AgDM newsletter article, January 1999

Contracting with near monopolists

Neil HarlBy Neil Harl, Charles F. Curtiss Distinguished Professor in Agriculture and Professor of Economics, 515/294-6354, harl@iastate.edu 

The signs of increasing use of contracts are everywhere—especially on the product side of agriculture.  Specialty grains, feeder livestock, even vegetables, are being produced under contract and have for some time.  So what’s the concern about the rising tide of contract agriculture?  Basically, the concern is the possible shift in bargaining power that is barreling down the economic highway.

This topic is particularly important in light of the Des Moines Register's recent series, "Can Iowa Tap It's Wealth?" beginning on September 6, and the Register's editorial on September 12, "Iowa's Golden Challenge."  I agree that the technology of processing and the exciting developments in corn genetics are important to the state.  The key question:  Who will benefit from these breakthroughs?

Concentration in the seed business

Except for those who are taking the scenic trip to Mars, it’s clear what’s happening with seed companies.  Mergers, alliances, and various other forms of arrangements are reducing the number of players—and increasing the level of concentration. 

Mergers, alliances, and various other forms of arrangements are reducing the number of players – and increasing the level of concentration.

But that’s not the whole story—the revolution in ownership of germ plasm, the feature of cells that determines the characteristics of offspring, is also moving rapidly toward concentration in a few hands.  The high profile alliance between DuPont and Pioneer Hi-Bred International, the Monsanto acquisition of a greater interest in DeKalb and the Monsanto acquisition of Delta and Pine Land Co. are examples from the last few months of how the ownership and control of genetic material in crops are falling into the hands of a few, economically powerful players.

This development is partly related to the changing role of the land grant universities, partly related to the ability in recent years to manipulate germ plasm through genetic engineering and partly the consequence of the ability to obtain a monopoly-like position over unique life forms.

Effect on negotiated contracts

So what effect will concentration in the seed business and control by the few resulting firms over germ plasm likely have on contract negotiations with producers?  It depends on the options open to producers who don’t like the terms of contracts offered to them.  With numerous contract possibilities available from input suppliers, each offering inputs of roughly equal productivity and cost, the answer is perhaps “not much.”

But, if there are just a few options—with the next best offering a much less attractive set of inputs in terms of cost and productivity, the answer is “take what you’re offered.”  The outcome is likely to be a tilting of the terms of contracts in favor of the input supplier.  The division of revenue from production thus would be expected to shift over time in favor of the party with the monopoly or near-monopoly position.  Seed companies—and other input suppliers—can be expected to drive the best possible bargain which means, in the case of seed, capturing the greatest possible percentage of the value from any yield premium.

A good argument can be made that this perception of potential profits in the future is part of what is driving the intense push toward concentration in control over germ plasm now occurring.

Shift in other terms of contracts

The negotiating power of seed firms could well have other impacts, as well.

These seemingly innocent shifts would mean, however, that the economic position of the producer would be transformed from that of a risk-taking entrepreneur into a relatively riskless world of fixed compensation.  Thus, a shift not only of compensation would occur in favor of the input supplier but also a shift of management functions in the same direction.  The outcome would be reminiscent of the limited role played by growers under broiler contracts.

What’s to prevent this outcome?

In general, one would expect high handed economic behavior by near monopolists to be met by entry of new competitors attracted by the generous terms of contracts in favor of the input suppliers.  And that would likely occur if entry were possible.  However, barriers to entry may be fairly high.

One possible strategy for farmers is to forge alliances among producers (which is specifically allowed by federal law so long as it does not "unduly enhance" price).  The push to achieve such countervailing power was the driving force behind the formation of labor unions a century ago.  Historically, however, farmers have been unwilling to accept such a disciplined approach to achieving bargaining power.

Another possible area of protection against a sharp tilt in the economic terms of contracts is vigilance by federal (or state) anti-trust agencies.  Certainly the Federal Trade Commission and the U.S. Department of Justice should be sensitized to the potential for economic abuses down the road.  It's been well established for decades that firms with monopoly power over a product should not be able to "tie" other products to the transaction and extend the monopoly position.  Such arrangements, which involve tying products over which a firm does not have monopoly power (such as financing, insurance or risk management) to a product over which the firm does have monopoly power (such as a seed variety), are illegal per se unless it can be demonstrated that the product in monopoly status wouldn't work as well with other firms' products.  And, that's rarely the case.  FTC and the Department of Justice should scrutinize all seed industry mergers carefully for anti-competitive consequences and all practices by seed companies in tying credit, insurance, risk management or other needed inputs to seed availability.

In conclusion

It seems a bit far-fetched for agricultural production to be transformed so dramatically.  And it may never happen to the degree painted by the scenario outlined in this article.  But, it’s well within the range of feasibility.  Only time will tell.

In the meantime, the prudent course would suggest careful evaluation of mergers and alliances now occurring in rapid succession.

 

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