CONTRACT FARMING AS PART OF A MULTI-INSTRUMENT INCLUSIVE BUSINESS STRUCTURE

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CHAPTER 3 INCLUSIVE BUSINESSES IN AGRICULTURE: DEFINING THE CONCEPT AND ITS COMPLEX AND EVOLVING PARTNERSHIP STRUCTURES IN THE FIELD⁶

 INTRODUCTION

Inclusive Businesses (IBs) are seen as an essential tool for raising low-income communities, across the developing world, out of poverty, and for stimulating rural development overall (Rösler et al., 2013; UNDP, 2010; World Bank, 2008). In this study, IBs are considered as encompassing profit-oriented partnerships between agri-businesses and smallholders that aim to integrate the latter equitably and sustainably into commercial value chains. Depending on the particular IB model being analysed, “smallholder” is used as a broad term, incorporating active small-scale farmers, small landowners and owners of land-related assets, and shareholding farmworkers, either as individual or grouped in a collective.
The inclusion of these smallholders is being considered necessary, particularly in an increasingly vertically integrated and concentrated agricultural supply chain (Reardon et al., 2009). Insights into the structure of IB partnerships in primary agriculture remain limited. Factual and analytical understanding continues to lean on rigid traditional models (McIndoe-Calder, 2012; Vermeulen and Cotula, 2010), despite calls for innovative organisational structures to be instituted to manage the relationship between non-traditional partners such as agri-businesses and smallholders (Halme et al., 2012; Schuster and Holtbrügge, 2014), and the existence of case-studies highlighting the heterogeneity of the governance structures between these partners (de Koning and de Steenhuijsen Piters, 2009; Romano and Liversage, 2010; Sopov et al., 2014). For example, in their analysis of IB models, Sopov et al. (2014) restrict themselves to the typology of contract farming proposed by Eaton and Shepherd (2001). Another study by USAID (2014) introduced models that incorporate smallholders as producers or customers, based on the challenge that the IB addresses. Each of these typologies is unable to capture the unique structure of each individual IB. The authors themselves acknowledge the shortcomings of their typologies, stating that “real-world investment projects may involve complex combinations of various models” (Vermeulen and Cotula, 2010, p.4) and that “models are not static, but rather, dynamic” (USAID, 2014, p.23).
The multitude of business structures not only requires a consideration to be given to how to define these set-ups, it also raises the questions as to why each IB combines various instruments in its own specific way.
This chapter addresses these two lacunas identified by proposing a new, flexible typology for the institutional set-ups of IBs, and – in order to do so – applying a theoretical framework to explain these institutional structures. Although valuable insights stem from, among others, transaction cost economics and agency theory (Bijman, 2008; Ollila, 2009; Ortmann & King, 2007; Valentinov, 2007), the chapter’s first objective is to apply a holistic theoretical framework, presented in Chapter 2, to explain the composite nature of the complex structures observed. This allows for conceptual insights to apprehend IBs as complex and unique governance structures and tools for smallholder integration into commercial value chains. The second objective of this chapter is thus to assess the how and why of this integration through these complex structures.
This study applies the concept of instruments as building blocks to accommodate the heterogeneity and complexity of governance structures into a typology. It identifies common instruments that are combined to form unique hybrid organisations: collective organisation, equity, lease/management contracts, mentorship, and supply contracts. Each of these building blocks, or instruments, has its own way of integrating smallholders or low-income communities into the commercial value chain, and thus transferring a share of the IB’s value-addition to these beneficiaries. An IB in this context is thus considered as the relationship between (a group of) smallholder(s)/low-income community and an agribusiness as defined by the combination of instruments that is implemented.
Regarding the theoretical understanding of an IB governance structure, this study applies the multiple-lens theoretical approach detailed in the previous chapter. This approach uses aspects of Resource Dependency Theory, Transaction Costs Economics, and Agency Theory, thus incorporating both ex-ante and ex-post reasoning. By applying a holistic approach in a broader scope of IBs, this study allows for insight to be gained into how the greatly varying, complex and unique organisational constructions develop, who drives the decisions that lead to the implementation of the particular structures, and what motivates these decisions.
Research for this chapter was done in South Africa where collaboration between agribusiness and smallholders is especially relevant. The country is characterised by a highly dichotomous agricultural sector. A policy framework, centred on land redistribution specifically, and wider sector transformation in general, has been implemented to transform the agricultural sector to become more equal, with greater participation by the previously excluded black population (Cochet et al., 2015). IBs are seen as being a critical component for bringing about the required transformation (DAFF, 2013). This combination of a dualistic sector and an inclusiveness-driven policy context renders the case of South African agriculture as pertinent for research into IB partnership structures.
