CONTRACT FARMING HAS LIMITED USE THUS FAR FOR ORGANIZED

UNCLAS SECTION 01 OF 05 NEW DELHI 000314 SIPDIS SENSITIVE SIPDIS USDA PASS FAS/OCRA/HIGGISTON STATE FOR SCA/INS JASHWORTH AND SCA/RA MURENA DEPT PASS TO USTR - CLILIENFELD/AADLER DEPT PASS TO TREASURY FOR OFFICE OF SOUTH ASIA - ABAUKOL USDOC FOR 4530/ITA/MAC/OSA/LDROKER/ASTERN TREASURY PASS TO FRB SAN FRANCISCO/TERESA CURRAN E.O. 12958: N/A TAGS: BTIO EAGR ECON EINV IN ETRD EFIN PREL SUBJECT: CONTRACT FARMING HAS LIMITED USE THUS FAR FOR ORGANIZED RETAIL, BUT APPEALS TO FARMERS REF: A) 08 NEW DELHI 95 B) 08 MUMBAI 19 NEW DELHI 00000314 001.2 OF 005 ¶1. (SBU) SUMMARY: Contract farming offers farmers a stable and profitable way to sell to agro-businesses, and is gaining popularity as a means of cutting out middlemen in the agricultural supply chain. A number of companies are successfully sourcing agricultural products directly from farmers for their needs and are looking to expand the goods procured through this process. Contract farming relies fundamentally on a long-term relationship with farmers, an established presence in the agri-business, and large investments by the company at the start of the venture with little help from the agricultural community. Although it forces companies to initially undertake a large amount of risk, this type of arrangement can also offer stable quantities and eventually create a mutually beneficial relationship between companies and farmers, which can then ultimately benefit the Indian consumer. Still, its applicability to organized retail and to smaller farmers is limited, and expanding the scope of this model may require more state involvement, at a time when agricultural is politically controversial. ¶2. (SBU) This cable is part of a series that will address the potential impact of organized retail on the agricultural sector. Although the front end of the "retail revolution" has attracted considerable attention through new stores and shopping formats, these cables will focus on the back end of the supply chain and examine a few of the business models being used by the private sector to engage India's farmers. END SUMMARY. BACKGROUND -------------- ¶3. (SBU) Contract farming is a system of sourcing that links suppliers to buyers through forward contracts. At the core of such an arrangement is the commitment of the seller to provide a certain quantity and type of commodity to the buyer at a specified time. The buyer in turn guarantees the supplier a fixed price for the produce. Contract farming has been used in India for hundreds of years, largely for commodities such as cotton and tobacco. The Agricultural Produce and Marketing Committee (APMC) Acts, state laws passed in the 1960s and 1970s, prohibited companies from contracting directly with farmers for farm produce, but since 2003, several states have amended these acts to allow companies to directly procure goods from farmers through either spot purchases or contract farming. The advantage of this model is that companies can easily procure goods and farmers have an alternative to selling at the mandis (market yards),at which they are charged large commissions by traders and earn a fraction of the ultimate retail price of their produce. ¶4. (SBU) The legislative changes - along with the increased use of branded products and the rise in organized retail driven by growing consumer demand - has prompted some companies such as Indian Tobacco Corporation (ITC) to attempt contracts in fresh fruits and vegetables. However, the proposition is risky because these contracts are still not legally enforceable in India; therefore, either side can choose not to honor the contract (which is usually verbal or informal). If the market price of the contracted commodity falls, the company could choose to procure the goods at the local mandi instead of paying the farmer a higher, pre-agreed price. If the price of the commodity rises, the farmer has an incentive to break the contract and sell at a higher price at the mandis. ¶5. (SBU) In order to mitigate the risks of contract default, successful companies have been using local partnerships and a long-term presence to assure needed quantities. PepsiCo started contract farming in 1989 with tomatoes - originally as part of a corporate social responsibility project - and McDonald's began entering into informal contracts in 1996 to supply its Indian stores. Recent studies point to contract farming as a means to improve farmer income. MCDONALD'S EXPANDING CONTRACTING OPPORTUNITIES NEW DELHI 00000314 002.2 OF 005 -------------- ¶6. (SBU) Congenoffs met on January 15 with Mr. Abhijit Upadhyaye, McDonald's