The “core- satellite” model links the processors with small farmers through the contract farming, exchanging agricultural inputs and services for assured deliveries of produce to agro-processing complexes. A processing facility, constituting the “corporate core”, associated with a “ satellite” farming system, linked through production contracts can help producers acquire a market for their output as well agricultural support services, permitting technology transfer, specialization and increasing productivity.

The system has long been practiced in developed countries, where it accounts for about 15 percent of agricultural output. Its use in developing countries is also significant and increasing. Both domestic firms and transnational corporations use this system. There have been many research papers that aim at identifying the elements, which have produced viable schemes beneficial to local communities and providing policy advice to firms, farmer’s organizations, and governments. These are comprehensive assessments of one particular form of agribusiness - contract farming, its social impact on the rural community and the ways in which farmers have responded (for example, Glover [1984, 1990, 1992], Goldsmith [1985], Little [1994], Watts [1990,1994], Williams, S. and Karen [1985]). The experience of such farming schemes in Africa, Asia and Latin America has shown that despite some attractive features, however, the model is feasible only when certain economic, technical, and social conditions prevail, including active government support. And the appropriateness of contract farming as a rural development strategy can change with a country’s state of development.

Because contract farming involves the multilateral relationships and the strong interdependence between agribusiness and small farmers, its interlocking can maintain a stable and long-term contractual relationship as quasi-vertical integration. The contract stands between the open market and the vertically integrated agribusiness.

In Vietnam, the interlocks of contracting have emerged after renovations in state-farms and processing enterprises, for example in Lamson Sugar Association, SongHau state-farm, DongGiao state-farm... The mentioned cases differ from each other by degrees of interdependence between the core and satellites. The agrarian and policy context in Vietnam causes the types of contract, which are various and have some special features in comparison with the other developing countries.

In case of Lamson sugarcane growing area, the presence of particularly close linkages and high interdependence between sugarcane growers and sugar factory is seen as a version of the core-satellite model. This case may in part explain the fact that under the same macro environment (though distorted), Lamson Sugar Company outperforms other sugar companies operating in the country, even joint ventures which normally did careful feasibility study before setting up a factory.

A main purpose of the research, therefore, is to answer a crucial question whether such a model can really play an important role in rural development in the context of Vietnam and if it does, under which conditions it can be replicated in other regions.

2. Focus of the research
The research focuses on explaining the nature of cooperation relationships in the model and its impact on welfare of parties involved, i.e. of the farmers and processors.

In Vietnam, there are also many schemes, which link the small-farmers and processor by contract. The large agribusiness cores are usually state-farms or state-owned processing enterprises or joint ventures. In this thesis, we analyze a perceived successful case of Lamson Sugar Company – a state-owned enterprise that after reforms has built close linkages with small sugarcane growers, and has by far outperformed other sugar companies in the country. The study will attempt to highlight the key institutional factors behind the success.

3.Methodology
The thesis will adopt a combination of descriptive, analytical and comparative methods. At the theoretical level, the thesis will review the literature and the empirical studies of authors considering contracting production in agriculture and will use microeconomics importantly vertical integration, bilateral monopoly to analyze the nature of the standard “core-satellite” model. In the analytical process, the thesis will adopt the theory of comparative advantage (Particularly, DRC) to examine competitiveness of sugarcane production, thus pre-condition for successful application of model in Lamson area.

At the empirical level, the thesis will make use of secondary data as well as primary data collected through field surveys and direct interviews with representatives of Lamson Sugar Factory and Lamson Sugar Association.

4. Research questions
The thesis will seek the answers to the following questions:

I/ Definition of the standard “core-satellite” model:
In practice, many terms have been used to describe variations of the system. There exists no standard usage; the terms are often used without intending to draw specific distinctions; and there is considerable overlap among them. They are all described based on the “core-satellite” model, though contracts can vary in “intensity”.

Contract farming: generally connotes a private sector scheme.

Outgrower scheme: generally connotes a government scheme, with a public enterprise purchasing crops from farmers, either on its own or as part of a joint venture with a private firm.

Nucleus - outgrower scheme: a variation of the outgrower scheme, in which the project authority also administers a plantation adjacent to the processing plants. Contract purchases supplement plantation production, the proportion varying from case to case.

Satellite farming: a broader term, referring to any of the variations mentioned above.

Multipartite arrangements: similar to outgrower/nucleus - outgrower schemes. The term is usually used to emphasise the participation of several actors, most frequently private firms, government agencies and foreign aid agencies.

However, in distinguishing contract farming and other types of corporate-small farmer system, it is useful to consider the degree of vertical integration in the production process and the extent to which the company is linked to farmers. Based on these two characteristics, the types of corporate-small farmer system can be arranged in a simple matrix, as Goldsmith had shown in following table.

Located in the upper left-hand cell is traditional agriculture, which tends to entail less integrated production processes. Although markets exist in traditional agriculture, the distribution chain is controlled by a variety of middlemen and small-scale processors rather than by an integrated food company. This type of agriculture has few forward or backward linkages to other rural or urban enterprises and agribusiness plays little role.

Large-scale food processors are far more important in the lower left-hand cell, in which a single plantation enterprise typically performs a sequence of activities, from primary production to marketing- a vertical integration system. The specialization and mass output of plantations make possible the application of increasingly productive technologies. But, as enclaves, plantations offer relatively few growth linkages to the small farm sector. They serve the rural community primarily by providing jobs, not by transferring skills and technology. The sharecropping theory is one particular institutional framework of the system.

