Understanding Contract Agriculture


Why do production contracts matter? The act of signing a contract in an agricultural transaction itself isn’t the problem. It’s the way the industry and the corporate monopsony powers have used these contracts to primarily benefit their bottom line, and shift production risks onto farmers, that is the real problem.

The Status of Agricultural Contracting in the US

As of 2012, 34.8% of the value of U.S. agricultural production was governed by production or marketing contracts, up from 11% in 1969 [1][2]. These contracts are made between a farmer and a contractor (another person or company, such as a processor) for the production of agricultural commodities. In theory, contracts can benefit both parties, but in some cases, and in the poultry sector in particular, the structure of the industry allows agribusiness to set contract terms that take advantage of farmers and federal subsidies while externalizing costs and risk.

The vast majority of chickens produced in the U.S. – 96%, according to the 2012 Census of Agriculture – are raised under production contracts, which set terms for how the chickens are raised, which inputs the farmer and the company provide, and how the farmer is paid. Marketing contracts, on the other hand, determine how the farmer is paid and other terms of sale, but leave the production process to the farmer. Marketing contracts are more common for crops, while poultry and livestock are more often produced under production contracts. The USDA describes these types of contracts as follows:

“Production contracts specify services provided by a farmer for a contractor who owns the commodity while it is being produced. The contract covers (1) the services provided by the farmer, (2) the manner in which the farmer is to be compensated for the services, and (3) the specific contractor responsibilities for provision of inputs. For example, farmers provide labor, housing, and equipment under livestock and poultry production contracts, while contractors provide such other inputs as feed, veterinary and livestock transportation services, and young animals.”

“Marketing contracts focus on the commodity as it is delivered to the contractor, rather than on the services provided by the farmer. They specify a commodity’s price or a mechanism for determining the price, a delivery outlet, and a quantity to be delivered. The parties in a marketing contract agree to its terms before harvest or, for livestock, before transfer.” [3]

Poultry contracts are the classic example of how contracts can undercut farmers. Poultry companies are vertically integrated – they control every stage of the supply chain, from feed mills to hatcheries to processing plants, and production contracts allow them to plug farms into that supply chain and to dictate the production process without investing in the facilities and capital it requires.

As of 2013, the top three companies – Tyson, Pilgrim’s, and Perdue – accounted for about half of U.S. poultry slaughter, and the top 20 accounted for 96% [4].

Under this system, poultry growers contract with poultry companies, called integrators because they collect birds from many individual farms into a single central processing plant. Growers provide the facilities, or chicken houses, in which the birds are raised, as well as labor and utilities for growing the chickens. The integrator provides chicks, feed, medicine, and technical support. On the farmer’s side, chicken houses represent a substantial upfront investment, with the average operation, which consists of four houses, being valued at about $1 million [5]. Once they have made this investment, their ability to walk away from contract production is severely limited – in many cases, chicken houses are built with loans, and a contract is the only feasible way to produce and market enough chicken to service loan debts. This leaves the farmer vulnerable to the risk of contract termination, changes to their contract terms, and integrator demands.

An individual farmer has little ability to negotiate with one of these companies. The small number of integrators means that chicken farmers have few options for obtaining and negotiating production contracts. According to the USDA’s 2011 ARMS survey, 21.7% of contract poultry farms are located in an area with only a single integrator [4]. Worse still, a 2012 study by USDA economists James MacDonald and Nigel Key found that growers in areas with only one integrator were paid an average of 7-8% less than those in areas with four or more integrators [6].

 

Want to Know More?

References

  1. USDA Economic Research Service. 2012 Agricultural Resource Management Survey: farms with contracts by farm typology, 2012. From Farm Structure and Organization: Background on Farm Organization.
  2. Hoppe, Robert A. Structure and Finances of U.S. Farms: Family Farm Report, 2014 Edition, EIB-132, U.S. Department of Agriculture, Economic Research Service, December 2014. .
  3. MacDonald, James M., and Penni Korb. Agricultural Contracting Update: Contracts in 2008. EIB-72. U.S. Dept. of Agriculture, Econ. Res. Serv. February 2011. .
  4. MacDonald 2014. Technology, Organization, and Financial Performance in U.S. Broiler Production, EIB-126, USDA Economic Research Service.
  5. MacDonald 2014. Financial Risks and Incomes in Contract Broiler Production. USDA Economic Research Service, Amber Waves.
  6. MacDonald & Key 2012. Market Power in Poultry Production Contracting? Evidence from a Farm Survey. Journal of Agriculture and Applied Economics 44.4(Nov. 2012): 477-490.