Contract design in agriculture supply chains with random yield

Abstract

Abstract In an agricultural setting it is natural to consider yield risk in the context of a three level supply chain: with a small number of suppliers, large numbers of growers, and a small number of buyers. In the cereal growing case that is our focus, there is a supplier of fertiliser, a potentially large number of growers of cereal crops and a buyer, who purchases grain from the growers. The yield depends both on the input level of fertiliser and also on random weather-related factors. We study the impact of a new type of contract structure in which the grower purchases inputs at a discount, but agrees to a reduced price for the crop. The buyer makes a payment to the supplier to compensate for the discount offered. We show how this can coordinate the supply chain and demonstrate the potential advantages of this contract form when producers are risk averse. We look in detail at the implications of the use of these contracts by Australian wheat growers using data generated by APSIM, a growth simulation tool, to understand the connection between yields, fertiliser use and the weather. By using APSIM we can estimate the distribution of yields implied by the grower’s decision on fertiliser application and hence estimate optimal fertiliser use for risk averse growers.