Contractual Coordination of Agricultural Marketing Cooperatives With Quality Provisions

Problem Definition: With increasing concerns about the quality and safety of agricultural products, many agricultural cooperatives (co-ops) have begun to specify quality provisions in contracts with farmers. Correspondingly, they are pooling products to quality-differentiated markets and offering quality-differentiated prices to farmers in multiple stages. Methodology/results: We propose a two-stage stochastic program to study the quality coordination problem in a setting where a co-op specifies a quality standard and offers a multistage payment scheme in its contract with multiple farmers who can exert quality-related effort and also show preference toward prompt payment timing. We first analyze a commonly adopted payment scheme, the pooling payment scheme, and then propose an improved payment scheme, the upfront incentive (UI) payment scheme. We find that the pooling payment scheme is able to coordinate the supply chain only when farmers’ time preference is higher than a threshold; otherwise, the scheme leads to the problem of over-motivation with respect to effort. However, the UI payment scheme can coordinate the supply chain unconditionally and is also robust to farmers heterogeneous in farm size. We further conduct two extensions, including farmers heterogeneous in farm size and dynamic market size. Managerial implications: The results provide guidance on a co-op’s contract design, including quality provision and payment mechanisms in multiple periods.