Contracts, Markets, and Prices: Organizing the Production and Use of Agricultural Commodities
by James M. MacDonald
, Janet Perry, Mary Ahearn, David E. Banker, William Chambers, Carolyn Dimitri, Nigel Key
, and Kenneth Nelson
Agricultural Economic Report No. (AER-837) 81 pp, November 2004
Production and marketing contracts cover a growing share of U.S.
agricultural production. These formal written contracts are
increasingly used in place of spot markets, where commodities are
bought and sold for immediate delivery, to set prices for
agricultural commodities and market them, as well as to govern
product quality, quantity, and production techniques. The expansion
of contracting is closely tied to other developments in
agriculture, such as increasing farm size, greater demand for
customized products, and tighter product monitoring from production
What is the issue?
Contracts can provide farmers with important benefits, such as
reduced income risks, easier access to credit, or higher prices for
products with special attributes. For buyers, contracts can deliver
products with desired qualities that reduce processing costs or
fulfill consumer demands. But the use of agricultural contracts may
also carry costs. They limit farmers' decisionmaking freedom, and
they may lead farmers to exchange price risks in the market for
unexpected contract risks. By reducing spot market volumes,
contracts can increase the risks of trading in spot markets,
raising costs and undermining the value of traditional USDA price
reports (which are useful only to the extent that they provide
information about products moving through the whole system).
Finally, some observers argue that contracts allow buyers of
agricultural commodities to exploit market power and reduce prices
paid to farmers.
This report assesses what we know about agricultural contracting
in the United States. It synthesizes existing analyses to evaluate
contracting's effects on risk, productivity, market power, and
What did the study find?
• Contracts governed 36 percent of the total value of U.S.
agricultural production in 2001, up from 28 percent in 1991 and 12
percent in 1969.
• Spot markets still dominate the sales of major grain and oilseed
crops like corn, wheat, and soybeans.
• Contracts dominate poultry, hog, sugar beet, and tobacco markets
and cover from a third to a half of fruit, vegetable, cotton, and
• Contracts are more likely to be used by larger producers and for
products with special attributes, such as corn or soybeans with
high oil content or animals raised on organic feed.
• While overall data for agriculture show steady expansion in the
use of contracts, dramatic shifts can occur quite quickly for
specific commodities. Tobacco and hogs each turned to widespread
use of contracts in just a few years, and producers expect a sharp
expansion of contracting in fed cattle.
• A major benefit of contracts is that they often offer higher
prices than farmers could receive in spot markets. Although
contracts can be designed to greatly reduce growers' risks from
price fluctuations, the study finds that producers may contract
mainly to secure higher prices for delivering products with desired
(and often higher cost) attributes. Well-designed contracts also
often lead to increased productivity, either by cutting production
or processing costs or by enhancing product value, with only
secondary attention to risks.
• Contract terms may, under some market conditions, allow buyers
to impose lower prices on producers. The exercise of market power
is of real concern in contract markets, which are often
concentrated markets with few buyers. But because contracts can
enhance productivity and response to consumer demand, broad actions
to ban or limit their use may raise production costs and reduce
demand for farm products. Thus, it is important to identify
contract terms that extend market power without reducing
• Contracting may complicate market price reporting. The growth of
contracting has affected USDA's voluntary price reporting program
for livestock, resulting in a drop in the number of transactions
whose prices are reported. This report looks at the early effects
of the government's imposition of mandatory reporting of livestock
prices in contract and spot transactions. After overcoming some
early transition challenges, USDA mandatory livestock price reports
now cover a much larger volume of transactions than the voluntary
reports were capturing. Deeper and more accurate livestock price
reports have yet to reverse the shift to more widespread contract
use, however, because contracts may continue to more reliably tie
prices to product attributes.
• Contracting creates an ongoing challenge for government policy.
To meet their own food safety, product attribute, and environmental
goals throughout their supply chains, processors and retailers can
use agricultural contracts to control many farm-level production
processes. The expanded use of contracts raises several issues for
government regulatory agencies with responsibility for ensuring
food safety, food attributes, and environmental control. For
example, should contractors bear financial liability for food
safety or environmental failures at contractee farms? When should a
contract be taken as evidence of compliance with public
regulations, allowing regulatory agencies to shift inspection
resources to facilities or activities that pose higher risks to
health and the environment?
How was the study conducted?
The report relies extensively on data collected through USDA's
annual Agricultural Resource Management Survey (ARMS), as well as
on predecessor surveys, to provide a comprehensive picture of how
contracts are used. The report then synthesizes existing analyses
of agricultural contracting to evaluate its effects on risk,
productivity, market power, and price discovery. This synthesis
makes it possible to arrive at conclusions that no single or small
set of studies can support. It also suggests areas where further
research would be valuable.