This post is Part VI of my reports using the USDA's breakdown of farm sizes, incomes, and production. Contract farming accounts for 40% of all production. It is commonly used for production of poultry, peanuts, tobacco, sugarbeets, dairy products, and hogs and is more common on the largest family and nonfamily farms based upon production numbers. It is less prevalent in wheat, soy, and corn producing farms.
A contract is a legal agreement between a farm operator (contractee) and another person or firm (contractor) to produce a specific type, quantity, and quality of agricultural commodity. Farmers typically use two types of contracts, marketing contracts and production contracts.
Marketing contract. Ownership of the commodity remains with the farmer during production. The contract sets a price (or a pricing formula), product quantities and qualities, and a delivery schedule. Contractor involvement in production is minimal, and the farmer provides all the inputs. For crops, the contract is finalized before harvest. For livestock, the contract is finalized before the animals are ready to be marketed.
Production contract. The contractor usually owns the commodity during production, and the farmer is paid a fee for services rendered. The contract specifies farmer and contractor responsibilities for inputs and practices. The contractor often provides specific inputs and services, production guidelines, and technical advice. In livestock contracts, for example, contractors typically provide feed, veterinary services, transportation, and young animals. The contract is finalized before production of the commodity.
Contracts can potentially provide benefits to both producers and contractors. Farmers get a guaranteed outlet for their production with known compensation, while contractors get an assured supply of commodities with specified characteristics, delivered in a timely manner.
Although contracts account for nearly two-fifths of U.S. agricultural production, the share varies by commodity. For example, U.S. farmers produce 85 percent of poultry under contract. Contracting also accounts for at least half of the production of peanuts, tobacco, sugarbeets, dairy products, and hogs. At the other extreme, only small portions of wheat, soybeans, or corn—all traditional field crops—are grown under contract. The aggregate data show slow and steady growth in contracting over the years, but change can be more rapid for some commodities. For example, the share of total agricultural production under contract grew by only 5 percentage points between 1996-97 and 2007, from 32 percent to 37 percent.
During the same period, however, the share of tobacco production covered by contracts went from less than 1 percent to 64 percent. Cigarette manufacturers replaced cash auctions with contract marketing because contracts better enabled them to acquire enough of the specific types of tobacco they needed.
The share of peanuts grown under contracts also increased rapidly, from 34 percent in 1996-97 to 63 percent in 2007. The 2002 Farm Act ended the peanut marketing quota established during the Great Depression. Quota owners received quota buyout payments and became eligible for the same type of Government payments received by other farmers. Peanut producers also managed price risk through marketing contracts with peanut shellers and other peanut buyers. The increase in the contracting share of hogs—from 34 to 65 percent—was of the same magnitude as the increase for peanuts.
Growth in hog contracting was driven in part by production differentiation. Processors wanted more control over the characteristics of the hogs they acquired, which helped them provide a consistent quality of meat to consumers.
The share of retirement and residential/lifestyle farms using contracts is relatively low, 2 and 4 percent, respectively. For the remaining types of family farms, the use of contracts increases with sales, ranging from 7 percent of low-sales farms to 57 percent of very large family farms. The share of their production under contract also increases with sales. Although a relatively small percentage of each small-farm type has contracts, small farms make up about half of the farms with contracts, reflecting the large number of small farms.
Production under contract, in contrast, is concentrated among large-scale family farms and nonfamily farms, which together account for 94 percent of the total. Very large family farms alone turn out 65 percent of the production under contract. Large-scale family farms and nonfamily farms also generate a 77-percent share of production not under contract—sold in the cash or spot market—with very large family farms alone accounting for 47 percent. Three commodities make up three-fourths of noncontract production in the United States: high-value crops (20 percent), cash grain (33 percent), and beef (22 percent).
Farms as Contractors
Farms can also serve as contractors. The 2007 ARMS questionnaire asked if any other operations produced livestock—including poultry—under a contract arrangement for the farm being interviewed. About 7,300 farms—less than 1 percent of all U.S. farms—reported acting as a contractor, but the percentage was higher (3 percent) for very large family farms.
Livestock valued at about $3.9 billion was placed on farms by contracting farms. Dairy herd replacements, other cattle, and hogs accounted for most of the placements.