Mumbai-based director of supply chain and menu management. McDonald's first store opened in 1996, he stated, and the company has since expanded to 140 total stores across India. However, he highlighted that the company arrived in India as early as 1990 to identify suppliers, create joint ventures, and contract with companies for logistics and cold chain help to establish an efficient and dedicated supply system. Upadhyaye explained that McDonald's uses "handshake" contracts with its suppliers, which means that no written guarantees are provided, but a supplier that breaks a contract loses McDonald's business completely - a large enough threat to any local supplier because of McDonald's sheer size, which keeps contracts largely intact. The supplier, he stated, has to work with the farmers to get needed produce, and until recently, had to procure these goods from the mandis. (Note: McDonald's works through a Canadian company, McCain, to procure its produce. McCain is ultimately responsible for filling the contract, either locally or through imports. End note.) ¶7. (SBU) Upadhyaye noted that McDonald's was now contracting with farmers, largely in Gujarat and Madhya Pradesh, for two products - iceberg lettuce and potatoes. He explained that McDonald's gives specifications on quality and size to the farmers, while an expert agricultural team provides them with extension services such as technology and training in good farming techniques. According to Upadhyaye, the company is also working to provide its farmers with access to credit through McDonald's or partner banking institutions. Through these services, he stated that farmers were improving their yields by up to 40 percent and developing higher quality products that fetch higher contracted prices from the company. However, he said that McDonald's uses primarily large landholders - farmers with 100 to 200 acres - for its contracts. Upadhyaye mentioned that the company still uses the mandis for crops such as tomatoes and onions, although it is planning to develop direct contracts for tomatoes in the near future. He further noted that other fresh produce used in McDonald's India offerings, such as peas and carrots, are too low in volume to be worth contract farming. McDonald's does not own cold chain infrastructure and does not plan to develop it, he added. ¶8. (SBU) Upadhyaye emphasized that the contracts were based largely on mutual trust between the producers and buyers, and took a long time to develop. He noted McDonald's commitment to on-time payments, technology transfers, and ability to reward reliable suppliers with new business. In return, he stated that McDonald's expects all suppliers to deliver assured quantities, quality produce, and competitive prices. He believes that this fair exchange makes both sides equally dependent and forms a lasting and stable business relationship. PEPSICO LEVERAGING GOVERNMENT, LOCAL INVOLVEMENT -------------- ¶9. (SBU) ECONOFFS also met with PepsiCo officials in New Delhi, who discussed the company's foray into contract farming in tomatoes as early as 1989. Sunil Duggal and Pawan Sharma, the director and general manager of corporate affairs, respectively, explained PepsiCo's early entry into such farming was part of a deal with the Indian government for the opportunity to sell their soft drinks in the country. The company opened a tomato-processing plant in Punjab, which sourced local produce for the manufacture and export of tomato paste and purees. Duggal relayed that the Punjab government was looking to diversify its farmers' output because paddy crops were badly stripping the soil and water levels in the state, and therefore partnered with PepsiCo on this venture. Local bodies such as the Punjab Agricultural University and Punjab Agro-Industries Corporation advised and provided extension services to Punjab's farmers for PepsiCo's needs, including inputs such as seeds, delivery of agricultural best practices, and regular crop inspections. Duggal praised their local knowledge, which he said helped the company's farmers vastly improve yields and quality. NEW DELHI 00000314 003.2 OF 005 ¶10. (SBU) Duggal noted that the company contracts with several hundred farmers, both large and small. He admitted that contract default is a risk in certain crops when mandi prices are higher, but the company can offer to match the market price of some contracted goods, which can be a high cost but assures quantity. He explained that Pepsi does not renege on its contracts, offers the farmer stability, provides regular advice and feedback on the produce, and can offer financial help when needed - all