The signs of increasing use of contracts are everywhere—especially on the production 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 as input suppliers gain greater economic power at the expense of producers.

Concentration in seed companies

Mergers, alliances and various other forms of arrangements are reducing the number of players in input supply, particularly in seeds, and increasing the level of concentration. Figure 1 shows the extent to which arrangements between and among the major firms in the seed area have come to permeate the input supply sector.

But that's not the entire story. The revolution in ownership of germ plasm, the feature of cells that determines the characteristics of offspring, also is moving rapidly toward concentration in a few hands. The high-profile alliance (and now merger) between DuPont and Pioneer Hi-Bred International, the Monsanto acquisition of DeKalb and the Monsanto acquisition of Delta and Pine Land Company are recent examples of how the ownership and control of genetic material in crops is falling into the hands of a few, economically powerful players. Increased concentration is also leading to control by a few firms over the major processes by which genetic manipulation occurs, thus enabling those controlling the technologies to block use by other firms.

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

• For decades the land grant universities developed the basic genetic lines and made those lines available to the seed industry. Because of limitations on university funding and the near-revolution in genetic engineering, the private sector several years ago began pouring more money into basic research.

• The advent of genetic engineering meant that scientists could manipulate genetic composition—not through conventional crop breeding techniques but through laboratory procedures—to change the genetic makeup of plant and animal life. That has produced herbicide-resistant crops, for example.

• Finally, the U.S. Supreme Court in a 1980 landmark case determined that life forms could be patented. In addition to federal Plant Variety Protection (PVP) and simply shrouding research efforts with secrecy, the ability to patent life forms provides a powerful tool to keep competitors at bay.

Effect of 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 in the terms of contracts in favor of the input supplier. The division of revenue from production 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.

• The outcome would be a smaller share of the revenue from production going to the producer, resulting in less compensation to the producer and less to capitalize into land values.

• Seed companies would end up with a larger share of the pie with more to capitalize into the stock of the input supply firms. Even if unique corn derivatives produce revenue of $2 million per acre, it's fairly clear that whomever holds the rights to the technology involved will capture the lion's share of the revenue, not the producer.

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.

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

• In an effort to control the germ plasm more completely, seed companies are likely to negotiate for ownership of the product with the producer under contract having only a contract right to payment, short of ownership of the crop or livestock involved.

• Similarly, the contract may contain what would appear at first glance to be an attractive feature—the input supplier bearing the price risks.

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.

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 barrier is capital needed to mount the kind of research effort needed to maintain a product flow similar to that of the firms pressing for monopoly-like concentration levels. The capital needed is very substantial.

• Also, existing patent and plant variety protection may mean that potential competitors are frozen out of competition as a practical matter for the duration of the patent or PVP certificate.

A major issue is whether smaller seed firms are likely to be able to acquire germ plasm and thus remain viable. Certainly the small firms have remained surprisingly healthy in recent decades as performance traits of the varieties and hybrids developed by the larger firms have tended to outdistance the performance of seed marketed by small firms.

But the era of transgenic hybrids produces both the incentive to maintain greater control over high performing germ plasm and the technology and resources to challenge those who manage to obtain the germ plasm in clandestine ways. The larger firms may acquire some smaller firms to complete their distribution network and licensing germ plasm for a fee may well occur. However, it is unlikely that the dominant firms will generate additional competition by licensing to smaller firms.

Indeed, with the smaller firms predictably unable to maintain access to higher performing germ plasm, the price of lower performing seed varieties and hybrids is expected to reflect the economic disadvantage inherent in the lower performing varieties. At some point, many if not most of the smaller seed firms that are unaligned with the dominant firms will be unable to survive economically.

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.

Certainly further consolidation in any highly concentrated sector merits scrutiny under the Clayton Act rules that impose limits on mergers expected substantially to diminish competition. So-called horizontal mergers or mergers of competitors are the most likely to be challenged. Other areas of antitrust challenge productions, include price fixing, agreements to control market divisions and group economic boycotts are all per se offenses under federal antitrust law.

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 also 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 is rarely the case.

In a 1936 U.S. Supreme Court decision, IBM was prevented from requiring purchasers of its calculators to buy punch cards for data entry from IBM. Similarly, in United Shoe Machinery Corp. v. United States, a seller occupying a "dominant position" in the shoe machinery industry, without more, violated the Clayton Act by contracts tying to the lease of its machines the purchase of other types of machinery and incidental supplies. In a 1947 U.S. Supreme Court decision, conditioning the leasing of patented machines for dispensing industrial salt on the lessee's purchase of the lessor's salt, the court said that it is "unreasonable, per se, to foreclose competitors from any substantial market" if the seller enjoys a monopolistic position in the market for the tying product or if a substantial volume of commerce in the "tied" product is restrained.

