Vertically integrated contract and independent poultry farming system inBangladesh: a profitability analysis

I A Begum

Laboratory of Development Economics, Department of Agricultural Economics,
Graduate School of Agriculture, Hokkaido University, Japan
ishameen@yahoo.com

Abstract

The paper examines the comparative profitability of poultry production in vertically integrated contract and independent farming systems in Bangladesh. Poultry meat is the most widely accepted meat in Bangladesh. The commercial poultry farming system started in 1980 but until now meat deficiency is 89.5%. Vertically integrated contract farming can be one possible solution in this deficiency situation. With effective management, vertically integrated contract farming system can be a means to develop markets and to bring about the transfer of technical skill in a way of increasing productivity that is profitable for both the integrator and farmers. The primary data were collected from 50 sample farms of ABFL, the pioneer vertically integrated farm, Kishorganj and 25 independent sample farms from Gajipur, the poultry region of Bangladesh.

It was revealed in the present study that although the independent farmer was able to take advantage of the increase in the price of broilers in the market, resulting in a higher price per bird as compared with the contract farmers, but the contract farmers were still better off in their net return or profit.

Keywords: Bangladesh, contract, poultry, productivity, profitability.

Introduction

Bangladesh is a country of serious malnutrition where about 48 per cent of the population live below the poverty line (Bangladesh Bureau of Statistics 1998). Protein deficiency has been taken as the major contributory factor in malnutrition. The per capita consumption of animal protein in Bangladesh is only 11.8 g per day (Bangladesh Bureau of Statistics 2001)  whereas the standard requirement of 36 g is recommended by UNO (Ahmed and Islam 1985). The poultry sub-sector is considered an important avenue to reduce poverty and malnutrition as well as unemployment problems of Bangladesh.

Although commercial poultry started in 1980, until now only14% of the meat comes from commercial farming systems (Alam 1995). The major portion of total poultry meat supply comes from traditional farming. Through contractual arrangements, agro-industry can assist farmers in developing countries to shift from subsistence or traditional agriculture to commercial or modern agriculture. Contract farming has recently been introduced in Bangladesh in 1994 by a big Company, named ABFL (Aftab Bahumukhi [multipurpose] Farm Ltd). Although there are a limited number of studies ( Karim and Mainuddin 1983; Ahmed 1985; Huque 1985; Islam and Shahidullah 1989; Ukil and Poul 1992; Bhuiyan 1999; Uddin 1999; Yasmin et al 1989) on production and economic aspects of commercial independent poultry farms the research work on contract farming is not plentiful. So far only a few studies (Chowdhury 2001, Karim 2000) have been done on benefit-cost analysis of contract farming systems. Contracting may raise farm profit by improving the quality of managerial inputs by speeding the transfer of technological information to growers or by facilitating grower's access to credit, thereby permitting the adoption of newer, more efficient technology.

The objectives of the study was to evaluate the comparative per bird profitability of vertically integrated contract and independent poultry farming systems in Bangladesh by analyzing per bird cost and return. This study also finds out whether farm productivity could increase by the contracting system or not.

Methodology of the study

The primary data for vertically integrated contract farming were collected from two sub-districts- Bajitpur and Kuliarchar, located in Kishorganj district, Bangladesh. A sample size of 50 farms was randomly chosen for this study. In order to fairly spread the sample over the entire study population at first a list of all 560 contract-growing farmers was prepared with the help of officials of ABFL to obtain a representative sample and then the farmers were categorized according to their poultry farm sizes as below: 1) Small farmers (average flock size of 1200 birds), 2) Medium farmers (average flock size ranging from 1201 up to 2000 birds), and 3) Large farmers (average flock size of more than 2001 birds). According to this category in the study area among 560 farms 202, 280, and 78 farms were small, medium and large farm respectively. So, in total 50 broiler farms under contract farming system were selected by the ratio of the observation, that's why 18, 25 and 7 were small, medium and large farm respectively. However, this category is operational category. Generally in Bangladesh, large scale farms means those having a total bird population of more than 50,000 to100,000 birds in a farm with 5,000 to 10,000 birds in each flock or batch. So, according to this definition,all of our sample farmers were under small poultry farm category because they raise less than 5000 birds in each batch. Figure 1 indicates the map with the study area.

The investigation period of this study covered one year beginning from December 2001 to November 2002. Data were collected from December 2002 to January 2003.

