Factors Affecting the Coordination of Agricultural Production and Marketing
Jeffrey S. Royer
Agricultural markets depend considerably less on open market transactions than 40 years ago. Increasingly, the production and marketing of agricultural products have been coordinated by forward contracting, production and marketing contracts, and vertical integration. The degree to which these alternative marketing mechanisms have been employed varies across commodities and products. Production contracts, marketing contracts, and vertical integration dominate in several livestock markets, including broilers, turkeys, eggs, and milk, and in most specialty crop markets, including fruits, vegetables, and sugar beets. Market transactions have continued to be more important for field crops and the cattle and hog markets although contract production and marketing of livestock, particularly sheep, lambs, and hogs, have increased during the late 1980s and the 1990s.
Economists have sought to explain and predict the choice of organizational forms used to coordinate the production and marketing of various products. Two areas of economics that are concerned with the choice of organizational form are transaction cost analysis, which considers the frequency of transactions, uncertainty, and asset specificity, and agency theory, which emphasizes individual incentives and measurement problems.
Recently, Professor Joseph T. Mahoney of the University of Illinois developed an approach for analyzing organizational form that combines aspects of both transaction cost analysis and agency theory. Table 1 presents the essential elements of Mahoney's framework, which is based on empirical evidence from research in the fields of industrial organization and strategic management.
Table 1. Predicted Organizational Form
| Low Task Programmability | High Task Programmability | |||
| Low Specificity | High Specificity | Low Specificity | High Specificity | |
| Low nonseparability | 1. Spot market | 2. Long-term contract | 5. Spot market | 6. Joint venture |
| High nonseparability | 3. Relational contract | 4. Clan (hierarchy) | 7. Inside contract | 8. Hierarchy |
Source: Joseph T. Mahoney, "The Choice of Organizational Form: Vertical Financial Ownership versus Other Methods of Vertical Integration," Strategic Management Journal 13 (1992), p. 576.
Mahoney focuses on asset specificity, nonseparability, and task
programmability in analyzing the choice of organizational
structure. Asset specificity refers to the
specialization of assets. Generally, the value of highly
specialized assets diminishes when they are shifted to
alternative uses. Therefore, large investments in specialized
assets increase the potential loss from an unexpected market
outcome and encourage internal coordination of production and
marketing. Nonseparability concerns the problem of
determining and rewarding individual effort in team production.
If rewards cannot be based on output (i.e., output is
nonseparable), a manager is required to monitor behavior or
effort. Task programmability relates to the ability to
measure inputs in a production process. Low task programmability
reduces the effectiveness of management monitoring efforts and
increases the likelihood of ownership integration.
Table 1 consists of eight possible combinations of asset specificity, nonseparability, and task programmability. When the output of an individual is easily measured (low nonseparability) and asset specificity is low, task programmability is inconsequential. In both cases (1 and 5), open market transactions (spot markets) should serve as an effective coordinating device.
When there is low nonseparability and high asset specificity (cases 2 and 6), a long-term relationship is necessary for parties to invest in highly specialized assets. The type of relationship will be influenced by the ability to measure input behavior. If task programmability is high, a joint venture is an effective organizational form. If task programmability is low, a long-term contract that specifies output performance and is enforced by courts is the predicted organizational choice.
A long-term relationship is unnecessary when there is high nonseparability and low asset specificity (cases 3 and 7) because of low switching costs or exit barriers. If task programmability is low, a relational contract that fosters a cooperative attitude is required because output and behavioral controls are ineffective. High task programmability suggests an "inside contract" system, in which departments are paid piece-rate and a manager is needed to monitor behavior.
Contractual problems arise when there is high nonseparability and high asset specificity (cases 4 and 8). If task programmability is high, vertical integration (hierarchy) is the most effective organizational structure. Low task programmability leads to what Mahoney calls the worst-case scenario, in which asset specificity is high and both input and output measurements are ineffective. The prescribed organizational structure is a "clan" relationship, in which individuals are not rewarded on the basis of performance and opportunistic behavior is replaced by an emphasis on organizational goals.
From Cornhusker Economics, Aug. 21, 1996.