U.S. farmers use contracts in many different ways. Some farmers use contracts (verbal or written) to rent land. For example, nearly 2/3 of commercial farmers in the U.S. rent land. Other farmers use contracts to out-source part of their production or marketing programs. Examples include custom hiring at harvest or hiring trucking companies to move grain and livestock to market. Of course a more recent form of contacts involve contracting for the marketing of commodities.
Today, more than 1/3 of the value of agricultural production is sold under some form of contract and that compares to 12% being under contract 25 years ago. Of course, production and marketing contracts have been very common in poultry and many fruit and vegetable enterprises. In more recent years, contracting has rapidly expanded in hogs, dairy, grains and oilseeds and tobacco. The U.S. Department of Agriculture reports that larger farms (those with sales greater than $500,000 per year) are more likely to use contracts than smaller farms. But larger farms produce by far the largest share of food and fiber production in the U.S. So smaller farms are less likely to use contracts, but their share of total farm production is quite small. The USDA also reports that more than half of the livestock sold in the U.S. is under contract while about ¼ of row crops are covered under contract.
Buyers, such as processors, are using contracts to control various aspects of production from inputs to use, production practices and the form of the final farm product they wish to buy. Often processors are looking for specific attributes in the products they buy and contracts are one way to help guarantee that the processor can get the product their customers are looking for. These attributes can include such things as moisture, oil content, weights of animals, grades of tobacco, etc.
However, the use of contracts does have it downside: For example specific feature production contracts may limit the decision making that a farmer may exercise in the production process. This characteristic in contracts is very common, for example, in countries such as Brazil and even in the U.S. with contracts in poultry as an example. The expanded use of contracting has meant that the volume of commodities being sold on spot markets (such as elevators for grain, stockyards for livestock or auction markets for tobacco) is much less thereby increasing the chances for more price volatility and higher market risk by selling on these spot markets.
The trend toward more contracting is expected to continue in agriculture. It will, in large part, be driven by continued buyer insistence on buying specific product attributes that the consumers of the final product are demanding.