of which help sustain the long-term relationship and avoid default. He said the company rejects less than 10 percent of produce because of failure to meet PepsiCo's specifications, and in those cases will turn to the mandis to make up the quantity needed. ¶11. (SBU) Duggal and Sharma on January 23 took ECONOFFs on a tour of a PepsiCo-operated farm in Jalandhar, Punjab for citrus fruit, one of the company's newer contracting ventures that was started in 2004, using citrus trees imported from Florida and California. The 25-acre nursery is owned by two farmers, but leased to the Punjab government through the Council for Citrus and Agri-Juicing in Punjab. Its representative, senior manager Baldeep Bajwa, explained that the area was operated by PepsiCo through a USD 5 million investment. Including nearby facilities, Duggal stated that PepsiCo contracts about 65 total acres of land for citrus, another 20 to 25 acres for direct growing of vegetables, and 10 additional acres to explore experimental practices for growing basmati rice. ¶12. (SBU) Dr. Susheel Sankhyan, Pepsi's general manager at the nursery, showed EMBOFFS the greenhouse plants, buds, and trees that PepsiCo is nurturing at the farm, using modern agricultural practices. The nursery's five greenhouses can produce a total of 4 million viable citrus trees per year. Sankhyan explained that because the orange is relatively new to India and a full orange tree takes six years to develop, the company grows the trees for 18 to 24 months and then turns them over to farmers to plant, nurture, and harvest the fruits. Sankhyan explained that farmers sign 12-year contracts (allowed by the Punjab government),in which they collect rent for the first six years, and receive both rent and 50 percent of the revenues of the citrus sales for the second six years. (Note: Duggal stated that the orange juice business is growing at about 30 percent per annum. End note.) ¶13. (SBU) Bajwa noted that while farmers seem happy with the arrangement now, it was difficult to initially persuade them to plant the citrus trees. He said that they generally intercrop (plant complimentary crops on the same land) for the first six years while the land is undeB lease so as to have supplemental income, but also to hedge against the risk of the company reneging on a contract. Bajwa also spoke of new employment opportunities for farmers in the area because of these new crops - farmers in Punjab were routinely leaving the area and leasing their land to other farmers, which reduced the overall number of employed landless laborers. Now, he stated, nurseries like this employed at least 75 people and could offer new opportunities if demand grows. In addition, the citrus crops use only a tenth of the water required for intensive and damaging crops such as rice, which will help stem the water depletion in Punjab's soil and sustain agriculture in the long-term. New techniques offered by PepsiCo and the government on farming are also applied to other crops to improve yield, Bajwa added. ¶14. (SBU) EMBOFFS then visited PepsiCo's nearby juicing plant, not far from the nursery. (Note: The short supply chain means that PepsiCo does not require cold chain infrastructure from the farm to the plant, though it does have cold storage at the plant for its concentrate. End note.) The multi-product plant opened in May 2007 but only operates when certain fruits are in season. Ashok Kumar, vice president of manufacturing for a food processing firm working with PepsiCo as a consultant, highlighted that PepsiCo used to import its oranges from Brazil and Mexico, but is now able to meet its demand locally because of its new contracting arrangements. SMALLER NICHE PLAYERS ALSO BENEFIT FROM CONTRACT FARMING -------------- NEW DELHI 00000314 004.2 OF 005 ¶15. (SBU) Congenoffs in Mumbai also met on January 10 with members of the Maharashtra Export Development Commission (MEDC),a small think tank that advises the Maharashtra government on a variety of economic policies, including agriculture. Mr. Kagliwal, the chairman of the MEDC and president of Nath Seeds, a Maharashtra-based oilseed company, asserted that organized retail, and especially contract farming, were "the best thing to happen to the Indian farmer." He said that farmers have four primary needs at the moment - credit, technology, an assured buyer, and a remunerative price. Contract farming, he stated, meets all of these needs; moreover, farmers can increase their quantity without deflating the price received at the mandi. Although the business model has higher risks and higher investment needs, it promises higher rewards to both