Nature of vertically integrated contract farming system in Bangladesh

Contract broiler production means agreements between farmers and companies that specify conditions of producing and marketing broilers. The term 'Contract' in broiler production may vary from country to country and the nature of the integrator company. In most of the developed countries contract farming system in broiler production was launched before 1960 but in Bangladesh it was started in 1994 through Aftab Bahumukhi Farms Limited (ABFL). ABFL is one of the leading poultry farm in Bangladesh under the Islam Group Ltd., Dhaka, Bangladesh. It was established in 1991 at Bhagalpur, Bajitpur in the district of Kishoregonj, about 110 km northeast of Dhaka City. ABFL introduced contract growing system of commercial broilers in 1994 as an experimental extension program whereby at first were selected 20 farmers, who had to enter into an agreement (Contract growing) with the ABFL on production and marketing of broiler products.

The agreements between ABFL and the farmer are very simple indeed. According to the agreement ABFL provides the day-old-chicks, feeds, veterinary supplies by kind or credit, and implements the final marketing of the output. ABFL also provides day-to-day technical assistance about chick rearing, feed rationing and disease control through their expert supervisor as service. The contract farmer typically provides the space and facilities (land and housing), equipment, labor (family and/or hired) and daily farm management. Any farmer in the company located area is eligible to enter in the ABFL contract system if and only if they could provide housing, equipment and labor facility. However, the number of birds per batch to be reared and managerial decisions are taken by the farmers. The average duration of the grow-out cycle is roughly 5 to 7 weeks for an average sized broiler (1.5 kg). ABFL buy the mature broiler from the contract farmer by paying a predetermined price per kg of live broiler and then market these broilers through ABFL sales centers in Dhaka. All the credit liability of the contract farmer is adjusted against price of their products. Since contract farmers are compelled to buy the ABFL's day-old-chick and feed, so ABFL has assured its product market by the contract farming system.

Motivating reasons behind entering contract farming

Poultry farming, until recently, was largely a backyard culture venture in Bangladesh. Since commercial poultry farming has an enormous potential for expansion, a great deal of investments have been rushed in this sector during the last few years. As a result, the production of livestock products such as meat and eggs have been increasing but the per capita availability is much below the minimum requirement (Table 1). The contract poultry farming system can alleviate this deficiency problem.

As a developing country where the majority of people are under poverty level, the farmer's decision to enter in a contract may have been motivated by some benefits from contracting. Risk and uncertainty are quite common facts of poultry business. Sometimes broiler prices go so down (which is lower than the production cost) in the wholesale market that many small and medium farms have no other alternative but to close down temporarily. Different constraints as faced by independent farmers have pointed other problems such as lack of capital, inadequate knowledge of poultry rearing, uncontrolled outbreaks of diseases, inadequate availability of inputs, inadequate institutional credit, guaranteed and profitable markets for output. These problems and constraints motivate the independent farmers to enter into the contract farming system.

Profitability of vertically integrated contract and independent poultry farms

Profitability from farmer's point of view

An attempt is made to determine the comparative per bird profit gain from contract and independent broiler farming systems. In this study, cost items consisted of feeds, hired labor, vaccines and medicines, transportation, litter, equipment and machinery, housing, land use costs, interest on operating capital and miscellaneous. On the revenue side, gross return, net return, rate of return were determined and analyzed in this study.

In Bangladesh, credit is the main constraint to most of the farmers. Hence because of poverty they do not have financial access to run a poultry business smoothly. Contract farmers receive advances from the integrated firm for feed, day-old chicks and vaccines and medicines in kind to overcome potential credit constraints. For total costs, expenses were also classified into variable and fixed items. Under variable costs, feeds, day-old chicks and medicine/vaccines were the major expenditures, accounting for 56, 28 and 4 percent, respectively. Variable costs were the major costs (96-98%) of the total cost (Table 2).

The data in Table 2 are indicative of the high operating capital investment required in the broiler business. It is also evident from Table 2 that in case of contract farmers, 100 percent of the average total returns were contributed by the total cash income. This was attributed to their contract with the integrators, under which the latter was to take all the broilers produced. Under this arrangement, however, only those birds meeting the basic live weight were given the premium price. ABFL fixed prices before the contract and farmers got the price on that basis. 

The total value of fixed costs per bird was tk 1.01 while variable costs were tk 52.93. The total costs per farm for contract growing amounted to tk 53.94 resulting in a net return of  tk 17.18 per bird. For the independent grower 98 percent of total cash returns came from the sales of broilers. Home consumed was reported to be tk 0.51 by the sample independent grower where as for contract growers this was zero. On a per bird basis, the total fixed cost of the independent grower was tk 2.83 while it was tk 69.52 for variable costs. In the study period average price received by the independent farmer was 63 tk per kg.  The independent grower incurred tk 72.35 total cost and obtained a net farm return of tk 10.04.

