The increasing dominance of confined animal feeding operations for many types of livestock and a growing reliance on production contracts have contributed to the growth of large, specialized poultry, hog, and dairy operations. While confined animal operations are not new, their use in livestock farming has been increasing. Changes in the relative prices of land, labor, and capital over the past three decades may have encouraged the substitution of cheaper capital (in the form of more mechanized animal housing, feeding, and manure management facilities) for more expensive land and labor. Furthermore, capital-intensive operations often find that increases in farm size can lower the cost of production per animal, leading to consolidation of production on larger operations. In contrast, the labor and management requirements of operations that raise animals under less confined conditions limit the potential growth of such operations.

Historically, most agricultural products have been bought and sold for immediate delivery (through “spot markets”), but a growing share of U.S. farm output is produced and sold under agricultural contracts that govern how and when commodities change hands. In 2008, contracts covered nearly 40 percent of the total value of agricultural production, up from 11 percent in 1969. Production contracts (where the contractor owns the commodity and pays the farm operator to raise it) are widely used in livestock production, while marketing contracts (where the farmer retains ownership of the commodity but promises future delivery to the contractor) are used for many crops.

Product differentiation, quality control, and the need to ensure a ready supply for processing facilities are key reasons why contractors prefer production and marketing contracts over spot markets. Production contracts are particularly prevalent in the poultry and hog sectors, accounting for 90 and 68 percent of production, respectively, in 2008.

Producers also enjoy multiple benefits from using contracts. Contracts allow them to focus on one production stage while not having to worry about other aspects of the agribusiness, such as marketing or feed formulation. This frees farm labor, enabling producers to increase production of the contracted commodity (that is, grow in size) or to diversify by growing other commodities or pursuing off-farm work. Moreover, producers with contracts enjoy better access to capital markets, allowing them to carry more debt—and therefore more capital—given their net worth than producers without contracts. Additionally, contracts ensure an outlet for their product and reduce or eliminate price risk for both the farm’s output and for farm inputs provided by the contractor.

Changes in marketing arrangements, like other technological developments, have had a pronounced impact on farm sector productivity and structure. By reducing price risk, rewarding contract farmers for increasing production efficiency, and allowing farmers to become more specialized, contract sales have encouraged increased capital investments on large farms and further consolidation of production. Depending on the terms of the contract, they can also encourage the adoption of certain farming practices (for example, by requiring more stringent food safety practices) and require that housing and equipment meet minimum specifications, thereby weeding out less efficient operators over time.