Contract farming and its impact on broiler producers in Lebanon. A systematic review

Abstract

This Thesis has been realized within the agribusiness sector and experiments the Transaction Cost Theory a branch of the New Institutional Economy which explain market failure caused by many factors. Transaction costs are associated with carrying a transaction between buyers and sellers. This study has been conducted between 2014 and 2017; and has collected data from 11 broiler producers in Jezzine, Lebanon, about: Production costs, capital investment, revenues, land tenure, access to infrastructure, and information about the contract. The propensity score matching method is used to compare the effect of participating in contract farming and to solve the hypotheses, which say: There is a positive relationship between contract farming and the economic benefits of broiler producers and the development of the broiler sector in Jezzine District. Findings from farmer’s interviews indicated that sustainability, guaranteed price, risk reduction, credit facilities and technical aids are the main reasons for signing a contract. In contrast, Farmers have expressed problems concerning the contractors’ responsibilities such as delay in payment and delivery. Also, when prices are high, it was argued that farmers were selling the products in the open market.

Keywords: Contract farming, broiler producers, economic sustainability.

Introduction

In the Global Value Chain, agriculture must be able to meet the rapidly growing demand for food, and a global strategy is needed to ensure a sustainable food production system, to face the challenge of feeding 9 billion people in 2050, and to ensure that every human being has access to adequate food (Godfray, Beddington, Crute, haddad, Lawrence, Muir & Toulmin, 2010). Agricultural value chains are undergoing rapid transformation changes because of urbanization, industrialization, globalization, and trade liberalization (Reardon & Barrett, 2000; Reardon & Timmer, 2007; Swinnen, 2007; Reardon, Barrett, Berdegue & Swinnen, 2009); also because of capital mobility, income growth, technology, innovation, product differentiation, changes in consumer preferences, diet westernization, shifting consumption toward processed foods, and improved communications which are linking small farmers with consumers worldwide (Pingali, 2007); besides the spreading of supermarkets and fast-food restaurants, and the growing importance of quality standards (Reardon & Berdegue, 2002; Weatherspoon & Reardon, 2003; Shepherd, 2005). Supermarkets procurement system favors centralized purchasing, specialized wholesalers, and certified suppliers (Neven & Reardon, 2004; Berdegue, Balsevish, Flores & Reardon, 2005); these characteristics require more vertical integration, thus favoring the introduction of contract farming (Key & Runsten, 1999; Bijman, 2008). Spurred by those changes, agricultural systems are being forced to adapt and modernize, they have been restructured, becoming increasingly market-oriented and consumer-driven, also new ways of organizing the agri-food sector are being promoted; and different forms of vertical integration are being introduced (Elms & Low, 2013). In these modern systems, the traditional spot market mechanism in which food is produced, without farmers having a clear idea in advance; to whom, when and at what price they are going to sell their crops, is being replaced by alternative forms of vertical integration, strategic alliances, or full ownership, also it has provided the drive for further development and a rapid expansion of contract farming, which has been studied extensively for decades, and has become an essential element of modern agricultural value chains (Shepherd, 2007).

Literature Review

Current literature for contract studies mainly focuses on incentives and risk shares. Some authors of case studies of broiler contracts between farmers and processors have argued that risk reduction is a major incentive for contracting and contract-farming reduces transaction costs and can make smallholders overcome existing market imperfections; Contract farming is an institutional solution to the problems of market failure (Grosh, 1994; Key and Runsten, 1999). It is generally considered that contract farming ensures consistent procurement and therefore helps processing companies to optimize their processing capacity and their fixed assets investment with regard to spot markets; discontinuity risks while avoiding integrated production risks (Eaton et Shepherd, 2001; Johnson and Foster, 1994; Knoeber and Thurman, 1995). Contracting is common for industrial crops (e.g. sugarcane, tobacco, tea, broiler, dairy, and horticulture) particularly when destined for high-income consumers willing to pay a premium for quality and food safety (Minot 1986). The origin of the contracting is so different. Development of agriculture from a traditional structure to a market oriented structure is the major challenge for developing, less developed countries and economies in transition. For these countries, it is generally agreed that food processing is a key industry which should receive high priority both at national and international levels. The food-processing industry is important for economic growth and health of people. Development of food industry promotes development in other sectors through forward and backward linkages. Developing countries need to develop their food resources more extensively not only to provide new job opportunities and increase national income via accruing value and exports, but also to supply safe and adequate processed food to consumers. In a globalized world, there is a close relationship between the changes in agricultural and food markets of developed countries and developments in developing and less developed countries through international funds and donors, foreign direct investments and activities of multinational companies. The wave of privatization and liberalization of the developed world have helped in bringing about a new form of vertical coordination between private companies and farmers in countries which are so called countries in transition. Recent developments in peri-urban areas of West Africa such as structural reforms, encouragement of subsistence farming to grow high-value crops, enhancing private sector have created remarkable changes in production and marketing organization using in many cases contract farming. It has been observed that there is an increased importance in close vertical coordination in the countries in transition.

Theoretical Foundations

The starting point for this perspective is Coase’s in 1937 with a simple question: why do firms exist? (Coase, 1937; Williamson, 1985) Coase’s answer is: to minimize the transaction costs of exchange (Coase & Piaget, 1661; Schlag, 1989; Coase, 2012). Thus, if it is cheaper for a firm to produce an input, compared to purchasing it, in an uncertain and unreliable market, then it will integrate backwards to do so (Stuckey & White, 1993).

