitable market the sponsor can then move on to assess whether that market can be profitably supplied by contracted farmers in a particular location of a particular country. This involves an assessment of the social and physical environment of the proposed contract area as well as the potential support likely to be provided by the government. The following sections therefore consider preconditions under the headings of:


Profit for the sponsor

The sponsor's decision to invest in a particular market must be based initially on the knowledge that, subject to certain conditions, it will be profitable. However, contract farming is then just one of a number of solutions to a commercial market opportunity. A market must have the capacity to remain profitable in the longer term. In the case of tree crops, for example, prices tend to be cyclical. An analysis of economic viability carried out when prices are high would produce very different results than those obtained at the bottom of the price curve. A "sensitivity analysis" is thus required to ensure that production can be carried out profitably even when prices are low.

The exporting of horticultural produce to the markets of Western Europe, Japan and the United States is very competitive. Subject to guarantees regarding quality and supply, importers purchase produce on the basis of price. A supplier, through contact farming or otherwise, can lose markets overnight if quality standards and deliveries become unpredictable and inconsistent. Companies considering high-value horticultural exports also need to be certain that they can meet existing quality standards and likely future requirements. For example, if importers started to demand "organic" produce, how easily would suppliers and farmers adapt?

Profit for the farmer

If either the sponsors or their contracted farmers fail to achieve consistent and attractive financial benefits a venture will collapse. A further precondition, therefore, is that the sponsor needs to be sure that farmers will obtain higher net incomes from entering into a contract than they could from alternative activities with the same, or less, risk. Sponsors should calculate realistic yields in order to forecast whether production by farmers can be profitable at prices the sponsors are able to pay. These estimates should be based on the experience of farmers in the chosen area, their historical production data, soil fertility and, sometimes, field trials. Once estimates are compiled and production costs known, the sponsors are in a sounder position to calculate a realistic pricing structure that is mutually profitable. Guaranteed, regular and attractive incomes should encourage farmers to make a long-term commitment.

Sponsors should be aware that yield results from research plots are normally far higher than results from farmers' fields. Agronomists in Indonesia noted that soybeans grown at research stations produced yields more than twice those achieved by small-scale farmers.11 Experienced managers of contract farming projects usually estimate yields based on the mean production over the previous three to five years. As new technologies are introduced and farm management improves the mean yield increases over time. When a new crop is introduced the yield estimates are based on historic knowledge of the crop grown in similar environments and on the results of field trials.


The main factors affecting the success of all agribusiness ventures are:

The physical environment

The success of any agricultural investment requires that two multidimensional preconditions be met. Firstly, the general suitability of the topography, climate, soil fertility and water availability. Secondly, the suitability of the physical environment for the specific plant genotype or animal for which there is a market demand. The extent to which all these factors interact determines production yields, quality and profitability.

Utilities and communications

A major precondition for agricultural investment in rural areas is the existence of an adequate communication system that includes roads, transport, telephones and other telecommunication services. Reliable power and water supplies are particularly vital for agro-processing and exporting of fresh produce. The availability of suitable educational and medical services is also important for those who participate in contract farming, whether they be direct employees of the sponsor or the farmers themselves.

Sponsors will need to be assured that farm produce can be easily transported and that inputs can be delivered to their farmers. While major road infrastructure may be adequate, approach (or feeder) roads to farms may not. This is particularly important in the case of perishable crops that need to be processed soon after harvest (e.g. tea, oil palm and sugar) or stored in a suitable environment (e.g. cut flowers). Where local transport access is inadequate, sponsors must decide whether the problems can be resolved or whether alternate areas should be selected. Sometimes farmer groups are given the responsibility for ensuring that company transporters can reach the fields. Before the start of any project, the sponsor, farmers and local government agencies must agree on who will ensure access to and maintain feeder roads. In Kenya, the sugar companies' agreement with farmers stipulated that the companies had the right to construct feeder roads on the farmers' lands. This inevitably caused resentment among the landowners.