Stronger linkages are possible in the upper right-hand cell, where the processor, rather than growing its own raw materials, buys them from local producers. Processors, however, generally prefer to buy in bulk from larger farmers. Their purchases, moreover, do not enable farmers of whatever size to overcome production problems. Breaking constraints on the supply side requires access to credit, inputs, and technical advice- services and resources typically provided by government, not by private firms. Simple market specification contracts or future-purchase arrangements (typically determining price, quantity, and time of delivery) are commonly used in the system.

The strongest type of interaction with small farmers seems to be presented in the last cell, where processors provide both an assured market outlet and critical productive resources. The processing facility comprises the “core” of the system, with the small farmers living around it making up the “satellite”. The factory and the producers are linked through production contracts, which usually specify the area farmers can plant in specific crops, the time they can harvest and deliver to the factory, and the quality of the crop they have to produce. Often the factory provides credit, inputs, farm machinery rentals and technical advice and it always retains the right to reject substandard produce.

In a descriptive sense, Watts defines contract farming by three broad attributes:

- A futures, or forward market, contract for a specific product is entered into by a grower (who typically controls the means of production and labour power in some way) and buyer/processor or contractor. Both parties commit to buy and sell at specified volumes and/or acreage though the completeness, duration, and specificity of the contract vary considerably.

- Production contracting links product and factor markets. Purchase commitments rest in some determinate way on the provision of inputs, services, and supervision to growers, who may or may not be organised. Contractually linked markets generate a marked division of labour in realm of farm management and hence a complex field of autonomy and subordination. There is no presumption of market destination.

- Production contracts differentially allocate production, price, and market risks. Crop-share contracts without price determination share production risk between contractor and grower. Conversely, in price – specified contracts, the grower is bound in a sort of piece – rate system in which he/she bears production risk but none of the price risk.

II/Experience of the core-satellite linkages in less developed countries
As examination experience of contract farming in LDCs, Glover (1990) showed the possible motives of each actor for participating in contract farming schemes.

For firms, delegating production to local agents has a number of benefits beyond technical advantages. Contracts allow the company a degree of control over the production process that is often comparable to that obtained on company plantations. Of the broader motives for contracting, avoiding conflicts over land-ownership and labour issues is probably more significant. Cost advantages may also be possible. For crops requiring much labour and careful attention, smallholder production may be more efficient than plantations. Contract farming may promote good public relations and present a progressive image by involving local producers.

For small farmers, they may see contract farming as a way to overcome some of their traditional problems. First, they face competition from producers who have adopted new technologies but they are often reluctant to adopt these technologies themselves because of risks and costs involved. For example, new crop varieties often have higher variances and are more input-intensive than traditional varieties.

Second,and related to the first, input supply is often weak in LDCs. Whether in response to lack of initiative from the private sector or as a matter of preference, governments have often taken over the supply of fertiliser and other agro-chemicals. But they are frequently unable to supply them in sufficient quantities or in time.

Third,agricultural extension is frequently weak, since neither the private nor the public sector is well positioned to provide it. The free-rider problem makes it hard for private firms to earn profits from extension while the difficulty of designing appropriate incentive systems for staff weakens public extension agencies.

Fourth,access to credit is difficult. Public credit is generally subsidised and must therefore be rationed; larger and more influential farmers tend to get more than their share. Private credit appears to be more effective in reaching smallholders but only partially so.

Fifth,local markets for high value perishable goods tend to be very thin and thus highly volatile. While products like fruit and vegetables may be suitable for smallholder production, prices are unpredictable and can drop suddenly and drastically if a few farmers market a day’s harvest simultaneously.

Sixth, international markets, which are deeper than local ones, are inaccessible to peasant farmers unless specific channels have been established.

Contract farming has the potential to overcome these problems. The risk reducing aspect of the contract may facilitate technology adoption. Input supply and extension may be superior to government services not necessarily because of private sector expertise, but because the firm has s direct interest in seeing that these are carried out efficiently; the results will be directly reflected in growers’ yields and quality and thus in the firm’s profits. Credit provision is facilitated because the firm can deduct loan repayment from crop payments and can use the crop as collateral. The existence of collateral in the form of a crop contract can also make it easier for a grower to get loans from a private or public bank. Since most agribusiness firms process perishable goods or export them to large markets abroad, they do not face thin markets. They can therefore offer growers fixed-priced contracts. Finally, transnational agribusinesses based on developed countries can often provide access to lucrative northern markets, through their expertise, brand names or oligopolistic marketing channels.

Local governments have a variety of motives for supporting contract farming schemes. These schemes avoid foreign ownership of large tracts of land, something nationalist government in developed as well as developing countries often object to. They also create expectations that other objectionable features of vertically integrated plantations will be avoided, for example, transfer pricing abuse and enclave effects. Outgrower schemes may also appeal to those governments, which have a fundamental distrust of markets and of the spontaneous behaviour of small farmers. Finally, contracting often creates lucrative opportunities for local businessmen, such as absentee landlords. Those schemes in which the firm provides most services and the grower essentially rents his land is ideally suited to absentee landlords.

Foreign aid agencies also find outgrower schemes attractive. These schemes allow the agencies to channel funds in fairly large doses to the priority area of agricultural development, often in LDCs in Africa. Given the interlocking of TNC, government and donor interests, it is not surprising that multipartite arrangements have become so popular. This interlocking also makes a careful examination of the effects on growers and communities, usually the least powerful members of the coalition, all the more important.

The system has some attractive features to widely application, however, whether it is feasible depending on special economic, technical, and social conditions. Goldsmith (1985) analysed under three aspects: product demand, technical requirements, and the local environment.

