Agricultural Contracting Update: Contracts in 2008
by James MacDonald
and Penni Korb
Economic Information Bulletin No. (EIB-72) 43 pp, February 2011
What Is the Issue?
Formal contractual arrangements in agriculture are substitutes
for spot market (cash) sales of farm commodities and now account
for 40 percent of the value of U.S. agricultural production.
Marketing and production contracts are reached prior to harvest (or
before the completion stage for livestock). Marketing contracts
govern the terms of exchange for sales of products from the
farm-the product to be delivered; the quantity, location, and time
window for delivery; and a price or pricing formula. Production
contracts govern an entire production process-farmers are paid a
fee to grow an animal or crop for a contractor who provides some
production inputs and who removes the product from the farm for
processing or marketing at the close of the production cycle.
Contracts can have many beneficial effects. They can help
farmers manage price and production risks, they can elicit the
production of products with specific quality attributes by tying
prices to those attributes, and they can smooth flows of
commodities to processing plants, thus encouraging more efficient
use of farm and processing capacities. But contracts can also have
less benign effects. They can introduce new and unexpected risks
for farmers-in some circumstances, they can extend a buyer's market
power-and they can effect fundamental changes in how farming is
organized and carried out.
This study updates previous ERS research by tracking the use of
contracts in U.S. agriculture through 2008. It also provides
detailed analyses of contract use in three areas:
- Hog and poultry production, where production contracts
- Major field crop production, where the use of marketing
contracts has expanded.
- Peanut and tobacco production, which has experienced a shift to
marketing contracts following major changes in Government
In each case, ERS analyzes the functions filled by contracts,
their design, and their adoption and impacts.
What Did the Study Find?
- Agricultural contracts covered 39 percent of the value of U.S.
agricultural production in 2008, compared with 28 percent in 1991
and 11 percent in 1969. In 2005, however, contracting covered 41
percent of production. The inter-year decline in the use of
contracts after 2005 largely stemmed from a change in the
composition of agricultural production, as prices and revenues rose
for commodities less reliant on contracts.
- Contracts are more widely used in some commodities than in
others. In 2008, contracts covered 90 percent of poultry production
and 68 percent of hog production. They also covered 90 percent of
sugar beet and tobacco production. Contracts are much less
prevalent in corn (26 percent of production), soybeans (25
percent), and wheat (23 percent), although use of contracting in
each of those field crops grew by at least 10 percentage points
between 2001 and 2008.
- Hog and poultry operations rely heavily on production
contracts-which specify services provided by producers-but with
important distinctions between the two industries. Hog contract
enterprises are usually part of larger, diversified farming
businesses, with the hog segment providing a relatively small share
of the farm income. The farmers typically have a range of
alternative outlets for contract hog production, and farm
diversification provides a range of alternative uses for their own
time. Farm households that engage in contract hog production have
relatively high incomes compared with other households-both farm
- In contrast, contract broiler enterprises are likely to be part
of smaller and less diversified farm businesses, and many broiler
operations have only a single contractor in their area. As a
result, their farm businesses are much more dependent on contract
production, and their income from contract production is much more
dependent on a single buyer. Operators of broiler farms have lower
household incomes, on average, than operators of hog farms, and
they depend far more on off-farm employment and income.
- Corn, soybean, and wheat producers who use contracts tend to be
larger producers who use marketing contracts to cover a substantial
share of production. For these producers, marketing contracts-which
focus on the commodity delivered rather than the services
provided-are used to manage price risks in combination with cash
sales, financial hedges, and storage options. Less than 20 percent
of corn, wheat, and soybean production comes from farms that are
fully exposed to cash markets for marketing options.
- Because larger farms tend to earn higher returns than smaller
farms, production is expected to continue to shift to larger
operations and to contracts. Contracting, however, is driven not
only by expanding farm sizes but also by market developments that
alter farmers' marketing risks.
For example, Federal marketing programs for tobacco and peanuts
limited price fluctuations for those commodities. Marketing
contracts also help farmers to manage price risks; but as long as
Federal programs limited such risks, farmers had little interest in
marketing contracts. After Federal programs were terminated,
however, and producers faced significant spot market price risks,
contract production in peanuts and tobacco increased sharply.
Marketing contracts in tobacco are also designed to better align
prices to product qualities that buyers desire, and this feature
played a role in processors' desire to shift to contracts. Thus,
farmers turn to contracts when they perceive the efficacy of spot
markets to be inadequate in handling their risks, and processors
turn to contracts as a way to encourage farmers to produce specific
products at desired times.
How Was the Study Conducted?
The analysis primarily draws on data from USDA's Agricultural
Resource Management Survey (ARMS), a joint effort conducted
annually by ERS and USDA's National Agricultural Statistics Service
(NASS). ARMS is USDA's primary source of information on the
financial condition, production practices, resource use, and
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
NASS, provides contract data back to 1969.