Findings in this chapter are based on 14 case studies that encapsulate the diversity of the South African agricultural sector. These cases studies bring to the fore the heterogeneity of the governance structures used to integrate smallholders into commercial value chains. The selected cases are all operational in primary agricultural production and include active smallholders, rural community members not active in farming activities, and farm workers engaged beyond an employment contract (Table 1.2, p. 25). These are collectively referred to as beneficiaries throughout this chapter.
Section 3.2 summarises the conceptual framework as posited in Chapter 1, comprising an overview of the instruments identified as building blocks, and the theoretical framework applied to the explanation of the combinations of these instruments. Considering the importance of the context on the IBs, section 3.3 outlines the policy framework in which the cases operate, before providing a short introduction to the individual case studies that form the basis of this study. The results are presented in section 3.4 – describing in detail IBs as complex combinations of instruments. The following discussion in section 3.5 re-contextualises these results in the view of the inclusiveness and dynamic nature of the IBs upon implementation. The chapter concludes by questioning IBs as a tool for development, within today’s development trajectories in section 3.6.

CONCEPTUALISING IB STRUCTURES FROM AN ORGANISATIONAL PERSPECTIVE

Publications in the field of IBs in the agricultural sector have identified several ‘models’ to describe how smallholders and low-income communities (beneficiaries) are included in commercial value chains. This conceptualisation according to ‘models’ proves inefficient for dealing with both the complex governance structures observed in the field, and the changes in these structures within IBs occurring over time. Equally insufficient is the continuum of coordination mechanisms, ranging from free market transaction to vertical integration (Peterson, Wysocki, & Harsh, 2001). For example, in this continuum, contracts and equity are considered as different options for vertical coordination, whereas in reality, these options are combined within one IB. Analysis of IB cases revealed five instruments that link smallholders and low-income communities with commercial agricultural value chains, namely: supply contracts (da Silva & Ranking, 2013; Prowse, 2012; Sopov et al., 2014), collective organisation (Latynskiy & Berger, 2016; Markelova et al., 2009), equity (de Koning & de Steenhuijsen Piters, 2009), lease/management contracts (Vermeulen & Cotula, 2010) and mentorship (Terblanché, 2011) (Table 1.1, p. 17). Rather than considering these instruments as ‘models’, this study considers them as building blocks that are combined to form unique, evolving business structures. This approach avoids the use of a rigid typology of IB structures which is too static to capture the dynamics and complexity of organisational structures implemented by IBs. Using the concept of instruments as building blocks also allows for the concurrent implementation of different strategic control options identified in the vertical continuum thinking (Peterson et al., 2001).
Inter-organisational structures and the relationships between business partners comprise the subject of analysis of disciplines that fall under the umbrella of organisational theory (Dekker, 2004; Smith et al., 1995). The objective of an IB is two-fold, namely economic and social. In the case of entities active in primary agricultural production the social aspect lies in the equal-based inclusion of smallholders/low-income communities. It is imperative that both these facets of organisational theory are included in the rationalisation of the governance structures (Ulrich & Barney, 1984). Furthermore, IBs tend to be characterised by a high degree of power imbalance, with the commercial partner being the better-endowed actor. Lastly, the inter-organisational relationship between the IB partners changes over time (Guidi, 2011; Ménard, 2004). This is partly due to the limited time span of several instruments, but equally important is the dynamic nature of dependencies and power relationships and changes in the broader context in which the IBs operate (Mainville & Peterson, 2006). These facets motivate adjustments of the IB structure. A holistic theoretical framework is required to address these complexities of IBs and the context in which they operate (Figure 1.1, p. 15). This allows for a holistic theoretical approach that explains the unique and complex, hybrid (Ménard, 2004; Williamson, 1991) organisational structures observed in IBs.
This study applies an inductive process to build a new conceptual framework from case study material. Firstly, the analysis of the organisational set-ups identified the instruments as building blocks (Table 1.1, p. 17). Secondly, individual, existing theories were found to be insufficient to rationalise the complex and unique structures observed in the field. Whereas some aspects of such theories were applicable, they proved insufficient to deal with the observed realities. In Chapter 2, a new theoretical construct was built inductively by identifying these elements and recognising patterns. This chapter applies this construct to all case studies to form an overall conceptual framework that motivates the multi-instrument structures observed in the field. As such, there is a reciprocal relationship between theory building and the empirical evidence.