Market conditions for export and local crops differ widely, a fact that affects the probability of successfully introducing a core-satellite scheme. Cyclical oversupply, combined with relatively stable consumption in the major importing countries, results in situation that traditional exporters have little incentive to organise small farmers around new processing facilities, most core-satellite farming of traditional exports will have to occur as processors phase out direct production. Demand prospects for less traditional export (primarily fruits and vegetables) are more favourable. Shifts in consumer preference will always create opportunities for specific commodities. But processors are going to face increasingly intense competition for most temperate fruits and vegetables, which will limit their willingness to start up contracting schemes for such crops with small farmers in LDCs.

The market prospects within LDCs themselves depend on the crops in question. The more traditional staple commodities entail minimal processing, and hence little value-added, they hold slight attractive for private food processors, especially MNCs in linking up with small farmers to grow basic foods. Branded foods enjoy strong growth prospects in the developing countries, markets likely to be dominated by multinational food processors. This will create numerous opportunities for core-satellite production of canned vegetables, jams, dried milk, and other items that can source from small farmers.

The physical characteristicsof the crops themselves are also important. Irrespective of demand, there are technical characteristics that make some crops more suited than others for contract farming.  Five properties stand out:

- Perish-ability. Crops that need to be processed quickly create incentives for elaborate collection systems. Less perishable crop may not justify the cost of setting up such a system
–Bulkiness. Crops with a high value per unit of weight or volume make the most likely candidates for contract farming. These include fruits, vegetables, and tropical beverages, all of which are compact and relatively easy to transport.

- Permanence. Permanent and semi-permanent crops are more suited than annual crops for core-satellite farming.The reason is that growers of coffee, tea, and similar crops cannot easily abandon production, and so are locked into a relationship with the processor. Growers of annual crops do not face these barriers to exit.

- Need for processing. Crops requiring extensive processing are most appealing to agribusiness, which can then use its processing facilities to discipline suppliers. But many crops have minimal or no processing requirements. Depending on price movements, farmers often suspend deliveries to processing facilities, which may threaten to bankrupt the core-satellite project. It is not surprising that whenever crops have alternate outlets, companies seem wary of initiating production agreements.

-Variations in quality. Crops that vary significantly in quality, and for which quality is important in processing, are well suited for core-satellite production. This category includes many tree crops and types of fresh produce. The contrast is with homogeneous commodities, such as grains, which may not justify an expensive system to make sure farmers follow recommended practices and meet stringent grading requirements.

These five technical factors do not determine by themselves, whether a company will agree to set up a core-satellite system in a particular locale. When other conditions merit, the management may decide to proceed with crops that are “unsuitable” in some respects. But these characteristics usually determine the essential precondition of quasi-monopoly for the model.

Features of the local environment also affect the feasibility of an agribusiness firm engaging in core-satellite production. One of the most important considerations is accessibility. The obvious explanation is that market access is crucial, especially for horticultural products. Another locational factor companies consider is whether farmers in the project area have experience growing the proposed crops. A third factor about the locality that enters the investment decision is its suitability for the crop to be processed. This is true in the obvious sense that agronomic and climatic conditions must be auspicious. But there is a less obvious consideration as well, namely, whether the area is also suited to other cash crop. Some firms may not want to enter a contract-farming scheme if competition from other crops is likely. Participating farmers’ exit barriers may be too low.

It is clear from many case studies that contract farming (CF) is not suited to all commodities or economic conditions. The Asian experience has shown that the appropriateness of CF as a rural development strategy can change with a country’s state of development. In Thailand’s competitive markets, income diversification and booming export opportunities, combined with the availability of efficient informal institutions in the form of quota-men have rendered CF ineffective and largely unnecessary.

Contract farming is not a means to solve the poverty problem of rural farmers in developing countries who are used to traditional or staple crops. It works well with certain farm products and only in certain areas and can not be used with general agricultural products, especially staple crops. Farmers with potential can benefit from contract farming, but they are not necessarily poor. However, through contract farming, poor farmers, like those engaging in pineapple and asparagus growing in Indonesia (although the arrangements were merely contract markets and not contract farming in the real sense) can also have access to the export market. Nevertheless, contract farming may help, to a certain extent, poor farmers who grow staple crops in that it may make them reduce production of staple crops and diversify to high value crops. An example is the rice farmers in the Central plains of Thailand who now use part of their land for growing other cash crops.

Contract farming is contradictory to farmer organisation in that it tends to reduce enterpreneurship of farmers. What they gain is more production specialisation. Participating farmers pay no attention to accounting systems or the markets of both inputs and outputs.

The dominant theme in most of the cases is the role of government directly and indirectly to initiate or design the projects and to promote them on a long-term basis. The government should have a policy to promote for specific crops, which are appropriate for contract farming. This means a review of existing regulations concerning both inputs and outputs so that they are consistent with one other. Co-ordination between government agencies and the private sector is also of importance, particularly in improvement of production efficiency, enhancement of homogeneity and improvement of farm level production. If farm produce is not homogenised, and there are quality problems, disputes over grading will be inevitable. It is recommended that there be independent organisations to resolve the disputes between firms and farmers and the government should facilitate efforts to increase the information efficiency of parties involves in contract farming in order to enhance vertical co-ordination among them.

3.1 Background of agrarian context and policy
Vietnam’s agriculture features predominately high population pressures on arable land, subsistence small farmers, less developed marketing institutions, and is placed at the initial stage of development. In such a circumstance, crop diversification is essential for economic viability of agriculture in the long run and offers the best opportunity to maximize return from agricultural land and to increase farm income. Some recent studies have common agreement that Vietnam has several favorable features, which will encourage agricultural growth and crop diversification. These are a large agricultural resource base, which is diverse in nature and responds productively to new technology, a largely literate society with access to reasonable quantities of agricultural information, and a relatively egalitarian society that lends itself to cohesive rural organization. These attributes are driving an already rapid agricultural diversification process as long as government provides institutional framework for the delivery of price incentives, technology, other agricultural inputs and sharing of risk in diversification. The strategy of agricultural diversification is closely linked to the need of developing efficient agroindustry. Coherent marketing structures and broader economic relationships that provides linkages between markets and agroindustry on the one side, and farmers on the other side, are essential for the efficient use of capital and for sustainable growth in rural Vietnam. On the surface, at least, the potential for modernizing smallholder agriculture through contract farming appears to be quite promising.

