Put every dime of portable personal net worth on the line. Work hard all season. Watch the weather and watch your animals. Keep your fingers crossed. Pray.
And then hope the market's got a good price for you in the end. If not, hope you'll keep enough to start all over again the next year.
For many American farmers--and their lenders--this annual dice roll is still the state of the art in financial planning. It's a wonder that any of them can stand it.
Then along comes a new concept, "contract farming." While it dates back to the 1950s in some form, it has become of increasing interest, particularly to livestock farmers. It's become the rule in poultry, increasingly common in hogs, and, as packers keep consolidating, the coming thing in beef.
The idea is so simple, and initially very attractive. Instead of repeating the annual gamble, the farmer takes on the responsibility of raising livestock or a row crop "to order," generally at a price or price range agreed upon in advance. (See "The many shapes of contract farming" on page 26.)
More than meets the eye
To the bank lender, this concept seems like one of the few certainties of farm banking.
Contracting has its positive points, agrees Michael H. Firestine, senior vice-president, agriculture department, $766 million-assets Lebanon Valley Farmers Bank, Lebanon, Pa. However, it also has a darker side, Firestine warned.
"Your contract," he said, "is only as good as your contractor."
It's imperative the ag lender have a strong sense of the contractor's financial strength, lest both the farmer and the banker wind up holding the hog. But being a "good" contractor doesn't hinge only on financial health.
Firestine noted that contractors might inadvertently deliver sick animals that might infect contract herd. And then, there are multiple types of contracts that must be distinguished from each other for the producer's own understanding and protection. Firestine's overall caution: "If it's not good for the contractor, you won't see it."
Risks of contracting
Besides those risks already mentioned, Firestine added several others to the list of challenges that farmers face with contracts.
One is that, while there is generally price protection, there is usually no potential upside gain. Should market prices boom for some reason, the farmer will sit on the sidelines watching things improve for others but not himself.
Another problem is that contract payments take place in a bit of a vacuum. "Contract payments generally do not offset depreciation of equipment and buildings," said Firestine, which takes away some of the potential advantage. The farmer gets his price, but the contractor escapes the costs of worn out facilities.
Another is that contractors, having more control on the overall process, can sometimes wind up playing games with farmers who have contracted in good faith. For instance, Firestine said he's had contractors who have already settled arrangements for feeder pigs make claims about being unable to line up sufficient stock, and "I'm starting to see the same thing with pullets." Sudden unavailability of stock may be a contractor's way out of what they decide has become a bad price deal.
A common concern in farm country is that contractors may eventually be able to control overall price levels, according to Kreg Denton, loan officer at $57 million-assets First Community Bank of Western Kentucky. "I'm afraid that's part of the trend of the future," said Denton.
The modernity--or lack thereof--can be a factor in a farmer's participation in contracts, as well. Contractors are often in the position of being able to dictate what kind of facilities they will find acceptable for their animals. The farmer may either have to pay the costs to upgrade or simply watch the contracts go to farmers more willing to make the changes and spend the money. …