The three theories are linked by common aspects, specifically the role of power imbalance and uncertainty (Chapter 2). Both these elements are particularly relevant to hybrid organisations in general (Ménard, 2004), and to IBs specifically, where uncertainty is exacerbated by partners who are unaccustomed to each other and where power relationships tend to be significantly skewed (Trienekens & Willems, 2007). It is these aspects, combined with the social objective of IBs, which make these organisational structures different from the more mainstream inter-firm partnerships. Although it falls outside the scope of this study to delve deeper into the common aspects of, and the differences between, the three individual theories, a discussion of them separately, but as interlinked, allows a better understanding to be gained of how they contribute to the assessment of IBs.
The starting point of the theoretical framework is RDT, which looks at the external dependencies of an actor. RDT argues that higher levels of dependency result in more integrated forms of partnership, especially if the dependency creates a high level of uncertainty (Pfeffer & Salancik, 1978). IBs are inherently uncertain in their dependency, as the commercial partner and the smallholders/low-income community are unaccustomed to each other (Schuster & Holtbrügge, 2014). Since the agribusiness is likely to be the dominant partner due to its larger ability for financial contribution, and its more developed skills and networks, dependency characteristics that initially shape the IB structure originate foremost from the firm’s dependency on the farm, not vice versa. However, to offer an attractive proposition to the smallholder/low-income community, the IB must incorporate elements that allow the beneficiaries to deal with their dependency challenges. This refers to the element of interdependency, acknowledging the fact that both partners depend on each other. A relevant extension to RDT has been provided by Casciaro and Piskorski (2005), who theorise that higher levels of mutual dependence will lead to an increase in vertical coordination, whereas a higher level of power imbalance reduces the likelihood of vertical integration. Considering the often more powerful position of the agribusiness, I posit that the firm’s dependency is the likely driver behind the IB initiation, and subsequently that the higher the firm’s dependency on the resources owned by the smallholder is, the more likely the agribusiness is to invest and co-opt with the smallholder in this partnership, if this reduces the level of uncertainty related to their interaction. As such, the theoretical framework aligns with the netchain concept, which combines vertical supply chains with more horizontally oriented networks, adding an extra dimension to inter-organisational coordination. According to this concept, the particular type of dependency impacts on the coordination mechanism between partners in the same netchain. The expectation is that pooled dependency, where actors make a discrete contribution to a task, leads to standardisation in market-like transactions. Sequential dependency, in which actors within a netchain depend on preceding actions from another actor, stimulates managerial discretion. Reciprocal dependency refers to a situation where netchain actors simultaneously depend on each other, and advances mutual adjustment (Lazzarini, Chaddad, & Cook, 2001). It is, however, important to note that organisational strategies in RDT are driven by power, rather than performance indicators such as profit or efficiency (Pfeffer & Salancik, 1978). Furthermore, RDT considers the ex-ante situation that explores where some form of resource internalisation is likely. These aspects set RDT apart from TCE and AT. Dependencies within an IB in primary agricultural production centre on land, quality and quantity of produce, financing, access to input and output markets, expertise, and infrastructural assets, which each can be managed by the identified instruments.
Once a partnership has been identified, TCE focuses (among other things) on the asset specificity of investments embedded in the hybrid organisation (Williamson, 2002). It argues that safeguards in the contract serve to protect the partner who has made relationship-specific investments. Investments in IBs are inherently skewed towards the commercial partner who has larger financial means than the beneficiaries. Thus, it is expected that safeguard instruments serve the interests of the commercial partner and not necessarily those of the beneficiaries. A second important aspect is that the partners aim to reduce the costs related to their transactions (Williamson, 1979). These include costs such as those incurred in finding a transactional partner and establishing and monitoring of a contract (Hobbs, 1996). According to TCE, a more hierarchal structure of the hybrid organisation suits situations of high uncertainty around the transaction, considerable asset specificity, and a high frequency of transaction (Ménard, 2004; Williamson, 1979). These concepts consider vertical integration as a necessary means to overcome opportunistic behaviour, often detrimental to the less powerful partner. The concept of complementarity instead highlights the point that increased vertical integration can instead benefit both partners (Mainville & Peterson, 2006).
