Can Food Processors Use Contracts to Influence Farm Cash Prices? The Competitive Implications of Top-of-the-Market and related pricing Clauses

Contracts are an important dimension of modern agriculture because they facilitate vertical coordination between producers and downstream processors and handlers. Because contracts are normally not settled in an open-market environment, establishing price(s) for contract sales is a pressing issue. When contract production is marketed contemporaneously with production sold through a spot market, a convenient alternative is to specify the contract price in terms of the subsequent cash price. This paper examines the competitive implications of such pricing arrangements, focusing in particular upon so-called “top of the market pricing (TOMP)” in cattle procurement, wherein the contract guarantees the producer the highest cash price prevailing at the time of delivery. These contracts are shown to have anticompetitive consequences when the same buyers who purchase contract cattle with the TOMP clause also compete to procure cattle in the subsequent spot market. By committing to purchase cattle at a spot price to be determined later, beef packers’ incentives to compete aggressively in the spot market are attenuated. Although TOMP pricing is not in producers’ collective interest, rational sellers may nonetheless sign these contracts, in some cases with little or no financial inducement. Acknowledgements: Without implicating them for the paper’s shortcomings, the authors wish to thank Giacomo Bonanno, John Crespi, Rachael Goodhue, Rob Innes and seminar participants at the University of Arizona and the University of California, Berkeley for helpful comments. Copyright 2002 by Tian Xia and Richard J. Sexton. All rights reserved. Readers may make verbatim copies of this document for non-commercial purposes by any means, provided that this copyright notice appears on all such copies.