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Why do farmers lock themselves into oppressive contracts?

When Costco Wholesale Inc. announced plans to build a chicken processing plant near Fremont, some in the agriculture industry hailed it as a rare chance to reintroduce some poultry farming back into a state that now accounts for only half of one percent of the nation's production, giving farmers a chance to earn as much as a 7 percent to 8 percent return on investment, according to the company. But critics of the plan were quick to caution potential growers not to trust the company. The Fremont plant's poultry, like 90 percent of all poultry raised in the United States, would not be purchased from farmers on the open market, but instead would be raised by hired farmers tending company-owned birds, using company-supplied feed.

Under such a system of raising farm animals "under contract," as it's called, "...there is no way that you can tell whether a poultry operation is going to cash flow your loans and make any income,” attorney Lynn Hayes, program director for Minnesota's Farmers Legal Action Group, told a public meeting in West Point.

But contract farming, in which an independent farmer invests to build barns and then works under contract for a specific production and processing company, has become virtually the only way to raise meat chickens in the U.S. and is also the system under which the majority of U.S. pork is now raised.

If it's such an oppressive system, why would any farmer trade his independence to work under such a system? Why do farmers do that?

  • Contracting takes risk out of the natural capital-intensity of modern animal agriculture. The cost of feed today accounts for more than 70 percent of the cost to raise a chicken, and since most farmers have moved away from combining cropping operations and livestock raising, most or all of that feed is purchased, not raised on the farm. The purchase price of that feed, subject to floods, freezes and droughts, can fluctuate over the course of a season. Such volatile swings in the commodity markets often force farmers feeding their own animals to either sell early or sharply cut back their herds, as we witnessed Nebraska ranchers doing during this decade's drought. Contract farmers, in contrast, get paid the same regardless of feed prices, while the poultry company absorbs the losses. As a result, according to one study in the American Journal of Agricultural Economics, contract-production companies remove an estimated 97 percent of the economic risk from growers, compared to independent growers who bear all of that risk on their own.
  • It smooths out cash flow and labor use. Similar to the above, contract-raising animals for a vertically integrated company allows farmers to plan, budget and smooth out income that is naturally volatile and seasonal in the old system of selling farm produce on the open market. In addition, it allows farmers who have other enterprises to better plan their labor use so they neglect neither enterprise.
  • It's simply another form of specialization. Farmers today understand the need for—and value to them—of specialized production. As agriculture grew more competitive in the 20th century, the traditional farmer who used to raise corn, beans, cows, chickens and pigs on the same farm found that his talents, labor and resources were better spent focused on a few commodities, or even a single one. They discovered that being a good cropman didn't make you a good dairyman, and being a good beefman didn't make you a good hogman. So specialization set in, and the mix of enterprises on any given farm shrank. Contracting simply extends that idea beyond species and crop choices. Being a good flock manager doesn't make you a good financial manager, and being a good feed manager doesn't make you a good marketing manager—all of which are necessary to succeed if you are buying, raising and selling your own animals. Contracting lets farmers instead specialize in their focused area of expertise: raising animals efficiently.
  • It may not be ideal, but it often beats the next alternative. In the early days of both poultry and pork contracting, it was often viewed as a temporary fix, something to carry struggling independent farmers through a down market. For most, it didn't turn out that way, locking the majority into the new system for the longterm. But that's not necessarily all bad. As unpleasant as it may be to those who see it as reducing the independence of traditional farmers, the hard truth is it kept many farmers on the farm who otherwise would have gone under. Even today, contract farming provides reliable supplemental income for farmers, most of whom already rely on off-farm income, in order to stay on the farm and in the countryside.

Like any economic system, contracting has its bad and good. One study, for example, shows it likely did contribute to the demise of many hog farmers in the 1990s, mostly because it spread the market risk that was concentrated on the packing plants across the packer and the hog producer. Another suggests the continuing market concentration of poultry businesses has probably caused small—but economically meaningful, nevertheless—reductions in the compensation growers receive.

However, a recent USDA research review suggests that despite sharply increased concentration in many U.S. agricultural markets, most research finds it hasn't had much impact on farm prices. Most agricultural processors, the resarchers note, have their own interests to protect, which usually represent large investments that must be protected over the long-run. For that reason, they realize they can't short their producers forever without driving them out of business. Although they may favor one grower over another, it's in their best economic interests to pay enough to keep their favored ones in business to ensure a stable supply of commodities. That increased coordination between producers and processors reduces costs of production and opportunity costs of inputs, moves information about consumer demand up and down the chain more effectively than traditional cash markets and ultimately increases total returns to producers and processors. The integration of the chicken industry and it's contracted pay-for-performance based structure has saved consumers well over $1 trillion since 1980, according to one estimate.

Listen as these producers explain the benefits of contract feeding in this video supplied by the National Chicken Council.

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