Finally, AT analyses the relationship between a principal and agent within a contractual arrangement. It argues that an agent will shirk in its behaviour towards the principal, resulting in risks for the principal in the form of adverse selection and moral hazard (Holmström, 1979). The contract aims to minimise this risk, through incentivising the agent, and by aligning the agent’s goals with those of the principal (Eisenhardt, 1989a). To ensure a positive outcome, the principal can incorporate monitoring and observation systems for agency behaviour, but these come at a cost, which the principal will aim to minimise (Shapiro, 2005). Aspects of outcome uncertainty are particularly relevant for IBs where non-traditional partners work together. Thus, further instruments could be incorporated into the IB’s structure to deal with this challenge.
This holistic theoretical framework, combined with the standard instruments, is applied to unique case studies to explain the complex institutional set-up of an IB. Not only does the implementation of an individual instrument differ per IB, the combination of instruments also varies, both at implementation and over time (Mainville & Peterson, 2006). For example, smallholders can have equity in the IB, but this might range from a small minority to a majority share. It is the multi-layered argumentation that underlies the adaptable combination of the standard instruments, as alluded to by previous authors (Sopov et al., 2014; Vermeulen Cotula, 2010), and that creates unique business structures which allow these “strange bedfellows” (W. Vellema, 2015) to enter into business relationships.

DECLARATION 
DEDICATION 
ACKNOWLEDGEMENTS
ABSTRACT
LIST OF TABLES
LIST OF FIGURES
ACRONYMS
CHAPTER 1 INTRODUCTION
1.1 Introduction
1.2 Background to the problem: IBs in agriculture as driver of development
1.2.1 Inclusive businesses – Innovative partnerships to stimulate economic development
1.2.2 Agriculture – How to stimulate its development?
1.2.3 Inclusive businesses in agriculture – a new paradigm? .
1.3 Statement of the problem
1.4 Research question
1.5 Conceptual framework
1.6 Methodology
1.6.1 Scope of field of study
1.6.2 Research strategy – A case-study approach
1.6.3 Case study selection
1.6.4 Phase I – The institutional set-up
1.6.5 Phase II – Inclusiveness measurement
1.7 Value-addition and additional research options
1.8 Outline
CHAPTER 2 CONTRACT FARMING AS PART OF A MULTI-INSTRUMENT INCLUSIVE BUSINESS STRUCTURE: A THEORETICAL ANALYSIS 
2.1 Introduction
2.2 Contract farming as part of complex inclusive businesses
2.3 Theoretical framework
2.4 Case description
2.5 Rationalising the organisational structure
2.6 Conclusion
CHAPTER 3 INCLUSIVE BUSINESSES IN AGRICULTURE: DEFINING THE CONCEPT AND ITS COMPLEX AND EVOLVING PARTNERSHIP STRUCTURES IN THE FIELD 
3.1 Introduction
3.2 Conceptualising IB structures from an organisational perspective
3.3 Socio-political context as driver of IBs .
3.4 Complex and unique arrangements of standard instruments
3.5 Do IBs foster inclusiveness or drive corporate control in an unequal society?
3.6 Conclusion
CHAPTER 4 INCLUSIVENESS REVISITED: ASSESSING INCLUSIVE BUSINESSES IN SOUTH AFRICAN AGRICULTURE 
4.1 Introduction
4.2 Methodology.
4.3 Results
4.4 Discussion
4.5 Conclusion
CHAPTER 5 INCLUSIVE BUSINESSES AND LAND REFORM: CORPORATISATION OR TRANSFORMATION? 
5.1 Introduction
5.2 From theoretical framework to concrete set-up – IBs as complex organisational
structures
5.3 Land reform policies as a driver of IBs
5.4 Varying results at IB project level
5.5 Results to be nuanced at smallholder and beneficiary level
5.6 IBs and their limitations for transformation
5.7 Recommendations – towards more sustainable and equitable Inclusive Businesses .
5.8 Conclusions: IB as a new paradigm for development and structural transformation?
CHAPTER 6 CONCLUSION: INCLUSIVE BUSINESSES – POTENTIAL WITH PITFALLS 
6.1 Introduction
6.2 Framing IBs in the South African context .
6.3 A renewed conceptual framework – Inclusive businesses as composite organisational structures
6.4 Inclusiveness assessed
6.5 IBs as tool for transformation and development, in South Africa and beyond
6.6 Recommendations – conditions for IBs to become (more effective) tools for development
6.7 Future research
CHAPTER 7 REFERENES 
APPENDIX
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