A precondition for the export of horticultural crops under contract is the availability of regular airfreight schedules; fresh vegetables and cut flowers depend on adequate cargo space to international markets. Unless quantities are large enough to justify chartering planes, the exporters will be dependent on space being available on commercial flights. The number of commercial flights depends on the number of passengers wanting to fly, and this can fluctuate rapidly. Several countries that have experienced coups or social disturbances have seen their tourism industries collapse overnight. This, in turn, has led to flight cancellations and the loss of markets for the exporters.

Box 3
Analysing the physical and social environment

An example of an investigation into the physical and social environment comes from Bali where an Indonesian corporation planned to grow tobacco under contract. Following a comprehensive survey of the factors listed above, it was recommended that the project be restricted to only two of a regency's (province's) seven subdistricts. This decision was based on the following analysis.

Government support:

  • Enthusiastic encouragement by the regency's leaders and the local agriculture department.
  • Adequate road and communications networks.
  • Two long-established irrigation systems - a traditional system maintained by the farmers, and a more sophisticated system constructed and supervised by the regency.

General conditions:

  • A responsive and progressive farming community that expressed a strong desire to cultivate the crops and enter into contracts with the sponsor.
  • Suitable friable loamy soils with the desired level of soil acidity.
  • A sufficient altitude that provided the preferred temperature range.
  • Minimal competition from the production of high-value, tourist-orientated crops such as those grown in other subdistricts.
  • Little evidence of the mosaic viruses that infect tobacco.
  • Farmers having adequate access to land, either as owners or as lessees.

Land availability and tenure

Contract farming can involve a wide diversity of land ownership and tenure arrangements. Farmers under contract must have unrestricted access to land on which to plant their crops. There must be an awareness and understanding on the part of management of how farmers gain access to land for cultivation and for that access to be acceptable within the framework of the contract.

In the majority of projects, sponsors contract directly with farmers who either own land or have customary land rights within a communal landowning system. However, within a single project there can be numerous variations of land tenure, including freehold title, formal lease of state land, leases from the sponsor's own estate and informal seasonal arrangements with landlords. Even if tenure is on an extralegal, customary and seasonal basis, short-term contracted crops such as maize, tobacco and all table vegetables can often be accommodated.

Despite the occasionally flexible nature of customary land tenure, the dominant factor now controlling land tenure under contract farming is the rent demanded by the landowner. In one venture land rents were dependent on the whim of the respective landlords. This resulted in a wide variation of charges, influenced by the nature of individual farmer-landlord relationships. Some of the land rents were relatively low, many reasonable and some grossly inflated. In such cases interventions by sponsors may be necessary to negotiate standard rents on behalf of all farmers.

Input availability

In most contract farming ventures the sponsors recommend, procure and distribute many or all of the material inputs. Sponsors need to be assured that they will be able to organize the supply of all necessary inputs for the farmers and for their own processing needs. All inputs should be identified and ordered well in advance, either from local sources or from overseas. Contract farming ventures call for varying levels of inputs depending on the nature of the crop and the degree of the farmers' sophistication. For crops such as Virginia flue-cured tobacco, farmers require a multitude of structural and material inputs that include curing barns, grading sheds, fuel, fertilizer, imported seed, pesticides and cultivation advances. Failure to have ready access to these can cause serious disruption to the production chain and can result in serious financial losses for all parties. Similarly, the failure of managers to supply feed on time to poultry and pig rearers can have major consequences for the farmers.

Social considerations

Many rural communities are wary of modern agribusiness and strongly influenced by traditional practices. Conventional societies are normally more conservative in their ambitions and material needs. There are often great disparities in cultural attitudes towards work. Before beginning a venture, managers need to develop an understanding of the cultural attitudes of those with whom they are working. They must also be particularly aware of the possibility of disputes when there is more than one cultural group working on the contract.

Box 4
Culture versus commercialism

The Dusan ethnic community of Sabah has a custom that, in the event of death, no person is permitted to visit the deceased's fields or gardens for a specific period. This is known as maganakan and the Dusan believe that if visitors set foot on the farm of the deceased all crops will die. Extension staff of a contract farming project in central Sabah were threatened with violence and legal action for transgressing this taboo.