3.2 Development of Sugar-cane Industry

Prior to 1994
Until 1994, the direction of sugar-cane development was not yet clearly identified. The government did not have concrete policies to develop sugar and sugarcane industry. In this period, Vietnam had to import sugar annually. In the period 1986-1993, sugar-cane industry was stagnant. In 1994, there were only 12 sugar factories in the whole country, in which includes 5 factories with crashing capacity of 1,000-2,000 TCD, the remaining with 100-500 TCD capacity. Most of sugarcane is processed manually. Sown area of sugarcane fluctuated (See chart 3.1). In this period, growth rate of gross output of sugarcane stood at only 3.2 percent per year. Yield of sugarcane increased slowly, and in 1993 it was still 42 tons/ha. In addition, sugar processors operated inefficiently because of obsolete equipment and technology. Thus, sugar output was only 270,000 tons in 1993-1994 crop and sugar import accounted for one third of the demand for sugar.

Since Prime Minister approved the “National project of sugar-cane production” in 13/10/1994, the sugar sector has been promoted vigorously. The measures of the government are production programs (area expansion and credit to farmers) and investment in processing (modern processing plants). This policy pursues two objectives: (i) to try to make Vietnam self-sufficient in sugar production; (ii) to promote rural industrialization. With a target of one million tons of sugar production in year 2000, the government has provided incentives to both joint ventures with foreign companies and 100 percent foreign direct investment. It has also given incentives to the domestic production of sugarcane, usually in the form of subsidized credit.

As a result, sugarcane production in the whole country has been accelerating rapidly. For a short period of 1994-1999, sugar output increased at 2.5 times to reach about 720,000 tons. In 1998-1999 crop, there are 42 sugar factories in operation, of which 7 factories start the first pressing crop, 18 factories have operating capacity higher than 80 percent of design capacity. However, 16 factories including even joint-venture factories (Vietnam-Taiwan joint venture Sugar Company, Bourbon-Tay Ninh joint venture Sugar Company) have operating capacity of less than 50 percent (See Table 3.2 in main text). Yield of sugarcane on average is still relatively low at 49 tons/ha comparing with yields of 60-70 tons/ha in India, Philippines, and Thailand. This also implies that sugarcane production in Vietnam has low comparative advantage.

In sum, sugarcane and sugar production operated at low efficiency though grew fast. This is resulted from inefficient incentives for investment in sugar sector as mentioned.

In addition to a severe problem of insufficient supply of material (sugarcane), sugar factories are now facing another serious problem of excess supply of sugar. The amount of sugar in stock is now about 300,000 tons, which is four times higher than the normal stock. The main cause of this situation is low international competitiveness of Vietnamese sugar. Although quotas and tariffs are still in place, large differentials between domestic and world prices of sugar make smuggling profitable and widespread, and this problem is becoming more serious as world prices continue to go down (See Chart 3.2). Here, we just want to emphasize that further cuts of production costs is the only solution and part of solution lies on considerable joint efforts by both processor and sugarcane growers, which is a topic of this thesis and will be discussed in details in the next chapter.

During 10 years (1989-1999), Lamson Sugar Company (LASUCO) has gained impressive success. Its output rose rapidly (Table 3.2) and the factory and the sugarcane area expanded fast (See Appendix 2b). The factory has managed to avoid a widespread problem of insufficient supply of sugarcane. This phenomenon leads us to a question why under the same macro environment, Lamson Sugar Company outperforms other sugar companies operating in the country, even joint ventures, which normally did careful feasibility study before setting up a factory.

A number of causes of the problems in supply have been identified as follows:

* Some factories located in areas where sugarcane has to compete with other crops. Low productivity of sugarcane meaning that the area does not have comparative advantage in growing sugarcane provides no incentives to farmers transforming to cultivate sugarcane; thus it is difficult to enlarge the factory’s raw material supplying base.
* Farmers who supply sugarcane to most of state-owned sugar factories have limited access to credit.
* In case of joint venture sugar companies, the relationship between factories and growers is the main cause. Establishing a stable relationship with farmers is not always easy, especially for foreign investors. Farmers refused to sign contracts with sugar factory (e.g. Sugar factory in joint venture with Tate & Lyle PLC (England) in NgheAn province, Vietnam-Taiwan Sugar JV in ThanhHoa province). From the farmer’s point of view, the contracts are too complicated and unfavorable to them. In some cases, coordination between farm production and processing schedules is interrupted (e.g. Bourbon–TayNinh JV sugar company). Thus, the farmers are forced to bear all damages of fallen productivity and quality of sugarcane. On the part of the company, they lost the advances of credit and inputs to farmers from time to time, since they could not control the farmer’s sugarcane production.

In short, location in regions with comparative advantage in sugarcane and sugar production, adequate access to credit and stable long run relationship between processor and growers are identified as key determinants to the success of a sugar factory. However, analysis of each factor in isolation cannot give a convincing explanation for the success of LASUCO relative to other sugar factories in the country. Indeed, with regard to access to credit, financial and managerial capabilities, Lamson Sugar company cannot be compared with sugar companies with foreign invested capital. Although LASUCO is located in a region with comparative advantage in sugar production (See Appendix 3), natural conditions in Lamson area are not any better than in Southern sugarcane areas where many less successful sugar factories are located. LASUCO is not any better in terms of other factors such as availability of cheap and skilled labour, incentives provided etc. All the aforesaid have led us to conclude that together with right positioning in a region with comparative advantage in sugar production, a well-established linkage between the factory and sugarcane growers is also a key determinant of the above mentioned success of Lamson Sugar factory.

