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Corn+Soybean Digest

Family Farms: Using Production Contracts To Manage Risk

In our ongoing series on the family farm, the USDA Economics Research Service has indicated they cut across the entire spectrum of agriculture, in location, type of operation and financial stability. But as we wrap up this series, we’ll take a look at a way that farms of all types may be able to protect their financial foundation.

The success of a farm depends upon its management of risk, both in production and revenue. One of the ways that many operators have achieved that goal is with production contracts, and USDA’s economists report that larger farms have a greater likelihood of using production contracts. Those percentages of farms with contracts are 31% of medium sales ($100,000-250,000) farms, 44% of large family ($250,000-500,000) farms and 57% of very large family (over $500,000) farms.

Contracting occurs throughout the country and across all commodities. Eighty-five percent of poultry is produced under contract, along with more than half of the peanuts, tobacco, sugarbeets, dairy products and hog. But only small portions of corn, soybeans and wheat are grown under contract. And contract production is growing. From 1997 to 2007, the total amount of agricultural production under contract increased from 32% to 37%, but in that same time tobacco production increased from 1% to 64% under contract. USDA says the cigarette manufacturers replaced auctions with contracts to better control the type of tobacco they were getting.

During that 10-year span hog production under contract increased from 34% to 65% because processors wanted more control over the characteristics of the hogs they were buying. That helped provide consistency in meat to consumers.

With little doubt, small farms, which are retirement or lifestyle farms, have little to do with contract production, and only 2-4% of them are engaged in contracts. “The use of contracts increases with sales, ranging from 7% of low-sales farms to 57% of very large family farms. The share of their production under contract also increases with sales. Although a relatively small percentage of each small-farm type has contracts, small farms make up about half of the farms with contracts, reflecting the large number of small farms.”

One of the major segments of family farms upon which USDA places a great emphasis is the limited resource farm. To qualify as a limited resource farm commodity sales are under $100,000, and having household income under $20,000. Value of assets is not included in the definition because the value is difficult to determine when farmers apply for various benefits available to limited resource farms. Currently 3-4% of farms fall into the classification. Usually acreage is between 26 and75 acres, with median annual sales in the $1,300 to $3,600 range. The median age of the operator for limited resource farms is 66 under the current definition and 58% are 65 years of age or more.

To conclude the USDA report on family farms, several conclusions were offered:

1. Large-scale family farms and nonfamily farms now account for about four-fifths of U.S. agricultural production. Million-dollar farms alone account for half of agricultural production. Yet, small farms make significant contributions to the production of specific commodities.
2. Farming is generally considered a purely rural pursuit. Nevertheless, two-fifths of U.S. farms and agricultural production are located in metro areas. High-value crops account for a large share of metro production, even outside the Fruitful Rim.
3. Large-scale family farms are generally viable economic businesses, with favorable financial ratios. Small family farms are less viable as businesses, but the households operating them receive substantial off-farm income and do not rely primarily on their farms for their livelihoods.
4. There are relatively few limited-resource farmers, regardless of the definition used. The number of limited-resource farmers, however, is sensitive to any farm asset or household wealth constraints imposed in the definitions.
5. Different types of farm program payments go to different types of farms. Most payments from commodity-related and working-land programs go to large-scale family farms because these programs target production (directly or indirectly). Land-retirement programs, in contrast, target environmentally sensitive land and go mostly to retirement, residential/lifestyle, and low-sales small farms.

Production contracts, which control many commodities except for small grains and oilseeds, have become increasingly popular ways of managing risk in agriculture. The volume of production produced under contract is growing larger annually, and the larger the farming operation the more likely it is to be using production contracts to manage risk. On the other hand, rural lifestyle and retirement farms are less likely to use them. However many of the smaller farms are coming to fit into the definition of limited resource farms, which have sales of less than $100,000 and household income under $20,000.

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