Agriculture Reference
In-Depth Information
into contracts were risk management and mini-
mization of production and/or transaction
costs. These two reasons for contracting are
essentially the same as the first three listed
by Mighell and Jones (1963), with efficiency
gains and financing being lumped under
the production-transaction cost minimization
umbrella. Some recent studies (e.g. Martinez,
2002; Allen and Lueck, 2003) have focused on
the single explanation of transaction cost eco-
nomics (Williamson, 1979) and its emphasis on
asset specificity as the driving force behind the
decision to contract. For example, Lajili
et al
.
(1997) found 'the degree of asset specificity sig-
nificantly influences farmers' choices of con-
tractual arrangements'. However, as pointed out
by MacDonald
et al
. (2004a), 'one weakness of
transaction-cost analyses is that they typically
do not nest market power and efficiency expla-
nations'. In Joskow's (1989) summary, they
'frequently ignore the possibility that there may
be market power motivations or market power
consequences for these organizational arrange-
ments as well'. Surprisingly, Mighell and Jones'
(1963) fourth motive cited, to gain market
advantage, has received the least research atten-
tion although it is argued here that it is the most
likely explanation in US agriculture's current
evolutionary state.
Gaining a market advantage may be easy
in an industry like agriculture, which has
imbalances in its structure (such as having
many sellers and few buyers of a commodity).
For example, Lanzillotti (1960) detailed how
firms dealing with agriculture were already
taking advantage of the production sector. He
concluded that 'leading firms possess consi-
derable market power and are inclined to uti-
lize such power to manage or administer their
market situation'. The result of that market
power imbalance was a significant difference
in the profit margins of agribusiness firms and
agricultural producers. In other words, gain-
ing market power facilitates taking actions
that improve a firm's profit margins, thus pro-
viding the strongest of incentives to seek bar-
gaining power. As a result, it is surprising that
relatively little empirical research was done to
sort out the relationship between industry
structure and market power. By 1986, the
story was still unsettled, as reported by
Schrader (1986):
The relation of integration or nonmarket
vertical coordination to market power has
two interpretations. Integration and contract
coordination are viewed by some as a means to
enhance the integrator's market power. Others
see market power on one side (or both sides) of a
market as an incentive for vertical arrangements
to capture gains from the side possessing market
power or to achieve joint profit maximization.
The uncertainty was still apparent in 2005 when
Ahearn
et al
. (2005) reported on the increasing
concentration in agriculture and agribusiness,
and noted that 'it is not obvious whether this
concentration is the desirable result of cost effi-
ciencies in production or the undesirable result
of market power on the part of various players
in the supply chain', citing the question raised
by Williamson (1968). Thus, more research is
needed on the influence of agricultural market
structure on conduct such as contracting.
There is little literature dealing directly
with the recent rise in production contracting.
This is due partly to the scarcity of data on con-
tracting (Ahearn
et al
., 2005). A review of the
scant literature points to three possible explana-
tions for the increased share of production
under production contracts. These are risk aver-
sion, the increase in processor concentration in
US agribusiness, and the increase in the total
scale of agricultural production. While risk
management is virtually undisputed in the liter-
ature as a catalyst for contracting in general,
MacDonald
et al
. (2004b) and Key (2004) stress
that it should no longer be considered the sole
motivating factor for farmers and ranchers in
choosing production contracts. The respective
causal relationships between the increase in
processor concentration and the increase in the
scale of production with production contracting
are less clear, but it is proposed here that concen-
tration and size lead to market power that is used
to expand contracting.
A defining characteristic of the ongoing
transformation of US agriculture may be the
rise in concentration in the food manufactur-
ing industry (Ollinger
et al
., 2005). According to
data from the USDA, the mean industry four-
firm concentration ratio (CR4) in food manufac-
turing has risen from 35% in 1982 to 46.1% in
1997 (US Department of Commerce, 2006; CR4
is the concentration ratio measured using sales
data from the four largest firms in the industry.
