Contract farming led by a seed enterprise and incentives to produce high quality: Which contract design performs best?

Abstract Motivated by real‐world practices in China, we consider a three‐level agri‐food supply chain consisting of a seed enterprise, a grower, and a buyer–processor, where the seed enterprise is fully vertically integrated in the seed industry and acts as the leader to coordinate the grower and buyer–processor of the agri‐food supply chain. We call this seed company‐led agri‐food contract farming. First, we develop analytical models to derive optimal solutions under penalty contracts, revenue‐sharing contracts and cost‐sharing contracts. Then, we analytically compare the optimal strategies of the three contracts using data from China's fresh maize industry as the numerical example. Finally, we do the sensitivity analysis of contract parameters. Results demonstrate that: (1) The seed company‐led agri‐food contract farming obtains quality advantages and improves profits by responding quickly to external demand changes and effectively coordinating internal technical capabilities. (2) The penalty contract performs poorly in both quality and profit. (3) The profit of the whole supply chain increases with the increase of the revenue‐sharing proportion from downstream supply chain participants to upstream participants; but the relationship between the proportion of cost‐sharing and the profit of the whole supply chain is nonmonotonic. [EconLit Citations: C79, O13, Q13].