3.3 Perspective of Sugar Industry in general and Lamson sugar factory in particular in the long run
Although sugar is on a “Sensitive” List in trade agreement with AFTA members, sugar import tariff of Vietnam will reduce gradually to 0-5 percent in next 12 years. Non-tariff barriers will be removed as Vietnam joins WTO. Over the medium to long run, fierce competition in sugar market will force the sugar industry to cut production costs of sugar by increasing sugarcane productivity as well as raising cane to sugar conversion efficiency up to the regional standards. This implies that sugar would be produced only in location that has comparative advantage in sugar production.

Domestic resource cost (DRC) calculation as well as direct comparison with sugarcane production in other countries indicate comparative advantage for sugar production and sugarcane cultivation in Lamson area, particularly when cultivated in hill area where the alternative use of land is limited to at best, producing single cropped rice (See DRC calculation in Appendix 3). DRC for sugar production at Lamson Sugar Factory is less than 1, so it is possible to develop the cash crop in Lamson area.

Another, simpler and more straightforward indication of comparative advantage of the region in sugarcane production is that the productivity of sugarcane in Lamson area is highest in the whole country. Furthermore, the region still has potential to raise sugarcane yield and the sugar extraction rate to 80 tons/ha and 12 CCS respectively, which are comfortably comparable to neighboring countries such as the Philippines and Thailand.

Thus, the analysis shows the viability of these activities of sugarcane and sugar production and thus viability of the contract farming system in the area.

Chapter IV:
Linkages between sugar processor (the core) and small farmers (satellites) in the Lamson Sugarcane Producing Area

This chapter presents a case study of core-satellite model that is perceived as a successful case in Vietnam - the Sugar Factory and sugarcane growers in Lamson area. Before making detail assessment of the contracting system, it provides a brief introduction to regional agricultural context of the case. Section Two describes linkages within the Association and briefly discusses the latter’s common and distinctive characteristics in comparison with other well-known cases. Section Three will examine the evolution of the linkages over time: from establishment of the Association to the emergence of farmers’ co-operatives and finally, the plan of equitisation of Lamson Sugar Company with shares to be sold to farmers. The latter is a move towards a higher level of linkage with an aim to reduce transaction costs and uncertainty and increase of stability of long-run relationship. Assessment of these developments on welfare of sugarcane growers is made throughout the chapter. The final section provides an assessment of result of the linkages, namely improvement of efficiencies.

4.1 Background of Socio-Economic characteristics in Lamson rural area

Lamson rural area bears common features of Vietnam’s agriculture. The community consists of the vulnerable sugarcane growers who live in subsistence and work with backwardness of technology, lack of capital and marketing knowledge. They need a model of development that can help them overcome their problems and to ensure that investment results in beneficial and sustainable long-term change in development of the sugarcane area. The new institutions that already emerged such as Lamson Sugarcane Association and new cooperatives need an in-depth analysis as to how they could do well these tasks?

4.2 The linkages in Lamson sugarcane production area
Chart 4.1 represents organizations and institutions in Lamson rural area involving the cane procurement. The basic production units are organized in three forms: groups of workers in state-farms, cooperatives and farmer’s voluntarily established groups. The existing farmer’s organizations are horizontal integration in sugarcane production process. The production contract system between processor and sugarcane growers’ constitutes vertical cooperative relations as in a standard core-satellite model. The participants in the model all have incentives to maintain the long-term stable relationships because they are closely interdependent of each other. The development of the relationship also resulted in the emergence of a new institution in 1995 – Lamson Sugarcane Association. Lamson Sugar Factory, Vietnam Bank of Agriculture and Rural Development (VBARD), 4 state-farms and over 100 members as cooperatives, farmer’s groups, and individual farmers compose this organization. The analysis of these institutions and their interactions and will be presented in the following parts.

Linking channels in vertical integration Sugarcane delivery and sugarcane price:
As the terms of delivery including sugarcane price reflect distribution of profit and risk between parties – a key factor determining the stability and sustainability of the linkage, it deserves an in-depth analysis. At the time of signing contract, the factory usually commits to buy cane at minimum price that covers all production costs and also provides 30 percent of profit for grower. The actual price that it pays is the market price at the time of delivery. The factory announces the standard price for one ton of 10CCS cane and detail purchasing policies before harvest. Sugarcane with higher sugar extraction percent percentage will be paid correspondingly higher. The factory purchases cane at field, this implies that the price excludes transportation cost to the mill and the producers are charged with harvesting works.

The factory also publishes a number of specific policies in sugarcane purchasing to take into account different terms of supply, such as:

In Lamson area, relative prices of sugarcane vis-a-vis sugar were equally 33-35 kg sugar in 1988-1989 crop. In 1998-1999 crop, the sugarcane price with 10CCS was equal to 50kg sugar, which is quite close to the mentioned ceiling of sugarcane price (equal to 54 kg of sugar). The price levels improved substantially, but are still "unfair" in disfavor of the farmers as the factory clearly dominates over a large number of contractors. This fact shows the monopsony power of the processor over the sugarcane growers. Another important evidence of monopsony power of the factory is the high income of factory workers relative to the grower's income. Average income of an employer in the factory is VND 1.5 million per month (approximately VND 12-20 million per year) while household's value added received from one hectare of sugarcane equals to VND 7-8 million per year.Factory's monopsony rent is evident. However, the improvement of procurement price of sugarcane in favor of farmers over past few years strengthens the linkage between factory and farmers and it is sufficient to avoid disputes among them and encourage farmers to considerably expand sugarcane area by cultivating idle land and shifting from existing land previously devoted to other crops.