sides, he noted. ¶16. (SBU) In a separate meeting on January 16, Mr. Kapadia, the managing director of Jayant Oilseeds, a Mumbai-based member of the MEDC, further praised contract farming's abilities to help both the company and farmer. Kapadia explained that the company, which began operating in 1952 and now is a large producer of castor oil seeds, uses contract farming to work with small and marginal farmers, 80 percent of whom own less than an acre of land. Kapadia claimed that the company now works with over 7,000 farmers. The company currently cultivates 20,000 acres but plans to quintuple this figure by next year, and reach over 500,000 acres in three years. ¶17. (SBU) Kapadia highlighted the ease of contract farming for oilseed, which is a technically advanced niche product. Although as a hybrid seed it requires much research and development on the company's part, farmers can use it as a profitable intercrop that requires almost no maintenance. The company, he added, gives the farmers technical knowledge, equipment, and the seeds and verbally guarantees to buy the produce. Because the crop is specialized and no other buyers exist in their market at the moment, the company's default risk is low; similarly, the farmer has no alternate buyer and so is likely to sell as promised. ¶18. (SBU) According to Kapadia, the company has seen the positive impact on farmers first hand. He cited farmers' incomes as having improved 25 to 30 percent from working with the company, and relayed stories of farmers who want to abandon the intercrop method and convert fully to oilseeds. He noted that the state of Maharashtra, which was looking for an alternate crop for its poor and debt-ridden sugarcane and cotton farmers, approached the company to develop new opportunities. Kapadia also highlighted expansion plans in Gujarat and Rajasthan, and praised the latter as being run by a forward-leaning and progressive state government. He related that initially farmers still need to be convinced of the profitability and ease of the crop, but the company's partnerships with state governments and local NGOs make market entry more efficient and logistically easier. COMMENT -------------- ¶19. (SBU) Contract farming is a clear success for agri-businesses and farmers in distinct and specific cases. The common themes for success of the three companies that we approached which have utilized contract farming appear to be a close link with state governments and local institutions, a long-term presence and reputation in local markets, and a willingness to take larger risks and make larger investments in the nascent stages - which in turn offer farmers stability, better incomes, and, ultimately, greater choice and employment opportunities. Contract farming offers farmers a chance to move beyond subsistence farming and break the debt cycle, though it appears that most of the beneficiaries remain large and wealthier farmers. ¶20. (SBU) However, contract farming is not being employed much by organized retailers and likely will not be in the near-term. Although ITC has begun using contracts for "exotic" crops such as celery, most of the retail players we spoke with do not believe they can either procure the volumes needed in a cost effective way - having to rely on too many transactions and individual farmers - or that farmers will actually honor their contracts, in which case the NEW DELHI 00000314 005.2 OF 005 company will have to take a hit. The trust deficit between farmers and companies appears to run both ways, as farmers also seem reluctant to trust a single buyer and convert their farmland into a commodity that may not sell. ¶21. (SBU) The political environment in different states influence the development of contract farming. Should state governments get more involved, however, the potential for contract farming in agricultural produce - as an alternative to selling at mandis - could become more viable and expand beyond its narrow scope. Amending APMC acts so that direct contracts between farmers and companies is possible is a good first step, but stronger state government-led extension services and links to agri-businesses may help reduce the trust deficit that is sidelining the emergence of the direct farmer-corporate relationships. Legal enforcement of contracts will remain difficult in agriculture given its political sensitivity, so local institutions may need to help foster these relationships. If the situation in Punjab before and after contract farming arrived is any indication, contract farming offers farmers substantial opportunities for cashing in on the agricultural retail boom. MULFORD