The Role of Contracts in the Organic Supply Chain: 2004 and 2007
by Carolyn Dimitri, Lydia Oberholtzer, and Michelle Wittenberger
Economic Information Bulletin No. (EIB-69) 45 pp, December 2010
Contracts are widely used for marketing agricultural products,
particularly when buyers seek products with specific attributes.
Economic research indicates that, under certain circumstances, both
suppliers and buyers can benefit from using contracts. The
production, handling, and marketing of organic products follow a
distinct process, as specified by the National Organic Standards.
For products to carry an "organic" label, their production and
handling processes must be certified by an accredited third-party
inspector. Retail sales of organic products have been increasing
rapidly, and the market has faced periodic shortages of some
What Is the Issue?
Contracts can be designed to provide suppliers with incentives
to deliver products with attributes desired by buyers. Conditions
in the organic sector suggest that organic handlers (i.e.,
processors, distributors, manufacturers, repackers), as well as
their suppliers (i.e., producers or other handlers), may
potentially benefit from contracts, given growth in demand for
organic products, short supplies, and the need for certification.
Previous research, however, has not investigated the use of
contracts in the organic sector. Data from two Economic Research
Service (ERS) surveys of certified organic handlers (or
intermediaries) provide insight into the extent of contracting in
the organic sector, the rationale for using contracts, and reasons
for contract termination. Other key questions relate to specific
terms of contracts, including whether buyers offer suppliers
assistance, how quality is specified in contracts and then
measured, how prices are determined, and the frequency of contract
What Did the Study Find?
In 2007, contracts were used chiefly to procure needed products,
particularly those in short supply. The next factor leading to
contract use is the desire to source products with specific quality
attributes. Large firms were more likely to use contracts for
procurement. Assistance offered by contractors to suppliers
typically included transportation or technical advice on organic
standards. Contractors rarely assisted suppliers with obtaining
organic certification or with the transition to organic.
Exploring contract use for a group of 13 commodities, the
analysis examines provisions on quality, organic certification
verification, and pricing. Nearly all contracts required firms to
provide evidence of organic certification. Most contracts included
provisions regarding quality, with the most common provision being
minimum quality standards. Best management practices, which can
have a significant impact on final product quality, are specified
in some contracts for nearly all products (except for nuts). Some
contracts impose a penalty for low quality (typically in corn,
soybean, and seed contracts, such as those used by farmers for
raising crops), while others offer a premium for high quality
(typically in milk, coffee, and wheat contracts).
Quality verification was an essential component of contracts,
and the verification method depended largely on whether quality was
observable. Grain quality has both observable and unobservable
attributes, so verification consists of both physical observation
and testing for specific attributes. Because the quality attributes
for coffee and milk are largely unobservable, nearly all quality
verification is done through testing.
The methods for determining contract-specified prices paid to
suppliers vary by product. The market price for organic products
was specified most often in contracts for apples/pears, coffee, and
seeds. Quantity discounts were part of contracts for nearly all
products, except for berries, and were most common in seed, wheat,
rice, and tomato contracts. Flat prices were specified most often
for onions/garlic, poultry, and grains. Flat prices that depended
on the supplier's past performance were most prominent for seeds,
coffee, apples/pears, berries, grapes, onions/garlic, and
How Was the Study Conducted?
The analysis is based on data collected when ERS conducted
nationwide surveys of certified organic processors, manufacturers,
and distributors for 2004 and 2007 practices. The surveys were
funded by a cooperative agreement with USDA's Risk Management
Agency and were developed in conjunction with a group of organic