The changes of relative price of sugarcane vis-a-vis sugar (i.e. terms of trade of sugarcane against sugar) indicated the changes of bargaining power between contractual parties. This result arises from the fact that the factory has continually invested in expanding its capacity. (See box 4.1) The high fixed cost of the company reduces his status quo (disagreement) payoff and increase bargaining position of the farmers. The company does not capture all increments in value generated by his investment because of the threat of not trading. But the suppliers/growers appropriate some of the larger pie.
Credit and Material supply:
As mentioned in the theoretical chapter, one of the attractive properties of contract farming, from the point of view of farmers, is their improved access to capital. This is very clear in the Lamson case. The factory provides the advanced investment, in return the right of buying sugarcane. The investment covers the components of costs as following:

- Land preparation: 600,000 VND/ha.

- Planting material (for new plantations):7tons/ha about 2 millionVND.

- Fertilizer: 1.5 tons/ha at price of VND 1.5 million/ton

- One million VND in cash for hiring labor during the critical periods of cane production, consumption and land tax.

Contract farming normally involves the participation of formal credit institutions as the third party in the linkage. This is also observed in the Lamson case. In fact, the company has a strong linkage with Vietnam Bank of Agriculture and Rural Development (VBARD). The investment fund is mobilized mainly from VBARD as the company’s loan. The farmer will repay the credit through deductions from sales to the processing plant. Thus, VBARD avoids the risk of lending. In some cases, the farmer may borrow directly from VBARD, in which the bank will accept the production contract with company as collateral. This is the reason while VBARD as the third party in the linkage is very active as contrast to its activities elsewhere in the country. (See box 4.2 in main text)

In addition, the factory had some specific investing programs. They include investments in improved seedling cane plantations and early/late matured material cane plantations; credits for buying new tools and equipment (tractors, vehicles, pumps); investments in infrastructure of new concentrating cane areas (including irrigation, transport infrastructure and other facilities of education and health). It also supports food grains and cash for households in transforming cultivation process from paddy to sugarcane.

Source:Cited in Review on Lamson Sugarcane Association, Report of Lamson Sugarcane Association and Lamson Sugar Company, 1997, p.20.

The mechanism of credit and input supply can partly transfer the risks of yield and market to the company. Particularly, the company’s input provision resolved production variability arising from input side. Credit provision is facilitated because the firm can deduct loan repayment from crop payments and can use the crop as collateral. Thus, farmers can tide over the risks from poor to good years. The risks reducing aspect of the contract may facilitate technology adoption.
Technology transfer and machinery services:
These investments in advance combining to extension services have effects on directing the grower to apply improved technologies. The application of new techniques determines the efficiency of using other inputs to increase productivity and quality product. Thus, the company established a nursery to provide improved varieties of seedling and had training courses that technical staff of the company show the need for improved knowledge about land technical criteria, density of the plants, irrigation, fertilizer and pesticide applications. The company manages a tractor station with 30 high and medium power engines for land preparation services. Through the agricultural services, the risk of catastrophic yield failures that are primary source of fluctuations in income is diminished, productivity and quality of sugarcane increased considerably.

The horizontal integration:>
The grower’s organizations in the location belong to three types of production teams of farm workers, groups of voluntary farmers, cooperatives and to the Lamson sugarcane association. These organizations except the Association all are the representatives for contracting units. The reorganization into horizontal integration helps reducing many linkages in the core-satellite model, thus the transaction costs of contracting parties. The intermediaries carry out redistribution of company’s services and regulating exchanges or co-operation among the participants. However, the interactions in them arise the extra costs to participating small-farmers, especially groups of voluntary farmers and in state farms. Additionally, group of voluntary farmers is informal institution, thus the legal system may not intervene to deal with disputes about sharing profit among farmers. The unreasonable costs will be removed when new organization designs gradually established.

Government assistance:
The government actually involved from initiating the system and pursued continuously with positive supports for fruition of the system. The coordination between government agencies and the actors participating in the contract farming system is important. Particularly, the government stimulated firm interest in core-satellite model (applying the contract style with growers in state sugar factories from 1988-1989 crop), supplied public resources where the private sector will not (such as infrastructure, agricultural research, social services), applied many programs of credit, technical transferring…in order to enhancing of vertical coordination among parties and improving of farm-level production.

4.3 Evolution of the linkage over time:
This section briefly analyses the dynamics of the linkage between two main parties in the Lamson case – LASUCO and sugarcane growers. A special and distinguishing feature of this case study is the emergence of new distinguished institutions. These are the Lamson Sugar Association and well-organized satellites in form of cooperatives. Recently, the LASUCO has been equitised with a quite significant part of shares being sold to sugarcane growers. This is a prominent distinguishing feature of the Lamson case as compared to the standard core-satellite model. This development may also have important implications for the linkage between the processor and growers. A common characteristic of these institutions is that all play important role in resolving many disputes between parties and hence, improving their welfare. They therefore help sustaining and strengthening the relationships between parties involved in the standard core-satellite model.

4.3.1 Establishment of the Association: First move in bringing in all parties involved to a forum
To be achieved a stable, long-term relationship a mutual trust between company and growers has to be established and any deviation from the agreement in this infinitely played game has to be avoided. In turn, this requires a forum where the involved parties can frequently meet and discuss any problems arisen. In this way, the likelihood of a “prisoner’s dilemma” can be minimized. As a logical development of the mentioned linkage, the Lamson Sugarcane Association has emerged to fulfill this task. In the middle of 1996, the regulation on members of Lamson Sugarcane Association, which consists of 6 chapters with 22 articles and the financial rules, were published. The components of the Association were introduced in the chart 4.1.

