Synopsis

Over the past two decades, the agrifood industry in developing countries has undergone rapid modernization. Economic growth, rising incomes, urbanization and spread of western lifestyle have led to changing consumption patterns. The demand for high-value agricultural products like fruit and vegetables, milk and meat has increased tremendously. Fresh and high quality produce is en vogue, and meeting consumers’ aspirations towards product quality attributes such as size, shape, color and taste but also process quality presents an immense challenge to processors, wholesalers and retailers. As timely supply of high-quality produce becomes a key factor, the degree of control required in the value chain increases. To facilitate supply chain relations, vertical integration is fostered: One widely embraced approach is contract farming. The arrangements between buying firms and selling farmers entail a large variety of oral or written agreements anywhere on the stratum between spot market transactions and full integration as the two extreme cases.

This exciting development in the agricultural sector of many developing countries brings new drive into rural areas which for a long time have merely been seen as a pool of labor for ever growing urban agglomerations. But who are the farmers benefiting from this development? Is it smallholders or larger producers?

If small-scale farmers were included in these emerging markets, the development had a distinct pro-poor dimension as a large share of the rural poor

engages in farming. Also, benefits could spill over into local communities as farms provide jobs and create demand for local goods and services.

Generally, high-value agricultural products, which are usually labor intensive, would fit well in a smallholder agriculture context where family labor is often abundant. However, to supply emerging markets, relationship-specific investments in knowledge, skills, technology and productive assets are required, because farmers engaging in contractual agreements with buying firms oftentimes have to become highly specialized. The initial investment cost presents a hurdle difficult to take for many smallholders, making larger farmers more likely to sign contracts. Due to scale effects, costs arising from repeated transactions are lower for buying firms when dealing with larger farmers. These two important factors may limit participation of small-scale farmers in emerging high-value markets. Indeed, empirical evidence on inclusion of smallholders is mixed. Buying firms seem to oftentimes prefer contracting larger farmers.

However, in regions where farm sizes are predominantly small, like in Vietnam, procuring processors or wholesalers have to cooperate with smallholders. It has been shown that those small-scale producers participating in high-value markets greatly benefit from a combination of improved access to production technology and input and factor markets as well as more stable income. Hence, an important question is how to better link smallholders to high-value markets, by increasing their attractiveness as partners for buying firms operating in these emerging markets.

With this study we contribute to both the literature on high-value markets and the literature on contract farming. We designed bespoke field experimental approaches to investigate two important aspects of contract farming critical to

tapping yet unused sources of smallholder productivity. On the one hand, looking into the nuts and bolts of contract design we identified financial incentives to effectively induce production of high quality in a smallholder context. On the other hand, we investigated the effect of more transparency in contracts where farmers’

compensation is directly linked to product quality attributes.

The major implications of this study are:

First, we could show that under smallholder conditions financial penalties

prove to be an effective tool to steer production decisions of farmers towards generating high quality output, but also highlighted the risks of purely malus-based incentive systems with respect to long-term effects for selling farmers and buying firms.

Second, if output quality affects farmers’ compensation, transparency with

respect to quality assessment is crucial. Incentives conditioned on output quality are only fully effective if farmers have trust in the system of quality measurement employed by the buyer. We showed that trust towards the buying firm can be raised if an independent third party directly assesses quality or, alternatively, if testing results for value-defining quality attributes can be easily verified by farmers. We have pointed out that as a result of more transparency yet blocked resources of productivity are freed.

Interestingly, we could also demonstrate that under specific circumstances third-party quality assessment or verification not only increases the welfare of farmers but also positively affects the buying firm. If a buying firms plays fair, i.e.

does not exploit the private information on quality to accrue quasi-rents but—due to the supply chain architecture—is unable to signal its type (“fair”) to farmers, third

party enforcement even leads to a Pareto improvement, as the firm would benefit from lower per-unit procurement costs.

Third, as the experiments in this study were carried out in close collaboration

with a private-sector company in a developing country setting, which had not been done previously, we also contributed methodologically to the existing body of experimental approaches in economics by pushing the frontier of field experiments further outwards.