The Ugly Face of Contract Farming

Contract farming has been hailed by many experts as the perfect economic arrangement between farmers and companies.

Corporations like Monsanto, McDonalds, Starbucks and KFC have become champions in the use of contract farming.

Companies claim that it is a beautiful arrangement that cuts out non value adding middlemen and therefore increases the prosperity of the farmers as well as the buyers.

However, this does not seem to be the case. Particularly when mega corporations like the ones mentioned above sign contracts in third world countries. In the absence of laws protecting the rights of the weaker parties, these multinationals draw up contracts which are exploitative in nature.

Companies like Wal-Mart and McDonalds have been accused of predatory practices that aim at maximizing their own profits at the expense of the others in the value chain. This article will list down some of the questionable practices followed by these companies.

Huge Upfront Investment

Contract farming requires a huge amount of upfront investment by the farmers. Multinational companies do not want to deal with farmers that still follow a primitive style of farming. This means that farmers have to make expensive upgrades. They are asked to purchase equipment, build warehouses and other such infrastructure if they want to be able to land the contract.

A lot of farmers do not have the required money. Hence, they end up taking huge bank loans to support their business. A lot of times it is the multinationals that have partnerships with banks that make such loans. Multinationals may benefit from this in the form of kickbacks and commissions that they receive.

Also, multinationals have a say in which suppliers you purchase your equipment from. In the name of standardization, these companies get you to purchase expensive equipment from their subsidiaries or from companies that give them commissions.

Multinationals often use their bargaining power to generate additional sources of revenue from commissions. Often these incomes are generated by subsidiaries which can be kept off the books.

Regular Upgrades

Multinational companies want their partners to constantly stay in debt. When people are in debt, they do not have much bargaining power. Making bank payments in their top priority and everything else takes a back seat. Hence, many of these multinational companies mandate that the equipment be upgraded every few years. Once again they have tie ups with banks and suppliers and generate additional revenues in the form of kickbacks.

Asymmetrical Bargaining Power

Once companies get farmers indebted, they have a lot of bargaining power over such farmers. Farmers can either agree with the company or face termination of their contracts. Since termination is not an option in the light of huge loans that have been taken out, these farmers have no option but to bow to the whims of these multinationals. Once they get into a contract with these multinationals, they give these companies excessive leverage over themselves.

Arbitrary Quality Standards

Multinational companies have clauses in their agreements which allow them to grade the produce of the farmers by following an arbitrary quality standard. This quality standard is considered to be an internal policy of the company and therefore can be changed at any given time without any prior notice. In fact a lot of times this grading system is used as a retaliation tool for farmers that do not agree with the company. The produce of these farmers is consistently judged as being inferior. Also, the payments made to this supposedly inferior quality are also markedly lower. Hence there is a clear cut economic impact that follows if the farmers were to raise their voice against any policy adopted by the multinational.

Competition

Many multinational companies have also introduced the bell curve system to grade the produce of the farmers. This means that by definition some of the farmers will be graded as bad producers. This situation can arise even if everybody has performed well. It therefore fosters an unhealthy competition amongst famers since one can and does benefit at the expense of the others.

Multinationals have such arrangements to prevent any kind of unity amongst farmers. Instead of uniting against the multinational, they spend their time competing with each other. This competition can be unhealthy to the extent that when the pay of one of the farmers is cut due to poor quality, the exact amount is given to another farmer of the same region for their supposedly higher quality. As a result, this bell curve grading of farmers ends up being a zero sum game.

Penalty Clauses

The penalty clauses in the contracts are pretty one sided. For instance, if the farmers have delayed the delivery of the produce, the penalties charged are excessive as well as immediate. On the other hand, if the multinational company delays its payments, there are no penalties charged at all! Penalties if any are very small.

Also, the payment terms mentioned in the contracts are excessively long. Multinationals want to collect their receivables as soon as possible. However, they are very reluctant when it comes to making payments. These payment terms are aimed at squeezing free credit out of poor farmers who do not understand cost of capital calculations.