Up to now, the operation of the Association has proved to be successful. The number of members among sugarcane growers has been increasing. However, there should be noted two points here. On the one hand, LASUCO clearly dominates other members in this forum. The rule “who has money can order the song” reflects the reality of the internal links between Association’s members – individual farmers or organizations/institutions alike. In other words, the emergence of the Association cannot itself improve bargaining power of farmers.On the other hand, the Association clearly plays its part in improving welfare of farmers. Their voices and wishes are heard. More importantly, this forum may facilitate the process of improving farmer’s welfare once other organizations emerge. This is analyzed in what follows.

4.3.2Establishment of farmers’ co-operatives: A further move towards a closer linkage and associated increased bargaining position of farmers
LASUCO has been in a constant search for cutting transaction costs. It therefore encourages larger contractors and hence, the establishment of co-operatives representing a large number of sugarcane growers. The latter apparently benefits the factory. However, as will be analyzed here, it also improves bargaining power of farmers.

As mentioned in the earlier parts of this chapter, the monopsony power of LASUCO is dominant in the relationship between the factory and growers. Consequently, the actors participating in the vertical integration gain unequal parts of welfare. This thing constitutes a potential threat to the linkage, thus the viability of the model. The solution of the problem is improvement of the growers’ status through instituting cooperative forms among them in horizontal integration. The emergence and development of co-operatives make firm-grower relations change over time towards improving the bargaining power of the growers, thus their welfare. Farmers now have an official co-operative form that is protected by the Law. Working together within co-operatives provide an excellent opportunity for farmers to learn and to get better informed about their position and hence, their bargaining power. The market structure is “dynamic” by nature. The progress of cooperative development may reduce the monopsony power of the core and market structure may change fast between the two extremes: from monopsony towards bilateral monopoly with improvement of welfare of sugarcane growers.

4.3.3 Equitisation of Lamson Sugar Company with shares being sold to farmers: a new height in vertical integration towards reducing uncertainty and strengthening long-run relationship.
About two years ago, the management of Lamson Sugar Company began to develop a plan of equitisation with shares to be sold on preferential terms not only to its workers but also sugarcane growers. This is a distinctive feature of equitisation of LASUCO as compared to other “standard” equitisation cases.The main reason for this plan, as explained by the management, is to return some benefits to farmers who have made a significant contribution to the success of LASUCO over past ten years.Another important reason is to further consolidate the linkage between the processor and sugarcane growers.

Here, we just like, however, to note two things. First, the growers- shareholders assume additional risk of the market compensated by higher return. Second, these growers-shareholders will be more committed to make every efforts for the success of sugar production in the region as they now also care about the processor’s profit, which is no longer completely captured by the factory as a monopsony.

4.4The results of the linkages: Improvement of efficiencies.
The core-satellite farming had made success for the company and beneficial impacts on the small farm community. During ten recent years, LASUCO has grown rapidly with expanding continually its capacity to 4 times higher of the initial one, with increasing in incomes of employees and profit of the company. The small farmers in the region also gained higher income and improved the productivity resulted from applying new and more productive technology in cultivation. Thus, they have improved their terrain in bargaining process with the company in long run as well as stimulated them transforming to commodity production in open market. (See appendix 2 and tables 4.6,4.8)

Source: Draft of The report of one operating year of five new cooperatives according to cooperative law in Lamson area by KAS – CECARDE – L ASUCO, June/1999.

(a)The average yield of sugarcane in the cooperatives.

(b)Yield of sugarcane of intensive cultivation field on average in Ho Dam cooperative. (This of non-intensive cultivation field is 56 tons/ha)

Table 4.8: Income, consumption and saving rate in Lamson area
<(In categories of household, in constant 1994 prices)
Unit:1,000 VND

Source: The reports of " Review on Lamson Sugarcane Association", in Apr. 1997 and Sep.1999

The core-satellite model not only has the benefit impact on the small farm community, but also is sufficiently profitable to the processor. With contract system, Lamson Sugar Company has achieved the impressive growth of all criteria (including in sale, profit, employer, and asset…) for past ten years (See the appendix 2). In 1993-1994 crop, the company actually processed at 69 percent of its design capacity. In 1994-1995 crop, the real capacity reached nearly 86 percent of the design. From 1995-1996 crop to now, its real capacities are always over the design capacity. The fact enables the company to expand its capacity to 6,500 TCD in 1999-2000 crop and to branch out into producing new products from sugar or auxiliary products related to sugar production process.

Chapter V: Conclusions
The answers for research questions now become rather clear. The experience of cases in less developed countries and of Lamson Sugarcane-Sugar Association shows that the core-satellite model is a promising institutional framework for the delivery of price incentives, technology, other agricultural inputs and sharing of risk. Policy implications and conclusions are drawn to suggest how to apply the contract farming system efficiently in agribusiness activities, e.g. sugar industry, tea industry and other food processing industries.

5.1 Conclusions
The CF literature has some attractive features to each actor participating in the schemes (small-farmers, firms, local government) and the expected beneficial impact on surrounding rural communities. The contracts represent close interdependent relationships between the firm and its farmers/ suppliers. However, within the broad interdependence, there is considerable room for conflicts of interest, exploitation and bargaining, with its internal dynamics.

Actually, the available evidence proves that core-satellite farming can raise productivity and income of both the company and the farmers. Through the contract farming system, Lamson Sugar Company obtains stable supply source, thus avoids the common problem of insufficient material in sugar factories in Vietnam. The farmers in the area also get higher income from increases in productivity, quality and yield of sugarcane.