In finding that the leases violated the Clayton Act, the court relied on International Salt's patents as establishing its market power in the tying products (the salt dispensing machines) and on the substantial dollar volume of business in the tied product which was foreclosed to competitors as establishing the requisite competitive effects. Once the minimum threshold conditions were met, the court held that a violation had occurred. As the court stated—

The court rejected the defense that the tying arrangement was necessary for the effective functioning of the potential product (or product over which the firm had monopoly power). As the court stated, "[b]ut it is not pleaded, nor is it argued, that the machine is allergic to salt of equal quality produced by anyone except International."

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.

The degree of consumer acceptance of genetically modified organisms (GMOs) will likely have a major impact on the speed with which consolidation and vertical integration in the seed business is translated into economic benefit for the major seed companies. Although resistance to GMOs is presently centered in the European Union, resistance may well spread in the next few months to other countries—notably Japan, Australia, New Zealand, India and Thailand in terms of imposition of labeling requirements. Moreover, resistance could spread to products involving GMOs, most notably meat and meat products.

Continuing consumer resistance would be expected to result in a two-track marketing system with the prospect of some degree of discounting of GMO crops and, concomitantly, discounting of GMO seed.

Widespread consumer resistance could slow perceptibly the move toward consolidation and vertical integration.

If sufficient public interest and political will are generated, three solutions seem to lie within the feasible set.

Antitrust oversight. First, aggressive antitrust oversight at the federal level (and among the states) is the traditional way for proposed mergers and alliances to be evaluated on the basis of potential anti-competitive effects.

Collective action by farmers. 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.

Section 1 of the Capper-Volstead Act of 1922 provides protection from antitrust challenge for producers who seek to bargain collectively with seed companies and other input suppliers. A resolution, passed in 1917 by the National Board of Farm Organizations, provided that—

This was the beginning of the drive for legislation to address the perceived problems of agricultural cooperatives. The objectives of the proposed legislation were to remedy two problems encountered under Sec. 6 of the Clayton Act in 1914 (which provided a limited agricultural exemption to antitrust enforcement)—(1) the limitation of the protection in Section 6 of the Clayton Act against antitrust challenges to organizations "not having capital stock" and (2) the failure of Section 6 of the Clayton Act specifically to permit certain cooperative marketing activities.

The Capper-Volstead Act provides that "persons engaged in the production of agricultural products as farmers, planters, ranchmen, dairymen, nut or fruit growers, may act together in associations, corporate or otherwise, with or without capital stock, in collectively processing, preparing for market, handling, and marketing in interstate and foreign commerce, such products of persons so engaged." The Act goes on to allow "Associations [to] have marketing agencies in common; and such associations and their members may make the necessary contracts and agreements to effect such purposes."

To come within the protection of the Capper-Volstead Act, an organization must—(1) be operated for the mutual benefit of its members; (2) either limit each member to one vote regardless of the amount of stock or membership capital the member owns or, if dividends are paid on the basis of members' stock or membership capital, the dividends must be limited to a maximum of eight per cent per annum; (3) not handle a greater amount of products from nonmembers than from members; and (4) not be operated for profit.

The grant of immunity from antitrust challenge was further limited by a provision that if the Secretary of Agriculture finds that an association "monopolizes or restrains trade in interstate or foreign commerce to such an extent that the price of any agricultural product is unduly enhanced thereby he shall issue…an order…directing such association to cease and desist from monopolization and restraint of trade."

The key question is whether producers will be willing to sacrifice independence of action in order to bargain collectively for access to seed and possibly, other inputs. The most likely avenue for such collective action is through cooperatives.

More germ plasm in the public domain. Another potential solution is for the public to increase its support for crop breeding by land-grant universities and other public agencies with transgenic hybrids and varieties made available to smaller seed companies. This would restore the land grant universities to the role played before the advent of genetic manipulation and the dramatic increase in private sector funding for new varieties and hybrids.

To a considerable extent, this possible outcome is dependent upon the perception in state legislatures and the Congress as to the public interest, long-term, in maintaining a greater degree of competition in seed supply. Legislative bodies are more likely to respond if convinced that dominance of seed supply by a few large firms, worldwide, could affect food costs by influencing the supply of food through contractual mechanisms.

Agricultural production may never be transformed as dramatically indicated by the scenario outlined in this article. But, it’s well within the range of feasibility.

In the meantime, the prudent course would suggest careful evaluation of mergers and alliances now occurring in rapid succession and careful consideration of the level of resources flowing into the development of transgenic hybrids and varieties in the public domain.

If economic abuses develop, producers may resort to collective action in acquiring germ plasm needed in their operations.