Incentivizing Farmers to Invest in Quality through Quality‐Based Payment

Abstract

We consider a for‐profit cooperative that sets a quality‐based payment to its risk‐averse farmers in order to incentivize them to invest in quality improvements. The quality of the farmer's harvest is affected by his investments during the growing season. To satisfy both the farmer and the cooperative, the payment must be competitive with the open‐market prices. Cooperatives often set payments that mimic the open‐market prices; however, this practice fails to incentivize farmers to invest in quality. Our work is motivated by the evidence of farmer underinvestment in crop quality in the olive oil industry. We define and analyze a model of this system where farmers operate under random yield, quality, and open‐market price. We find that farmers consistently underinvest in crop quality under the payment policy that mimics the open‐market prices because (1) the cooperative can command a higher retail price than a farmer and (2) farmers are risk averse. We propose two alternative payment policies that are new to the agricultural literature, both of which can coordinate farmer decisions with the system but differ in terms of ease of implementation and susceptibility to risk aversion. We identify an easy‐to‐implement policy that can lead to meaningful gains when introduced in conjunction with crop insurance. We calibrate our model using data from the olive oil industry in Turkey and find a profit improvement of 10–15% over the current open‐market payment approach.

Insight into China's Economically Motivated Adulteration Risk in Online Agricultural Product Sales

“…Zhao et al (2021) found that internal and external supply chain integration are the key factors to improve product quality. Ayvaz-cavdaroglu et al (2021) explored how a quality-based payment approach (with market prices) to incentivize farmers to improve quality. They found that this approach, combined with crop insurance, could achieve meaningful gains.…”

Socially relevant and inclusive operations management

“…Studying a setting where farmers are exposed to yield, quality, and market price uncertainties, Ayvaz‐Çavdaroğlu et al. (2021) show that the farmers underinvest in the crop quality when they are compensated based on the market price. Levi et al.…”

Do quality incentive payments improve cooperative performance? The case of small French agricultural cooperatives

“…Historically, in a cooperative, there are no differentiated payments according to quality, but instead a payment based on a pooling price received by cooperatives on the market (Liang & Hendrikse, 2016). However, in recent years, an increasing number of cooperatives have used incentive payments (Ayvaz‐Cavdaroğlu et al, 2021). This practice is generally used by large agricultural cooperatives, but these contracts have clearly been widely adopted by the cooperative movement.…”

“…Incentive through quality will bring about among members competition on investment in quality. This investment aims to capture the quality premium paid by the cooperative, which is perceived as a return on investment (Ayvaz‐Cavdaroğlu et al, 2021).…”