The successful application of the core-satellite model in LASUCO has main reasons as follows:

The favorable domestic market: Our analysis of Domestic Resource Costs (DRC) presented in Appendix 3 shows that LASUCO has comparative advantage in sugar production. The sugar factory and the sugarcane growing area in Lamson are viable even if distortions are removed.

The technical feature of sugarcane crop: The characteristics of sugarcane material (seasonality and perishability) make necessary vertical integration between producer and processor.

- Features of the local environment: The agronomic and climatic conditions are suitable for sugarcane crop. Cultivating sugarcane in the hill land provides higher profit than other crops. The agricultural economy of Lamson region is attributable to the predominant subsistence of small-farmers that can expect highly gain from core-satellite model. The homogeneity of farm level production is good condition in which core-satellite development can occur equitably.

- Enterpreneuship: Good management and goodwill are also these important factors that has made the success of LASUCO.

- Government assistants: The government plays an important role in the development of this area. Institution reforms must be considered firstly, particularly the reforms in state farms and processors with diffusing the contract style between processors/ state farms with farmers, the new cooperative law, and the equitization program. The government’s measures of public investment, trade (i.e. sugar import) and credit also supported positively for fruition of the system.
The special feature of “core-satellite” model in LASUCO is the attendance of a number of new institutions in evolution of the model’s linkage over time. They are an Association of members diverged in organizing, financial capacity... cooperatives/well-organized satellites - the collective representation of a number of small-farmers, and an equitized company with its farmer’s own stocks that will take over LASUCO.

5.2 Implications
The model is not suited to all commodities or economic conditions. It works well with certain farm products normally, those which only in certain areas and can not be used with general agricultural products, especially staple crops. The appropriateness of contract farming as rural development strategy can change with a country’s stage of development. At the same time, the resultant class and regional income disparities have social costs, so the appropriate government policy should be encourage core-satellite projects where they are feasible, while trying to minimize the undesirable side-effects. To achieve these twin goals, the following actions should be considered:

Feasibility studies: These studies are examination of the specific economic, technical and social conditions that influence the likelihood of a firm actually entering a joint production project with small farmers. The advantages and disadvantages of production contracting for the parties involved will be analyzed to specify the feasibility of core-satellite farming projects.

The government supporting policies for crops that are appropriate for contract farming on a long term basic:
* Effective local organizations: Cooperatives or other independent organizations to resolve disputes between firms and farmers concerning grading are prerequisite for core-satellite farming. For example, the Lamson organizational solutions- including producer associations, farmer’s groups, cooperatives and mill equitisation with local farmers- will enhance vertical coordination and reduce imbalance in the bargaining power and distribution of benefits among the actors involves.

* Credit support: Government backed financing is usually needed to get core-satellite systems underway.

*Agricultural research: Public funding will continue to be needed for basic agricultural research. Opportunities may exist, however, to get companies to contribute collectively to research facilities specializing in crops the companies process.

*Infrastructure and Social services
10.0pt'>: Good transportation facilities are essential to a successful core-satellite system. Policy makers may want to consider linking an existing road building or investment program to efforts to expand private food processing in rural areas. Rising income in the project area, combined with an influx of new residents, will increase demand for social services.

Overview of Vietnam’s agriculture reveals a context that encourages core-satellite farming application in agribusiness investments. In the previous time, the economic transformation has brought considerable achievement to Vietnam’s agricultural sector, especially to paddy rice production. However, it should be admitted that Vietnam’s agriculture is still characterized by backwardness and placed at the initial stage of development. And, further increases in paddy production are not attractive and future rural development must come from diversification into higher value cash crop and an expansion of off-farm employment opportunities. According to the result of a FAO’s survey, soil and climate conditions in Vietnam are highly suitable for a range of cash crops, such as tea and fruit… which offer higher returns and greater on and off-farm employment opportunities than paddy. Moreover, demand for these crops are rising in domestic and export markets.

At the moment, there is considerable evidence that Vietnam has begun to reorganize its state farms and processing enterprises in to the contract farming system. Actually, the irony that processing factories can not get enough materials even though these can be grown very well in the country, even in other regions excess supply still may lead to uncertainty incomes to farmers, has vexed the experts for some years. The problem is common for sugar industry in Vietnam. The case study of Lamson sugarcane producing area indicates that establishing the close linkages among company and its farmers through production contracts is a good solution for getting stable supply, increasing commitment of the two parties, cutting down costs and rising to new challenges. At the same time, it also helps the companies could become more involved in promoting rural development as the government’s objective for sugar industry.

The initial successes of the core-satellite model suggest that it may become more common in Vietnam’s agro-industry sub-sector, if the government has an appropriate institutional and policy framework, combining to adequate support services and sufficient credit for these appropriate crops.


The Lamson Sugar Company began to sell shares on 10 and 11 December 1999 and has therefore become a joint stock company,.

Dinh Quang Tuan (1996), where, CCS is the abbreviation of Commercial Cane Sugar. CCS is measured as follows (called Queensland formula):

C.C.S = 3/2.Pol₁.[1-(5+F)/100]- 1/2B₁[1-(3+F)/100]

Where Pol₁ is % sugar in juice (% sucrose), B₁ is the share of Dry matter, F is the share of fibre in cane. CCS indicator measures the share of sugar (%) that a standard factory can extract from cane, according to theoretical calculation. The recovery rate is in fact less than the CCS because there is sugar loss in milling process. The indicator is used commonly in purchasing sugarcane in the World as well as in Vietnam.

Williamson (1975) calls this opportunism. Then Gravelle, H.(1992) presented a simple illustrated model of bilateral bargaining with specific investment in chapter " The theory of the firm", p.25.

You should indicate original sources and also check where monopsony is present in other countries.