The desire for specific attributes in agricultural products
is making contracts the method of choice for moving products through
the production and marketing system. These attributes cover everything
from oil content in corn, which affects feed digestion, to the weight
of market hogs, because uniform weights can reduce processing costs.
Other examples include milk produced according to organic standards,
or attributes tied to a product’s delivery, such as a certain
volume of peas provided during a specified time window, that can
reduce processing costs and better meet consumer demands.
Buyers—processors, elevators, and retailers—use
production contracts to control input choices and production methods.
They also use marketing contracts that offer farmers price premiums
for desired attributes. Farmers can benefit from contracting as
well, in that contracts can reduce income risks, ease credit requirements,
and provide higher prices for providing specific product attributes.
But there are downsides to contracting. Specific features
of contracts, like requiring use of a specific feed ration, can
limit farmers’ decisionmaking freedom. Contracts can reduce
volumes traded on spot markets (where individual buyers and sellers
agree to a price at the time the product changes hands), thereby
increasing price volatility and risks of trading in spot markets.
They can also be structured to limit competition among buyers.
An observed expansion in contract use is closely tied
to consolidation in agriculture. Among farms with at least $500,000
in annual sales, 61 percent used contracts for at least some of
their production in 2001, compared with only 8 percent of farms
with sales under $250,000. Because most farms are small, only 11
percent of all farms used contracts in 2001, up from 6 percent in
1969. But because large farms account for most agricultural production,
contracts cover a large and growing share of production—36
percent in 2001, up from 12 percent in 1969 and 28 percent in 1991.
The use of contracts can spread rapidly through an industry.
Virtually nonexistent in tobacco marketing in 1999, contracts covered
half of 2001 production and almost 100 percent of 2002 production.
In just 5 years, from 1996 to 2001, contract coverage grew from
one-third to two-thirds of hog production, as spot markets commensurately
diminished. By 2001, contracts covered 54 percent of cotton and
39 percent of rice production, compared with 30 percent and 20 percent,
respectively, in 1991.
Growing demand for specific product attributes should
lead to continuing expansion of contracting. In turn, spot markets
will come under continuing pressure to adapt to the challenge posed
by the contracting alternative, by providing better means of defining,
measuring, and communicating product attributes.
Download PDF version