The highlightof my recent week in Nigeria was working on two potential Business Innovation Facility agricultural supply chain projects.   What I enjoyed most is what I learnt from the large companies involved.  Both projects show a real understanding of smallholder farmer perspectives, and why contract farming can be an effective way to engage them in supply chains.

Contract farming has been defined by the FAO as ‘agricultural production carried out according to an agreement between farmers and a buyer which places conditions on the production and marketing of the commodity’. Contract farming can be an attractive business model for companies that need regular and consistent supply.  It can also be beneficial for small farmers, who can secure a market for their products, often at a guaranteed price.  Contract farming can also be contested as a development tool, a debate that has been ably taken up in recent blogs by two of my BIF colleagues.

The Nigerian projects have provided me new insights into how contract farming works from the farmer’s perspective, and I have begun to make connections with quite a number of other BIF agricultural supply chain projects. Jotting in my notebook, I have crystallised these connections in terms of the risk and return decisions that smallholder farmers take.  

Rationally, smallholder farmers will operate a low return farming system, as such farmers usually do not access agricultural inputs such as fertiliser and improved seed.  Even when they do have access to these inputs, many farmers will not have the ability to make good use of them.  It is therefore logical for many small farmers to choose this low risk/low return option.

Accessing inputs and mechanisation often requires smallholder farmers to borrow money, which could result in devastating consequences if they can’t repay this debt. It is quite likely that many will struggle to repay, as:

• They may well receive a low price for the crops as they are very likely to have to sell their crop into a highly volatile market at the time of peak supply;
• Theyare unlikely to have the skills or information necessary to fully realise the higher yields available from a more intensive farming system;
• If they also borrow to pay for other elements of more evolved farming systems, such as mechanised land preparation, the risks are even higher.

For these reasons, farmers are unlikely to benefit as fully as they could from simply accessing inputs on credit. Lesson one for me from our BIF projects is therefore that, even if they are able to borrow money, it is unlikely that this will be enough to incentivise smallholder farmers to access this finance.  Why? Because they perceive that they are likely to face significantly increased risk without any certainty of commensurately greater returns, and therefore for small farmers this is seen as high risk / low return option. 

Lesson number two is that packaging training of farmers and agricultural information services alongside the credit for inputs is very helpful, as it enables farmers to make best use of   inputs. These services unlock the ability for small farmers to better realise the significant yield increases that are available from inputs.  For example, improved seed will flourish when it is planted at the optimum depth, into soil prepared in the right way, and with the required level of nutrients and water available in the soil.  However, even with these elements in place, farmers know that they are still exposed to high risk from price volatility and from a range of external influencesbeyond their control, such as adverse weather.  This is therefore a high risk / high return scenario for farmers.

The final element of the system is the most important because it reduces the risk. The risk reduction from contract farming comes from the links to markets through pre-contracted sales, possibly also involving some kind of insurance.  This is necessary to reduce the risks that arise from excessive price volatility. 

The third lesson from the BIF projects is that contract farming systems should address both risk and return the ways I have described.  This gives small farmers a credible low risk / high return option.

However, even then often that isn’t enough. Such a model requires soft finance or a public subsidy until such time as the smallholder farmer is converted to a commercial farmer with the skills, scale and market access to be able to absorb the costs of soil testing and to be able to access information without support.

The model also requires involvement of a third party who can facilitate the one to many / many to one relationship.  Large institutions in the value chainsuch as banks, grain silos, processers and producers – the ‘few’ - are usually not set up to manage complex schemes with the ‘many’, the smallholders. Thus there is often a brokering role for an NGO or other non-value chain partner, and also potentially fairly small aggregators and traders.  These actors will usually not be present in more evolved situations where financial and commodity markets work better, and farms become more sizeable businesses.

In summary, the contract farming models that the companies are seeking to implement with BIF support have the following elements in addition to the marketing ‘contract’, for the reasons I have surmised above:

1. Source of credit for production costs, to include fertiliser, quality seed and ideally mechanised land preparation and harvesting;
2. Upgrading of farmers skills;
3. Access to information to enable ‘precision farming’(e.g. soil testing, mapping);
4. A third party to break down and/or aggregate from many small farmer to larger value chain actors;
5. Soft funding and/or public subsidy, at least in the early stages, to pay for 2,3 and 4.  These costs should taper off as the farmers realise the benefits financially and both productivity and average farm sizes grow.

This summary list checks out well with published material on contract farming.  For example, ‘The Growing Role of Contract Farming in Agri-food Systems Development: Drivers, Theory and Practice’ by Carlos Arthur B. da Silva, which is on the FAO website lists the advantage to farmers of contract farming as follows:

• Inputs can be provided
• Services and technological assistance can be provided
• Production and management skills enhanced
• Market outlet is secured
• Income stabilization is promoted
• Credit access enhanced
• By-products can be used.

These points are remarkably similar to the summary I made of lessons from the BIF projects.

 The FAO toolkit also lists the following critical success factors:

• The basic tenet is that contractual relationships will only be sustainable ifpartners perceive that they are better off byengaging in contract farming compared to other choices they have
• The importance of the enabling environment
• Minimization of contractual hold-ups
• Need to countervail uneven balance of power
• Need to reduce the transaction costs ofdealing with multiple contracting parties
• Appropriate consideration of production andmarketing risks in the design of contracts
• High value, processing andexports are better candidates for contract farming.

Again, there is a good degree of overlap between this list and what I learnt from the BIF projects. 

This supports my conclusion that the companies that BIF is supporting in contract farming projects are doing so in a way that demonstrates a real understanding of smallholder farmer perspectives.