All markets require some form of vertical coordination between participants, such as farmers, processors, wholesalers, and retailers (Minot, 2011). Often transaction without any contract is called: spot market or open market that involves no written or oral commitments, it provides freedom but uncertainties for buyers and sellers (Rehber, 1998, 2000). In general spot markets show deficiencies; in overcoming problems resulting from imperfect markets, and in transferring information regarding quality, timing and future demand. One way of vertical integration in agriculture is contract farming; it is an intermediate form of industrial organization standing between spot markets and full vertical integration (Kirsten & Sartorius, 2002). It is evolved in order to overcome constraints of market failures, and missing markets: observed in terms of natural vagaries and price fluctuations, to ensure market participation of smallholder and marginal farmers (Barrett, 2008).

Foundation in Transaction Cost Theory

The major theoretical background for contract farming is based on the Transaction Cost Theory, which is a branch of New Institutional Economics, which provides a useful explanation of many problems of market failure and missing markets caused by asymmetric information and a range of other factors (Kherallah & Kirsten, 2002).

According to the New Institutional Economics, all market transactions between economic actors are hazardous, involve costs, and can entail considerable losses; institutions have been created to reduce the costs of resource allocation and uncertainty level (Williamson, 1979). Transaction costs are defined as the costs associated with carrying out a transaction between buyers and sellers, including: finding a buyer, reaching, negotiating, delivering the commodity, obtaining payment, enforcing agreements as well as the risks associated with the transaction (Coase, 1960; Allen, 1999; MacDonald, Perry, Ahearn, Banker, Chambers, Dimitri & Southard, 2004; Minot, 2011). Because contracting involves costs, it is economically justifiable only: when the buyer is a large firm; when the product is characterized by large quality variations, perishability, technically difficult production, and high value product; when the policy environment is conducive, and the destination market is willing to pay a premium for certain product attributes (Minot, 2007, 2011). Transaction costs in agriculture sector are high in many developing countries; they contribute to market failures and imperfect markets (Pingali, Khwaja & Meijer, 2005). Different governance structures and contracting forms arise and the most suitable depends on the costs and the characteristics of a transaction (Williamson, 1981).

Factors for the emergence of contract farming

We consider many factors for the emergence and evolution of contract farming: bounded rationality, opportunistic behavior, asset specificity, uncertainty, and frequency of transactions; in the absence of these factors, spot market trading is most efficient, and contract farming would not occur since agribusiness firms could buy all their produce from the spot market which would be instantly and perfectly responsive to their demand (Williamson, 1979; Simmons, 2002). However, in reality one or more of these problems may happen which indicates the need for contract farming. Another procurement option for agribusiness firms is to operate their own plantations; yet, with this option they may face other transaction costs such as supervision costs, costs of land and skill acquisition, and crop risk. Therefore, contract farming may occur only if it generates lower transaction costs compared to the other alternatives of market arrangement (Hobbs, 1996; Eaton & Shepherd, 2001; Simmons, 2002). Among the many aspects in current analyses are organizational arrangements like:

Bounded Rationality: Contracted parties suffer from information deficiencies and are unable to process all the information available to them to formulate solution and solve complex problems in a costless and straightforward way (Simmons, Winters & Patrick, 2005; Bijman, 2008);

Opportunistic Behavior: The probability that the other party will engage in opportunistic behavior is hard and costly to predict. Actors seek self-interest without considering the other party; they can deceive, lie, cheat and steal (Bijman, 2008);

Asset Specificity: An investment made by farmer or buyer which is dedicated to a certain transaction has little or no value in alternative use which leads to asset specificity and may result in hold-up problems. Thus, commodities with a higher degree of asset specificity require an involvement in vertical coordination in order to reduce risks, and to protect those assets (Gow & Swinnen, 1998; Martinez, 1999; Bijman, 2008);

Level of Uncertainty: Lack of information about market conditions for farmers, and about the quality of product for buyers is a challenge in carrying out profitable transactions. The main source of uncertainty is incomplete and asymmetric information on current and future conditions (Bijman, 2008; Prowse, 2012);

Frequency of Transactions: A repeated interaction between trading partners to maintain a reputation for fair dealing and to mitigate opportunism, even in the absence of contracts or vertical integration (Klein, 2006).

Hypotheses Development

It is clear that there are some controversies and gaps in the existing literature about the impacts of contract farming on broiler producers, certain areas have been widely addressed by researchers, while other areas such as long-term profitability have been less explored. The contract system has advantages and disadvantages, one of the key advantages for producers, is the shift of production and market risk to the integrator. Similarly, contracts that broiler companies have with family farmers have allowed thousands of people to get into farming, diversify and expand their farming operation, and more securely lock in a stable income flow. Thus the hypothesis we have formulated likely mirrors the situation.

- There is a positive relationship between contract farming and the economic benefits of broiler producers and their sustainability.

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Figure 1: Contract Farming Conceptual Framework

Source: based on Eaton, C.S., 1998b: 274

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Figure 2: Contract Farming Theoretical Framework; Majid, R., & Hassan, S. (2014). Performance of broiler contract farmers: A case study in Perak, Malaysia. UMK Procedia, 1, 18-25.

Methodology

Agricultural contracting has been identified as urgently needing further research, in order to explore the topic in depth; we compiled a literature review of existing contract farming studies, the methodology that we will use is by observing outcomes across different farmers implementing contract farming in a given time period in different areas. This kind of methodology reflects the majority of the existing literature around contract farming. It is a questionnaire data; the data will allow us to better understand the variations in the industry. In our study, we will complete a comparative analysis between contract and non-contract broiler producers in Jezzine District, Lebanon. We will collect data from a sample of eleven broiler producers from different village based on a questionnaire, the sample of those farmers we choose is based on those 11 respondent criteria:

- Geographical location which is Jezzine District.

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