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7 Importance of VCF

White and Gorton (2004), Dries et al. (2009), and Swinnen (2006) find that the introduction of VCF programs by agribusiness companies is a common phenomenon across transition countries.

Also in Latin America, VCF through credit and input provision in contractfarming schemes is widespread over many different agricultural sectors such as fruits and vegetables sector, poultry, tobacco, sugarcane, barley, and rice (Dirven, 1996). Similarly, at least in some value chains in India, VCF is quite common. Gulati et al. (2007) point out, with evidence from several South and Southeast Asian countries and from several sectors that smallholder and poor farmers participate in and benefit from contract-farming schemes and VCF systems in food supply chains in Asia. In Sub-Saharan Africa (SSA), private VCF has become a dominant system of rural financing. For example, in Mozambique and Zambia it is virtually the only source of finance for agricultural households (IFAD, 2003). It is estimated that for SSA as a whole, 50 percent of rural households that access credit do so from wholesalers, retailers, and processors in the form of VCF. (DFID, 2004). According to IFAD (2003), the VCF in Sub-Sahara Africa is mostly direct VCF in the form of seasonal credit and input provision in contract-farming schemes; and is most com-

mon in traditional, tropical export sectors (coffee, tea, cocoa, rubber, oil palm) and in high-value, non-traditional export sectors (horticulture)[1].

In summary, in many countries and sectors VCF is becoming more important than pure credit transactions in traditional commercial and informal lending. Maertens et al. (2007) have analyzed the importance of VCF for smallholder horticulture households in Senegal and find that farmers who contract with exporting companies receive on average about 300,000 FCFA seasonal credit from the companies, mostly in the form of inputs, while on average farm-households can access only about 130,000 FCFA of credit a year from other formal and informal sources.

8 Impact of VCF on Productivity, Quality and Output

Empirically, the impact of private VCF systems on productivity is difficult to quantify as several other factors affect output simultaneously and as companylevel information is difficult to obtain. Still, whatever evidence is available suggests that successful private VCF has important positive effects, both direct and indirect.

Case studies indicate that private VCF programs can lead to strong growth in output, quality, and productivity. For example, case studies of the sugar and dairy sectors in Eastern Europe show how VCF caused output, yields, and investments to grow dramatically (Gow et al., 2000; Swinnen, 2006). In the case of Polish dairy farms, VCF induced an increase in farm investments (in particular cooling tanks and better cows) in the mid-1990s. As a result the market share of the highest quality milk increased from less than 30 percent on average in 1996 to around 80 percent on average in 2001 (Dries and Swinnen, 2004).

VCF has indirect spill-over effects as households' overall access to capital increases and their risk reduces. VCF also implies guaranteed sales, often at guaranteed prices, which reduces marketing risk for farmers. Coordinating firms also share in the production risk of farmers through ex-ante provision of inputs and credit. Moreover, credit arrangements and prompt cash payments after harvest in VCF programs improves farmer's cash flow and access to capital, with spillover effects on other household activities, including other crops. Reduced risks, improved income stability, and access to capital are particularly important effects in the case of capital and insurance market imperfections.

A number of empirical studies provide evidence for these household spillover effects. Henson (2004) shows that contracted vegetable farmers in Uganda benefit from reduced risk and improved access to credit. Another illustrative example comes from Minten et al. (2009) on the vegetable sector in Madagascar. A large number of very small farms benefit from vegetable contract farming through more stable incomes, shorter periods without revenue, and technology and productivity spillovers on rice. Studies examining the motivations of farmers to engage in contract-production with VCF show that access to inputs, credit, and guaranteed sales prices, are the most important motivations, not direct income effects (see table 2).

If the processing firm can set the terms of the VCF contract such that it captures the rents, the productivity growth may not benefit the farms (Bardhan, 1989); and interlinking may even bestow additional monopoly power upon the processing company, which may exploit unequal power relationships with farmers to extract rents from the chain. While empirical evidence on this issue is limited, and very few studies have actually tried to measure this, what is available suggests that farmers do share importantly in the benefits of VCF. For example, studies on the horticultural export sector in Africa (Madagascar by Minten et al. (2009), and in Senegal by Maertens and Swinnen (2009), and Maertens et al. (2011)) find that there are strong poverty reduction effects from vertical coordination and VCF in high-value supply chains.

  • [1] For example, in Mozambique 270,000 and 100,000 smallholders respectively receive input credit from cotton and tobacco companies in contract-farming systems (IFAD, 2003).
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