Vol 24, No 4; Article by Woonghee Tim Huh, Stergios Athanassoglou, Upmanu Lall; December 2012
One of the Millennium Development Goals adopted by the United Nations is the eradication of extreme hunger and poverty. Since a large proportion of the population in developing countries is rural, and engaged in agriculture, this goal is closely related to profitability and crop yield management of small-scale farmers in those countries. The most common approach for addressing the problems of the global and national food security as well as the rural poverty and equity issues has been government intervention. While such interventions are well intentioned and often provide short-term relief to farmers, their outcomes have been at best mixed in terms of providing long-term sustainable solutions. Meanwhile, the private sector may play an increasing role in improving the overall efficiency in the agriculture industry and the agri-business industry. One of the avenues of forming a symbiotic partnership between private corporations and farmers is through contract farming. Despite several potential advantages of contract farming to both the corporation and the farmers, one of the problems associated with its implementation is that farmers may sell outside the contract.
Motivated by this concern, we consider a model of contract farming which explicitly accounts for the possibility of the farmer's reneging. We consider a processed-food manufacturer that faces uncertain exogenous demand and procures a farm crop either from the outside market or from local farmers via contract farming. The contract price is determined at the beginning of the season when the market price is still uncertain. When the market price is realised, we allow the farmer the possibility of reneging from the contract, which occurs if the market price is sufficiently high. We show that granting farmers the option of reneging on the contract may improve the manufacturer's expected profit, and identify the conditions under which such an improvement can be expected.