Every poultry house has its maximum bird rearing capacity, but for lack of liquid capital independent farmers sometimes failed to rear the same amount of birds in every batch. Using the bird maximum rearing capacity per batch would have resulted in an average per year of 8239 bird whereas independent farmers actually reared 5037 birds (Table 3).

However, the results imply that contract farming system is substantially more profitable compared to the independent farming system. Per bird net return of the contract farm was more than 1.7 times higher than the net return of the independent farm. Rate of return also indicates that the contract farm is more profitable than the independent farm.

Part of the profit gains from contracting might be explained by the difference in productivity. Productivity as well as inputs for contract and independent farming are presented in Table 4. The table highlights several clear differences between the contract and independent poultry farm.

On average, contract farmers are older than independent farmers. Contract farmers had less formal education and less experience in poultry farming than independent farmers, but these two variables are not statistically significant. The table also indicates that contract producers are on average much more productive than independent producers: they produce much more per unit of feed, labor, and capital, and have higher total factor productivity. The higher productivity of contract farming system may be due to a transfer of "know how" from integrators to growers, which may be particularly important given the relative lack of poultry rearing experience of the contract farmers.

Commercial poultry farming requires highly technical knowledge to run the farm efficiently. The highly technical knowledge refers to knowledge of keeping temperatures in different stages for rearing poultry birds appropriately. Also, the appropriate timing of feeding, lighting and vaccination are important. Also, feed amount of  chicks varies according to growing stage. In many cases farmers are not in touch with modern technology to augment production. Inadequate knowledge about poultry diets are the major problem, most of the independent broiler farm owners reported that they do not have sufficient knowledge about broiler diets. Ratio of feed varies from starter, grower and finisher of broiler production. In case of contract farm, farmers receive assistance and technical advice and information from the company appointed supervisor on a regular basis. This information transfer may involve knowledge about feed mixtures or feed timing that results in higher feed productivity and lower labor costs.

In addition, it is possible that the goods and services provided by the integrator - such as veterinary care and feeds, may be superior to that available to an independent producer, resulting in greater weight gain. Moreover, some of the productivity gains from contracting might be explained by differences in access to capital;  if contract growers are able to obtain more financing because they face less risk then they could more easily adopt newer and more productive capital equipment (such as brooder, generator) than independent growers. For the same investment, contract growers can produce more because they could purchase day old chicks, feed, and vaccine and medicine on credit from the integrator. Table 5 shown that contract growers have more farm equipment such as brooders and chick guard.

Brooder and chick guard provide necessary heat to baby chicks which may increase growth. For the same investment, contract growers can produce more because they could purchase day-old chicks, feeds, vaccines and medicines on credit from the integrator. Therefore, contract farming system has a possibility to increase productivity through the extension service. Such productivity also increases the profit of  the  contract farms.

Furthermore contract farmer's higher profitability could be explained by reducing risk exposure. There are two types of risk in poultry production. One is price risk, another is production risk. In case of price risk, broilers are perishable, if the farmer fail to sell at the proper time, they will face a great loss. So, the biological nature of broilers is the cause of price instability. In the study period independent farmers received price of broiler 56-70 tk per kg, whereas contract farmer got 54 tk per kg. A telling factor was that contract farmers were not much affected by fluctuating prices since the price agreed upon at contract signing was fixed, regardless of market price changes. As a result, grower payment depends upon production outcomes but not price outcomes. So, growers do not bear price risk. Besides that most of the independent respondents stated that sometimes they faced the problem of selling broilers at a time which affects their selling price. In the study area the poultry farms used different channels to sell their broilers (Figure 2).

Production risk mainly happens in broiler farming due to death loss of the birds. Outbreak of disease is causing a considerable economic loss and erosion of confidence in poultry farming. The major poultry diseases that the farmer faced in the study area were (a) Fowl cholera, (b) Gumboro disease, (c) Fowl pox and (d) Newcastle disease. Gumboro and Newcastle diseases affect in epidemic form and large losses can occur. Contract growers were freed from the dreaded pests and diseases or epidemics since the integrator provided technical assistance and insurance. ABFL is the only company in Bangladesh which introduced an internal insurance scheme to cover the risk of loss and safeguard the interest of the contract growing farmers in case of immature death of chicks by diseases and other cogent reasons. According to this scheme, ABFL operates a contributory security fund. Farmers contribute Taka 1.50 per chick to the fund. If the mortality is less than 3 percent, 4-6 percent, 7-10 percent and 11-15 percent then 80, 40, 20, 10 percent of the contribution made by the farmer is refunded, respectively. If the mortality rate is above 15 per cent, then the farmer can claim for insurance money, Taka 20 per bird is paid after deducting 15 percent of the mortality quantity from the total mortality quantity within the period up to 20 days. After 20 days Taka 30 per bird is given to farmers after calculating the benefits of 20 day age as stated earlier. Because of this measure, farmers feel secure and are encouraged to take up this venture.

