February 15, 2006 | By: Aimee Nielson
LEXINGTON, KY.

According to a recent U.S. Department of Agriculture study, agricultural contracts are covering an increasing share of farm production. Up to 10 percent from just 12 years ago, contracts now govern about 39 percent of the value of U.S. production.

University of Kentucky Agricultural Economist Larry Jones said contracts are increasingly common in the livestock sector, particularly broilers and turkeys, but increasing rapidly in swine and dairy.

“Major crops under some form of contracting include fruits and vegetables and tobacco,” he said. “But contracting the major grain and oilseed crops is also increasing, just at a slower rate.”

The use of contracting is more common among larger farms, or those selling more than $1 million per year in agricultural products. Jones said nearly two-thirds of these larger farms use contracting. By contrast, only 20 percent of farms selling less than $250,000 each year use contracting.

“Contracting can take two forms,” Jones explained. “One is a production contract and that is most common in poultry and hog operations where a producer provides mostly service, like labor, but the animals are owned by a contracting firm and the contractor provides major inputs, like feed.” 

Jones said the second form of contracting is referred to as a marketing contract.

“Here the emphasis is on the commodity as it is delivered, rather than the services that a producer provides,” he said. “These contracts specify the price, a delivery outlet and usually some form of quality specification. Tobacco and fruit and vegetable contracts are common examples of a marketing contract.”

Farmers may use contracts for many reasons; however, the most common reason is to reduce the risk of price swings. Jones said that farming is a risky business that is often made riskier by weather and fluctuating input and commodity prices. Contracts are one way the producer can share the risk with another party – the contractor, he said.

“With a contract, the farmer knows the selling price in advance for various quality grades,” he continued. “So, the risk of an adverse change in market prices is reduced, if not eliminated. The same argument applies on the purchase of inputs. You can lock in the price for buying an input, rather than face the risk of price increases later.”

If contracting takes away the guesswork, why do some farmers choose not to contract? Jones said the biggest reason is a loss of independence because contracts often limit farmers’ control over their business. Jones said that contracts can also limit a farmer to one buyer or contractor and the farmer risks harvesting crops or producing animals that fall below the contracted quality or quantity specified in most contracts.

“Contracts are not for all producers, but they do offer a means for reducing price risk to those who choose to use them,” Jones concluded.

 

Contact: 

Larry Jones (859) 257-7289