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Contract farming is the process of agricultural production carried out according to an agreement between unequal parties, companies, government bodies or individual entrepreneurs on one side and economically weaker farmers on the other which establishes conditions for the production and marketing of farm products. 

 In this process, the farmer agrees to provide established quantities of a specific agricultural product, meeting the quality standards and delivery schedule set by the purchaser. In turn, the buyer commits to purchase the product, often at a pre-determined price. In some cases, the buyer also commits to support production through supplying farm inputs, land preparation, providing technical advice and arranging transport of produce to the buyer’s premises.

Today, contract farming is emerging as a preferred mechanism through which agri-businesses can directly engage with farmers. An expanding urban middle class and increasing commercial investment in agricultural retailing and processing are creating demand for more standardized, higher-quality agricultural produce. But underdeveloped supply chains and small farm sizes make sourcing such produce difficult.

PepsiCo was one of the earliest promoters of the contract-farming model in India. In 1997, it set up a tomato processing plant in Punjab, not a traditional tomato growing area, and started tying up with local farmers to grow tomato varieties needed for ketchup.

Although PepsiCo has since exited tomato processing, it still works with 12,000 farmers, primarily to procure potatoes for potato chips.

Objectives of the contract farming:

• To reduce the load on the central & state level procurement system. 

• To increase private sector investment in agriculture. 

• To bring about a market focus in terms of crop selection by Indian farmers. 

• To generate a steady source of income at the individual farmer level. 

• To promote processing & value addition. 

• To generate gainful employment in rural communities, particularly for landless agricultural labour. 

• To flatten as far as possible, any seasonality associated with such employment. 

• To reduce migration from rural to urban areas. 

• To promote rural self-reliance in general by pooling locally available resources & expertise to meet new challenges.

Models of contract farming:

• Centralized Model (Out-grower Schemes): Under this, contracting company provides necessary support to the farmers for production of required crops; purchases the crop from the farmers, and then processes, packages and markets the product by tightly controlling its quality. This type of farming is quite famous in developing countries for high value crops such as tobacco, cotton, paprika, sugar cane, banana, coffee, tea, cocoa or rubber etc. It may involve tens of thousands of farmers and level of participation of the contracting company in production may vary.

• Nucleus Estate Model: Under this, company own and manages an estate plantation to ensure the limited guarantee of required output. This type of contract farming is highly used for tree crops such as palm oil etc. and also sometimes used in case of export of fresh vegetables.

• Multipartite Model: It is a common joint venture approach in between statutory bodies or state agencies and private companies; those are jointly participating with farmers. Multipartite arrangements may include different specialized organizations for purpose of credit provision, production, management, processing, distribution or marketing etc. In Mexico, Kenya, and West Africa, among other countries, governments have actively invested in contract farming through joint ventures with the private sector.

• Informal model: It usually includes small entrepreneurs or companies who enter into informal contracts with farmers on a seasonal basis which mainly includes crops like fresh vegetables, watermelons or tropical fruits etc. Material inputs are mainly limited to fertilizers and seeds. A common example of the informal model is where the sponsor, after purchasing the crop, simply grades and packages it for resale to the retail trade such as supermarkets, etc.

• Intermediary Model: Under this model, companies make formal sub-contracts with intermediaries (like agents, farmer groups or NGOs) for production of crops. The intermediaries generally enter into informal contracts with farmers to meet the obligations under formal contract with companies. This is a common practice in South-East Asia region.

Advantages of the contract farming:

To the farmers:

• Easy to get credit from Bank under contractual agreements.

• It helps in skilling of farmers as farmer learn to use resources efficiently like fertilizer, pesticides and get in touch with new technology in some cases.

• Farmers get opportunity for diversification of crops and learn about new crops that have demand in market.

• Farmers' price risk is often reduced as many contracts specify prices in advance.

• Contract farming can open up new markets which would otherwise be unavailable to small farmers.

To the sponsors:

• Uninterrupted & regular flow of raw material and that of high quality.  

• Protection from fluctuation in market pricing.  

• Long term planning made possible.  

• Concept can be extended to other crops.  

• Builds long term commitment.

• Dedicated supplier base. 

• Generates goodwill for the organisation.

Environmental impact of contract farming:

• Contract farming leads to monocultures which lead to depletion of soil quality, and effect of fertilizers and pesticides on natural resources, environment, humans and animals. 

• It lead to over-exploitation of groundwater, salination of soils, decline in soil fertility, and pollution 

• The firms do not pay heed as the costs of such effects are externalized so far as the firm is concerned

• It is also argued that CF as part of the globalization process might lead to increasing investments in developing countries which have low environmental standards and, thus, the natural resource base might end up irreversibly depleted or damaged.

Limitations of contract farming:

• Contracting agreements are often verbal or informal in nature, and even written contracts often do not provide the legal protection in India that may be observed other countries. 

• When growing new crops, farmers face the risks of both market failure and production problems

• Farmers investing in crops with a long growing period receive no income until the crops bear fruit. For most small farmers such investments are impossible without funding from a company, the government or a development bank. Even if such funding is available it is unlikely to come as a gift and thus farmers become more indebted than they would if following traditional farming practices, even though in the long run they may be much better off.

• Farmers tied to a contract are unable to benefit from high prices on the open market. 

• Most of the crops grown under contract arrangements are cash crops which give more income to farmers but at the same time due to this profit motive food crops are being neglected.

• The seeds of generally modified crops to tackle pests, diseases and to get maximum output are sold by the MNCs. The seeds once used cannot be regenerated as is the case of BT cotton.

• There are no standard legal procedures in resolving the disputes arising under contract agreements.

• It leads to greater casualisation of labour as well as the greater use of female and child labour.

Hence to overcome these limitations the Government should play the role of a facilitator and not that of a regulator in developing and promoting a healthy system of farmer-corporate relationship for mutual benefit. This will help in development of agriculture sector in India.