Profitability from integrator's point of view

Vertically integrated contract farming system will sustain in the long run if both parties (principal and agent) benefit from the contractual system. In the principal - agent game, the principal, in this case the integrated company (ABFL), defines the terms of the contract anticipating how the agent , in this case the contract farmer, will respond to each strategy it proposes. The firm maximizes profits subject to two constraints: that the grower will accept the contract - it must give him greater profits than he can derive from his next best alternative, and that the grower will abide by the terms of the contract. It is already known from the previous section that contract farming is a profitable farming system from the view point of farmers (agent). So now in this section an attempt is made to find out whether integrated firms (principal) are in a profitable situation or not from the contractual agreement.

The profitability of contract farming for a vertically integrated firm will depend to a large extent on the firm's pre-fixed contract price and its contract enforcement costs. The average open market price (yearly average) received by the ABFL was tk 85.05 per kg broiler. In Figure 3 total return of ABFL from broiler sales is shown from 1994 to 2003. It is evident that the integrator's return from broiler contracting is increasing. ABFL invested in cash and kind in advances on credit to the contract farmers in raising broilers.

However, Figure 3 shown the sales value or return, which is not profit or net return. If we want to calculate net return or profit then we have to know the actual cost (such as, marketing expenditure, credit and extension facilities) which is paid by the integrator company.

It is very difficult to find out the net return or profit share of the integrator. In the study period,  ABFL bought the birds from the contract farmers at the rate of taka 52.5 per kg and sold it to the open retail market (ABFL's sales centre) at the rate of taka 85.05 per kg, so, their profit was 85.05 -52.5= 32.5 tk per kg broiler. This, however, was not the net return or profit because according to the agreement ABFL as it stands to-day is to extend a credit facility to the farmer to cover supply of day-old chicks, all vaccines, medicines, feeds along with the supervision of regular basis. So, from the Taka 32.5 per kg ABFL's marketing expenditure in terms of storing, handling, carrying, packaging, plus extending credit and cost for extension facilities to the broiler growers for proving technical support, had to be deducted from this 32.5 Taka per kg. Efforts were made to discern these figures but the local management failed to provide these expenditure data. In 2002, a total of 24 supervisors were employed in ABFL to provide technical assistance to farmers; they had a salary of 2500 taka per month. Besides that, 31 more employees were engaged in broiler contract system in various purposes. Furthermore, those 31 employees were not included only in broiler contract system. ABFL has various projects on livestock, fisheries, layer farming, and the crop sector. Employees who were working in feed-mills or hatcheries, were not only supplying feeds or birds to contract farmers. ABFL also sells feed in the open market nationwide.. Therefore, Taka 32.5 per kg, as the ABFL per bird return from sales, was not considered here as net return or profit.

So, it could be concluded from the above discussion that not only from the farmers (agents) points of view,  broiler contract farming is also profitable from the vertically integrated firm's (principlal) point of view.

The number of contract broiler farms and number of birds raised per month from 1994 to 2002 is shown in Figure 4.

According to Figure 4, it seemed that the people of that locality started taking interest in contract poultry farming because of its profitability. The producers in the contract system attained the highest gross margins as well as net return (profit). The producer clearly favors the vertical integrated contract system as it has the highest gross margins, net return and rate of return of the two systems. The summary results indicate that vertically integrated contract farming is more profitable compared to independent farming.

Conclusions

• Contract farming system is substantially more profitable compared to the independent farming system. Net return of vertically integrated contract farming system  in broiler production was 1.7 times higher compared to the independent farming system.

• The higher profitability that results from contracting may be due to productivity which comes from financial support, technical information exchange and marketing assistance. Moreover, in the contract farming system, price risk and part of production risk due to mortality was shared by the integrator insurance policy. Contract farmers were also assured of more stabilized prices even during period of low demand.

• Well organized vertically integrated poultry farming could be a feasible approach to increase the poultry production in Bangladesh and by following this system various problems of running commercial farms may be solved as well as contract poultry farmers will receive more benefits than independent farmers.

• It could be suggested that for increasing the poultry production and developing poultry industry, government as well as other private integrators could take the initiative to establish such effective and well-organized contract farming systems in Bangladesh.

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