There is always the possibility that the economic success of a contract farming venture could, in fact, have social repercussions that jeopardize its long-term success. This may occur, for example, because the opportunity to participate is limited to a certain number of farmers. If farmers are chosen on the basis of the size of their farms and resources, contract farming may widen pre-existing economic disparities and lead to resentment on the part of those excluded. In India there is concern that contract farming has led to a reversal of previous tenancy arrangements, with small-scale farmers now renting out land to large-scale farmers who have contracts.


Governments have to play an important role if contract farming is to be successful. A relevant legal framework and an efficient legal system are preconditions. Moreover, governments can do much to foster success by developing linkages between investors and farmers and can play an important role in protecting farmers by ensuring the financial and managerial reliability of potential sponsors. The role of national governments and their local agencies can be divided into:

The enabling and regulatory role

Contract farming depends on either legal or informal agreements between the contracting parties (Chapter 4). These, in turn, have to be backed up by appropriate laws and an efficient legal system. Relevant laws can be grouped into three categories: enabling functions, economic regulatory functions and constraining functions.12 In the context of contract farming the enabling aspect of the law is perhaps the most important. Laws of contract, in particular, allow the evolution of commercial transactions beyond direct barter exchanges. Legal mechanisms for granting a group of individuals recognition as a legal entity have also been central to the development of commerce. A classic example is the limited-liability company. However, in the context of contract farming, a sponsor entering into agreement with a cooperative also needs to be assured that the cooperative is on a sound legal footing.

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 the Philippines, for example, fast-food chains had been importing frozen french fries. Although that particular variety of potato could be grown in the Philippines, the Government had imposed import restrictions on seed potatoes, resulting in the unavailability of the required variety. Approaches to the Government by the companies eventually resulted in the ban being lifted and this permitted the establishment of two contract farming ventures to supply the rapidly growing fast-food industry. Thus a simple policy reform ultimately benefited the sponsors and a large number of small-scale farmers.13

While it may not be considered a precondition it is desirable that governments play an arbitration or dispute resolution role. For example, the Government of Malawi established dispute resolution guidelines for agricultural contracts and offered the services of the Ministry of Labour to mediate. Likewise, in many large-scale, sugar-producing countries there are statutory bodies that act as arbitrators between sugar-cane growers and the sugar mills. In Canada, thousands of potato growers under contract with a single buyer negotiate prices and contract terms through the offices of the New Brunswick Potato Agency.14 It is compulsory that all potato farmers join the Agency.

Other government enabling activities to sustain contract farming may include:

At the national level, it is a precondition that specialized services are available to provide institutional support to production, processing and marketing. Government services, such as quarantine controls, plant pathology clinics and research stations are important for contract farming. Such services are particularly necessary for companies that invest in high-value crops for export or in organic farming.

In most countries there is no legislation that specifically regulates contract farming. If legislation is introduced it should ideally be based on the industry's ability to regulate itself. However, governments have sometimes attempted to overregulate. This is often done when the sponsor is a parastatal or other government agency. For example, legislation in Kenya authorized the parastatal sponsor of contract tea farming to issue licences to farmers on rigid conditions. These governed aspects such as authority to uproot tea bushes, pest and disease controls, unauthorized planting of tea, failure to cultivate in the approved manner, and the right of the parastatal to grant or refuse a licence to plant tea. Although regulations such as these may have done the opposite, it can be argued that governments should enact legislation to protect farmers as the weaker of the contracting parties. This is particularly the case where the farmers involved are tenants of the sponsors and have little security.

Businessmen, particularly those involved with exports, frequently complain about the red tape and the costs involved with complying with excessive bureaucratic regulations and procedures. A simplification of official documentation, for example, could have a positive impact on the outlook of potential investors.

