Pros and Cons of Contract Farming

Particularly in underdeveloped markets it is not uncommon to see in the media reports of farmers crops going to waste and spoiling in the fields due to not having markets to sell the produce. You are just as likely to have also seen reports of buyers; processors, exporters, food service, retailers and hotels complaining that items are scarce, supply is unreliable and/or prices are unstable.

Contract farming can be a good way to correct this issue by giving the farmer a "guaranteed market" in the form of a legally binding supply contract with a specified volume that the buyer is obligated to purchase and the supplier gets a promise to supply at a specified price.

The advantages are:

1. Farmer has security in knowing his crop will be purchased

2, Some banks will accept a supply contract from a reputable company as collateral for a loan

3. Farmer can concentrate on growing and not worry about marketing and sales

4. Encourages development of longer term relationships between buyer and farmer

5. Buyer is able to plan ahead and secure raw material supply as opposed to leaving it to chance and depending on the market to have the volume and price at the time that it is needed.

A disadvantage may arise if the contract price is fixed and the market price becomes significantly higher or lower than the contract price. When this happens there may be significant temptation by one party to break the contract. If the market price goes significantly higher than contract the farmer may be tempted to side sell into the market. If the market price is lower the buyer may be tempted to buy on the open market instead of from the contracted supplier.

This issue may be solved by having flexible or semi fixed price contracts where contract price is allowed to vary slightly with market price based on a pre-agreed formula.

In essence, once both parties are committed to operating with integrity, contract farming's benefits far outweigh the disadvantages.

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