Agricultural contracting, competition, and antitrust.

Two powerful and related trends in the organization of U.S. farming are: production is shifting to larger family farms and agricultural contracts are increasingly being used to guide the production and marketing of farm commodities. These combined structural changes affect productivity and costs in agriculture and in the broader food sector, and also affect the financial returns to farmers, benefiting some while harming others.

Structural changes have also led to initiatives, including legal challenges and legislative proposals, primarily in livestock industries, aimed at limiting the use or ameliorating some effects of contracts. Cattle feeders sued meatpackers over packers' use of contracts to influence prices in contract and cash market sales. (1) Congress passed, and USDA implemented, a law mandating price reporting of livestock and meat sales, aimed at improving the information available to market participants in the wake of sharp declines in cash market volumes and related voluntary reporting in the late 1990s. In the current Congress (109th), one bill (H.R. 4713 and S. 818) would prohibit, except within seven days of slaughter, packer ownership of livestock, or arrangements that give packers "supervisory, managerial, or operational control" of livestock. Another (S. 960 and H.R. 4257) would prohibit the use in livestock transactions of forward contracts that do not set firm prices in dollar terms (no formulas); forward contracts that cover more than 40 cattle or 30 hogs; and forward contracts that are not offered for bid in a public manner. A third (S. 2307) aims to alter the environment for livestock production contracts, by requiring clear statement of certain terms and by providing producers with rights concerning contract cancellation and bargaining associations, among other provisions.

Agricultural marketing and production contracts can be designed to limit competition in commodity markets; but they can also improve market efficiency by lowering production costs or ensuring expanded variety. Because contracts can produce societal benefits, it is important to distinguish harmful from beneficial features. In this paper, I describe how contracts can be used to limit competition, and link those conditions to antitrust policy tools. However, antitrust tools, focused on competition, are relevant to only a few of the issues created by contracts. Some issues are actually antithetical to antitrust as it is now applied; others, while important, are not remediable through antitrust. Attempts to use antitrust tools to attack the second and third sets of issues are likely to be ineffective.

The Growing Importance of Contracting in U.S. Agriculture

Contracting in U.S. agriculture can be summarized with data from USDA's Agricultural Resource Management Survey (ARMS), and from its predecessor, the Farm Costs and Returns Survey (FCRS). These annual surveys elicit information on farm finances, production practices, marketing decisions and outcomes, and farm household demographics and finances. (2)

Contracts covered 39% of the value of agricultural production in 2003, up from 36% in 2001 (table 1), with a strong long-run trend-contracts covered 28% of production in 1991--3 and 11% in 1969 (this last according to data gathered for the 1970 Agricultural Census).

The ARMS survey distinguishes marketing and production contracts. In production contracts, farmers provide grower services, and contracts delineate grower services, contractor responsibilities, and compensation. Contractors usually retain ownership of the commodity during production and provide key inputs, such as feed, pigs or chicks, and veterinary and transportation services for hog or broiler contracts, or seedlings and transportation for horticultural contracts. Marketing contracts focus on the commodity as delivered to the contractor. They specify a commodity's price or a mechanism for determining the price, a delivery outlet, and a quantity to be delivered. The pricing mechanisms may limit a farmer's exposure to the risks of wide fluctuations in market prices, and they often specify price premiums to be paid for commodities with desired levels of specified attributes (such as oil content in corn, or leanness in hogs). Growers retain primary control over production.

Table 1 shows that contracts, almost always marketing contracts, cover just under a third of crop production (production contracts are used for some seed production, as well as some vegetable and horticultural production). In contrast, contracts cover nearly half of livestock production, and production contracts cover about two-thirds of contract livestock production.(3)

Contracting is far more prevalent among larger farms--only one in ten farms use contracts, but contracts cover nearly 40% of production (table 1). Only 6% of farms with sales under $250,000 use contracts, and contracts cover one-fifth of their production (table 2). But nearly two-thirds of farms with at least $1 million in 2003 sales used contracts, and contracts covered over half of production from those farms.

Expanding contract coverage coincides with important and ongoing structural changes in agriculture. Those structural changes include:

* A sharp shift of agricultural production to larger family-operated farms, in most commodities, with an accompanying sharp decline of smaller commercial family farms (Hoppe and Banker 2006);

* Increasing concentration, often to just two to four competitors, among many buyers of agricultural commodities, usually accompanied by shifts to much larger plants. This shift is ongoing in livestock and poultry slaughter, and in grain processing and distribution industries, fluid milk processing, and retail supermarkets; and

* Increasing concentration in many ancillary input- and service-providing sectors, such as rail transportation, seeds, farm chemicals, and farm equipment sectors.

The structural upheavals reflect, in some and perhaps most cases, the exploitation of new scale economies (Buccola, Fujii, and Xia 2000; Key and McBride 2003; MacDonald et al. 2000; Ollinger, MacDonald, and Madison, 2005; Morrison-Paul, Nehring, and Banker, 2004; Mosheim 2006). As such, structural change can lead to lower costs, lower prices to consumers, and higher returns to resource providers; it also leads to lower returns for those competing producers who do not adapt to new technologies.

Increased concentration, associated with many of the sector's structural changes, may lead to increased market power, expressed as the ability of sellers to raise prices above, or of buyers to reduce prices below, competitive levels. (4) But the linkage between concentration and the exercise of market power is conditional on many other factors, including entry barriers into a market, the alternatives available to those facing potential market power, and the nature of the product being sold. Theory and empirical evidence show that there is no simple monotonic relationship between concentration and market power. (5)

Contracting enters in complicated ways. Contracts may help to exploit scale economies by assuring the commitment, to provide or accept large commodity flows, that participants and their lenders may need before investing in large, capital intensive production facilities. Or, some differentiated agricultural products, such as specific varieties of hogs, lambs, corn, or flowers, may be highly specific to one buyer; and producers, concerned with the hold-up risk that the buyer would seek to drive prices to variable costs after the producer commits, might then seek the assurance of a contract before committing to production for one purchaser. But contracts can also help buyer or sellers realize market power in concentrated markets.

Structural change and contracting thereby have varied impacts on market participants.

They may improve efficiency through increased productivity, either through the exploitation of scale economies that reduce costs or through the provision of valued varieties that would be otherwise unavailable. Improved efficiency benefits consumers, may benefit some resource providers (as reduced retail price leads to increased consumption), and usually harms non-adopters.

* Contracting may make some marketing channels less viable if channel costs have scale economies and contracting shifts volumes away from other channels. In brief, this is the theory of mandatory livestock price reporting (Perry et al. 2005). Here, contracting provides benefits but generates externalities (Roberts and Key 2005).

* The larger antitrust and industrial organization literature contains numerous examples of the use of contracts to create or exploit market power. In these cases, contracts benefit the monopolist seller or monopsonist buyer, and harm other participants in the supply chain. We turn to those applications now.

Contracts and Antitrust Tools