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Agricultural Contracting Update, 2005
James M. MacDonald and Penni Korb
Economic Information Bulletin No. (EIB-35) 37 pp, April 2008
Most transactions for U.S. agricultural products are conducted through spot market
exchanges in which commodities are bought and sold for immediate delivery. But a growing
share of U.S. farm production is produced and sold under agricultural contracts. Such
contracts between farmers and their buyers are reached prior to harvest (or before the
completion stage for livestock), and govern the terms under which products are transferred
from the farm.
What Is the Issue?
Contract use is growing. Agricultural contracts covered 41 percent of the value of U.S.
agricultural production in 2005, up from 39 percent in 2003, 36 percent in 2001, 28 percent
in 1991, and 11 percent in 1969. Use of contracts is closely tied to farm size; large
farms are far more likely to use contracts than small farms.
Contracts lower the costs of large-scale commercial agriculture, and hence help to drive
production toward larger operations. Contracts are also widely used to guide the production
of differentiated agricultural products, such as specialty grains, organic poultry, or
heirloom hog breeds. Contract production is expected to continue to expand, as consumer
demand for differentiated products grows, and as large family farms encompass
growing shares of production.
What Did the Study Find?
Formal contractual arrangements cover a growing share of U.S. agricultural production.
Contracting is closely tied to other features of structural change in agriculture, including:
- shifts of production to larger farms;
- greater product differentiation; and
- more onfarm specialization.
Agricultural contracts compete with spot markets. Farm commodities may be traded
under contracts when spot markets do not function well, so choices between contract
and spot markets reflect spot market performance as well as contract features.
Contracts can be used to manage price risks, smooth the flow of commodities through
the marketing system, provide stronger incentives to produce specific product varieties or qualities, or elicit the capital investments necessary to realize economies of scale in production. But contracts can also create new risks for producers, and they can extend a buyer’s market
power by driving commodity prices below competitive levels.
Contracts cover some commodities much more than others. Taken together, hogs and poultry (including
broilers, turkeys, and eggs) account for nearly 40 percent of all contract production. That is nearly double
the hog/poultry share of all agricultural production. The pattern is reversed for major field crops (corn,
cotton, soybeans, rice, and wheat). The major changes in the organization of livestock and poultry production
in the United States also encompass important shifts to various kinds of contractual relationships.
Hog and poultry production rely heavily on production contracts, but with important distinctions between
the two. Hog contract enterprises are usually part of larger, diversified farming businesses, with the hog
enterprise providing a relatively small share of the farm income. The farm operators typically have a range of
alternative outlets for hog production and for the operators’ time. Farm households that engage in contract
hog production have relatively high incomes compared with other households—both farm and nonfarm.
In contrast to contract hog operations, contract broiler enterprises are likely to be part of smaller and less
diversified farm businesses. Most broiler operations report that they are dependent on a single contractor
for broilers. The households that operate broiler farms depend far more, on average, on off-farm employment
and income than do households who operate hog enterprises.
As for field crops, most producers do not use contracts. But the corn, cotton, rice, soybean, and wheat producers
who do use them tend to be larger producers who use marketing contracts to cover a substantial
share of production. While marketing contracts may be used for specific thinly traded products, they also can
smooth out price fluctuations and reduce income risks for producers of more widely traded commodities.
Because larger farms tend to earn higher returns than smaller farms, production would be expected to
continue to shift to larger operations and to contracts. However, contracting is not driven only by expanding
farm sizes, but often results from market developments that alter farmers’ marketing risks. For example,
contract production in peanuts and tobacco increased sharply after Federal marketing quotas for those
commodities were terminated, increasing the likelihood of sharp market price fluctuations that would
increase price risks. By contrast, spot market transactions for cattle increased at the expense of contract
transactions after mandatory price reporting improved spot markets by providing deeper information.
Thus, farmers’ use of contracts also depends on the efficacy of spot markets in handling risks and providing
incentives to produce specific products at desired times.
How Was the Study Conducted?
The analysis primarily draws upon data from the Agricultural Resource Management Survey (ARMS) of U.S.
farms, which is USDA’s primary source of information on the financial condition, production practices and
resource use, and the economic well-being of U.S. farm households. The survey asks farmers about the use of
production or marketing contracts and the volume of production and receipts for each commodity under contract.
ARMS has been conducted annually since 1996. The Farm Costs and Returns Survey (a predecessor to
ARMS) provides contract data back to 1991, and the Census of Agriculture, conducted by USDA’s National
Agricultural Statistics Service (NASS), provides contract data back to 1969.
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