Agricultural Contracts and Alternative Marketing Options: A Matching Analysis

Article excerpt

The increasing use of agricultural contracts and processor concentration raises concerns that processors may offer lower contract prices in absence of local competition. This study examines the price competitiveness of marketing and production contracts depending on the availability of alternative marketing options. A propensity score matching method is used to compare prices using contract data from a farm-level national survey. The results show that the absence of other contractors or spot markets in producers' areas does not lead to statistically significant price differences in agricultural contracts for most commodities, providing evidence that most agricultural processors do not exercise market power by reducing prices when other local buyers are not available.

Key Words: agricultural prices, alternative marketing options, local competition, marketing contracts, production contracts, propensity score matching

JEL Classification: Q13

Some of the key trends in the industrialization of U.S. agriculture include tighter supply chains with greater concentration of production on a decreasing number of farms, more vertical coordination in the production and marketing system, and significant concentration downstream from the farm (Ahearn, Korb, and Banker, 2005). The increased use of agricultural contracts is one of these significant structural changes in organizing the production and marketing of crop and livestock commodities. For instance, in 2003 producers used marketing and production contracts to market 39% of the value of U.S. agricultural production, up from 28% in 1991 and 1 1% in 1969 (MacDonald and Korb, 2006). According to United States Department of Agriculture statistics, the concentration of the food manufacturing industry has also been increasing with the mean industry four-firm concentration ratio increasing from 35% in 1982 to 46% in 1997. An important policy question is whether the increased concentration in the processing industry and the increased use of agricultural contracts are a desirable result of cost efficiencies in production or the undesirable effect of market power from the agribusiness processors (Ahearn, Korb, and Banker, 2005).

Agricultural contracting is typically studied using the principal-agent economic framework. In this framework, using contracts instead of spot markets can include improved risk management and reduce production and transaction costs. Despite these benefits, the increased use of agricultural contracts raises concerns that contractors may exploit market power by deterring other contractors from entering a local market, setting quality standards and timing of input provisions for production contracts, or by reducing the prices paid for agricultural commodities, especially when there is little competition from other local buyers. MacDonald et al. (2004) argue that there is little evidence that contractors interact with each other or control spot market prices. Yet contracting in the livestock industry is particularly controversial where a few meatpackers handle most of the livestock purchases while quantities sold on the spot markets continue to decrease. In response to these concerns, Congress has passed laws and considered proposals in an effort to regulate livestock contracts and require mandatory price reporting.

The literature examining agricultural contracts is relatively small mostly due to the fact that data on commodity contracts are scarce. Most empirical studies examining marketing and production contracts have explained the factors affecting the adoption of various types of contracts (e.g., Davis and Gillespie, 2007; Katchova and Miranda, 2004) or have made comparisons between contract and independent producers (e.g., Key, 2004, 2005; Wang and Jaenicke, 2006; Xia and Sexton, 2004; Zhang and Sexton, 2000). Many studies have examined market power in the processing industries, finding that processors exercise market power but the price distortions are small in magnitude. …