Agricultural Economic Report No. (AER-837) 81 pp

November 2004

Contracts, Markets, and Prices: Organizing the Production and Use of Agricultural Commodities

Production and marketing contracts govern 36 percent of the value of U.S. agricultural production, up from 12 percent in 1969. Contracts are now the primary method of handling sales of many livestock commodities, including milk, hogs, and broilers, and of major crops such as sugar beets, fruit, and processing tomatoes. Use of contracts is closely related to farm size; farms with $1 million or more in sales have nearly half their production under contract. For producers, contracting can reduce income risks of price and production variability, ensure market access, and provide higher returns for providing differentiated farm products. For processors and other buyers, vertical coordination through contracting is a way to ensure the flow of products and to obtain differentiated products, ensure traceability for health concerns, and guarantee certain methods of production. The traditional spot market-though it still governs nearly 60 percent of the value of agricultural production-has difficulty providing accurate price signals for products geared to new consumer demands, like produce raised and certified as organic or for identity-preserved crops modified for special attributes. We are likely to see a continuing shift to more explicit forms of vertical coordination, through contracts and processor ownership, as a means to ensure more consistent product quantity and quality.

Keywords: contracts, contracting, marketing contracts, production contracts, vertical integration, vertical coordination, market structure, risk analysis, price signals

In this publication...