The developmental role

As contract farming grows in importance governments should perhaps reallocate development resources towards its promotion. For example, the Philippines Government, with assistance from an FAO project, promoted contract farming for small-scale farmers who were allocated land under the agrarian reform programme. A major feature of this was a "market matching" exercise. This involved organizing forums where agribusiness entrepreneurs could meet farmers' representatives to discuss their requirements. The forums were followed by more detailed discussions between individual sponsors and individual cooperatives or farmer organizations. By 2000 at least 27 companies had established contractual relationships with farmers as a result of the programme. Other activities carried out by the Department of Agrarian Reform included dissemination of market information, highlighting the products for which there was a commercial demand that could be satisfied through contract farming operations. The Department also agreed to act as arbitrator in the case of disputes.15

Another example of promotion of contract farming comes from India where the regional office of a government-owned bank organized a meeting of bankers, agribusiness executives and the government extension service in order to explore possibilities of creating market linkages for agricultural products. This led to a major poultry producer contracting 2 200 farmers in 164 villages to grow maize and soybeans for feed purposes. Finance is provided by the banks, with a tripartite agreement being signed by farmers, the company and the banks.16

Where contracted farmers are organized into cooperatives or groups, governments can play an important role by carrying out activities to strengthen the managerial skills of these organizations. Although the performance of agricultural cooperatives in developing countries has been marginal at best, improving a cooperative's managerial capability should, in theory, greatly enhance its business performance, the transfer of technology to farmers and its marketing skills.

The government has a role to play in ensuring that companies proposing to invest in contract farming are bona fide and are planning long-term partnership arrangements with farmers, rather than short-term operations which may leave farmers with considerable debts. Sponsors must have demonstrated financial strength, proven managerial competence and technological experience. Before promoting and launching projects, sponsors should create a suitable management and administrative structure and the purchase or lease of land for offices, processing facilities and transport needs should be organized in advance. Some projects may involve considerable capital investment and elaborate infrastructure such as that required for sugar milling, tobacco processing and vegetable canning.


Tables 1a and 1b show theoretical examples of an inventory of preconditions that sponsors need to carry out before negotiating with farmers. Table 1a indicates a socio-political climate that is positive for contract farming. Of particular importance is the favourable response from local community leaders. The inventory as presented in Table 1b shows that key physical determinants of productivity, evidence of past farmer productivity and proven market demand make the venture attractive. In addition, suitable temperatures, adequate sunshine and a reliable irrigation system provide other advantages. While there is concern in the example that some farmers do not have permanent land tenancy, the majority of farmers have either outright ownership or long-term leases which are positive advantages for the stability of a contract.

Table 1a
Example of an inventory of preconditions for contract farming - Socio-political assessment









Political environment




National political stability.
Stated support for project.



Modest support for project.



Positive response from
local community leaders

Public utilities & services




Well maintained but limited
road network.

Public transport


Sponsor provides project



Poor. Project to provide
own communications.

Electricity supply


On national grid
for processing.

Water supply


Adequate for project.

Hospitals & health


One hospital and two
health clinics.



One high school and
three primary schools.

Government agencies


Positive response from research and
extension sections

Quarantine services


Good location and well administered.

F = Favourable A = Adequate M = Marginal

Table 1b
Example of an inventory of preconditions for contract farming
- Physical and social assessment









Market Identification


Manufactured product


Proven demand for manufactured product.

Fresh produce


Adequate demand for secondary grades in fresh form.

Physical environment


General climatic factors


Adequate, no frosts in season, 80% sunlight hours.



Erratic and unreliable.

Natural water availability


Adequate for crop requirements.

Irrigation availability


Favourable irrigation system for project.

Soil fertility


Soils very suitable for crop.



Only a small percentage of farms have steep eroded slopes.

Natural vegetation


No effect on natural vegetation and proposed crop.

Social and farming environment


Existing cropping mix


Practice of interrow and relay planting.

Historic productivity


Very productive farming community.

Cultural influences


Cultural obligations no obstruction to project.

Land tenure


Landowning farmers


58% of farmers cultivate their own land.

Tenancy farmers


32% of farmers on long-term leases.

Customary farmers


10% of farmers growing on temporary customary tenure.

F = Favourable A = Adequate M = Marginal

11 Roling, N. in Beets, W., 1990: 256.

12 FAO, 1999.

13 Panganiban, D.F., 1998:19-20.

14 Glover, D. and Kusterer, K., 1990: 89.

15 SARC-TSARRD, 1998.

16 NABARD, 1999: 56.

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