Contracting
Broadly speaking, a contract is a written or oral agreement
between parties involving an enforceable promise to do
or refrain from doing something. In agriculture, contracts
are agreements between farmers and companies or other
farmers that specify conditions of production and/or marketing
of an agricultural product. By combining market functions,
contracting can reduce industry participants' exposure
to risk. Contracts can specify not only quality requirements
but also price and quantities. The form of the contract,
specific provisions, and terms can vary greatly among
commodities, and among producers of the same commodity.
The degree of control that a contractor has over a farmer's production
decisions varies depending on the type of contract. There are generally
two types of contracts—marketing and production contracts.
Marketing contracts refer to verbal or written agreements between
a contractor and a grower that set a price (or pricing mechanism)
and an outlet for the commodity before harvest or before the commodity
is ready to be marketed. Most management decisions remain with the
growers since ownership is retained while the commodity is being
produced. The contractee also assumes all risks of production, but
shares price risk with the contractor. Marketing contracts can take
many forms such as:
- Forward sales of a growing crop where the contract provides
for later delivery and establishes a price or contains provisions
for setting a price later
- Price set after delivery based on a formula that considers
grade and yield
- Preharvest pooling arrangement where the amount received is
determined by the net pool receipts for the quantity sold.
A distinguishing characteristic of production contracts is that
they specify in detail the production inputs supplied by the contractor
(processor, feed mill, other farm operation or business), the quality
and quantity of a particular commodity, and the type of compensation
to the grower (contractee) for services rendered. Since contractors
control the amount produced and the production practices that are
used, they tend to dominate the terms of the contracts. One advantage
of production contracts is that the grower and contractor share
risks of both production and marketing of the commodity. Another
advantage of the production contract arrangement is that financing
is available either directly from the contractor or indirectly through
other lenders who are more assured of loan repayment.
Farmers themselves can be contractors. Most often a farm business
will contract for another farmer to complete a stage of production
in the raising of livestock. The farmer, as contractor, can then
specialize in one of the stages of production, and pay another producer
to either provide young animals or finish the production cycle.
For more information, see "Agriculture
and the Rural Economy: Contracting Changes How Farms Do Business."
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