As the industry evolves, a hybrid structure is likely to emerge, in which end-users closely cooperate with producers through long-term contracting, rather than as direct owners or operators of biomass farms. We term this a “vertically coordinated” industry model. A vertically coordinated model presents several benefits over a vertically integrated system used in other industries dependent on vast quantities of raw materials, such as steel or petroleum products. For example, a vertically coordinated system does not disturb traditional agricultural practices or rural social structures that would result from transferring land and resource control to large energy companies. To the contrary, a vertically coordinated system that employs a variety of production contracts comports with recent trends in other agricultural sectors. This model also permits a greater number of producers to participate by increasing contracting opportunities, and allows greater management flexibility for producers. Vertical coordination also facilitates biomass production on more marginal lands, which increases economic feasibility in areas with relatively high farmland values such as the Midwest. Finally, a vertically coordinated model is compatible with existing cooperative business structures, thereby easing the long-term assimilation of producer cooperatives into the biomass supply chain. Myriad contract theories can inform the transition to a vertically coordinated supply chain model, how to dry cannabis ranging from consideration of the social compatibility between actors, and risk- and cost-minimization behaviors.
This article examines for the first time in scholarship the interactions and differences between these various theories in the context of building effective contractual relationships to facilitate the novel, emerging bio-economy. We first explore the influence of producers’ social networks and trialability on contract design. We then turn to the importance of risk management tools already available in the traditional agricultural commodity space to combat the uncertainty that can plague achievement of complete contracts, and highlight the importance of the parties’ learning and experience as a risk management tool. Risk-sharing affects costs, and thus risk management theories overlap with the large body of economics literature on the role of cost in contract design. We thus incorporate economists’ identification of adverse selection problems that stem from information asymmetry and moral hazards into potential contract-based solutions, such as rationing, screening, signaling, and auctioning, as well as measurement and monitoring strategies. But, these theories assume that parties are able and willing to write complete contracts, or contracts that specify each party’s obligations for possible contingencies. The section concludes by explaining why this is not always the case.While variations of the risk- and cost-minimizing perspectives are traditionally recognized in contract theory literature, scholars rarely apply sociological perspectives directly to contract theory. Scholarship should not underestimate, however, the influence of rural community norms and the learning styles of farmers who potentially will produce biomass. The legal profession should therefore explore the ability of contracts to ameliorate the range of societal pressures that inhibit contract formation and execution.
Sociological research has identified several factors that determine farmers’ willingness to adopt new technologies, as well as techniques to encourage innovation adoption. This framework draws largely from the work of Professor Pannell, which summarizes decades of innovation adoption research through an interdisciplinary perspective. According to Pannell, technology adoption research accedes that producers’ willingness to adopt depends on their “subjective perceptions or expectations rather than objective truth” that the technology will help them to better achieve their goals. Pannell further divides producer perceptions into three sets of issues: characteristics of producers within their social environment; technology attributes; and, the process of learning and experience. The more complex and serious the consequences of the decision, the more producers seek information and social interaction. Producers will look to those they perceive as trustworthy, credible, and possessing expertise, such as other farmers, researchers, and university extension agents. Farmers process information according to their numerous and varied individual goals, as well as their familial and social network. We address in subsequent sections the purely economic goals of wealth and financial security. Non-economic goals, however, impact greatly technology adoption. Pannell lists several categories of non-economic factors, such as environmental protection and enhancement; social approval and acceptance; personal integrity and ethical standards; and balance of work and lifestyle. As farmers increasingly rely on social networks for information, technology adoption will more likely impact these variables. As the adoption process progresses, “social commitment and support will help maintain confidence in the uncertain stages of field testing and early adoption.
Peer expectations of continued commitment or personal support and encouragement will reinforce commitment and provide a buffer against setbacks.” In sum, these non-economic social constructs can increase the likelihood of contract formation and performance. And, because the process of technology adoption is dependent on the producers’ social environment, maintenance of these social considerations should be taken into account in contract design. Specific factors that aid in technology adoption in the rural context include: relative strength of social networks and local organization; proximity to other adopters and sources of information; history of respectful relationships between adopters and innovation advocates; education; promotion and marketing programs by the government ; and the private sector. A national-level biomass production trade organization, along with local chapters, could increase social networking opportunities and identify potential peers for farmers seeking and processing information on conversion to biomass production. For example, the Illinois Biomass Working Group provides a collaborative network and educational opportunities for farmers considering biomass production in Central Illinois, while the Council on Sustainable Biomass Production, a private standards development initiative, links farmers with industry experts to explore sustainable production methods for biomass. As rural communities have greater access and familiarity to web-based sources of information and social networks, the importance of geographic proximity may decline in favor of general ease of information access—with Facebook and email replacing the coffee shop as the primary location for community information sharing. Social networks, while significant, are not determinative, and, as may be expected, specific characteristics of the actual innovation also heavily influence the adoption of technology. Relative advantage, defined as “the degree to which an innovation is perceived as being better than the idea [or practice] it supersedes,” is one key characteristic. An innovation’s cost, risk, and profitability relative to current practices are major contributors to an innovation’s relative advantage. But in addition to economic factors, the literature identifies several non-economic attributes with particular relevance to technology adoption in the sociological context. These include non-economic adjustment costs; compatibility with a landholder’s existing set of technologies, practices, and resources; government policies affecting the innovation, such as mandates or incentives to adopt or otherwise alter practices; compatibility of a practice with existing beliefs, values, and family lifestyle; self-image and brand loyalty; and the perceived environmental credibility of the practice. How much these factors influence technology adoption will again depend on the goals of the producer, and the social environment discussed previously. In this respect, the practical application of the concept of relative advantage is rather elementary: the greater the contracting parties can align the innovation adoption process to the non-economic goals of the producer, the greater the innovation’s relative advantage. Where the goals cannot be aligned, additional incentives may be required as compensation. As a step toward aligning these goals, how to cure cannabis recent efforts to develop sustainability certification schemes for biomass production seek to incorporate many of these social considerations into certification metrics, thereby creating a level playing field across biomass production markets. A second innovation characteristic—trialibility—refers to how easily an innovation can be sampled in a small quantity or with low initial cost. Relative trialibility includes not only the ease of establishing a trial, but also the ability to learn from the endeavor. Risk and uncertainty are decreased through trialibility in two ways: providing the producer the opportunity to gain skills in relation to the innovation, and allowing small scale adoption to avoid risks of large-scale loss due to inexperience or failure of the innovation. Several factors improve an innovation’s trialibility, including possessing characteristics of divisibility and observability, as well as trials that are indicative of long-term performance. On the other hand, innovation complexity, trials with long time-lags, high up-front capital costs, and potential hazards provide significant barriers to trialibility.
As with knowledge and learning, a trial experience minimizes uncertainty and increases the probability that the potential adopter will make correct decisions regarding whether and how to accept and implement the novel technology. A corollary to trialibility may be the presence of a certification regime, such as sustainability certification. The certification process may replace some aspects of trialibility as the communication mechanism between the sustainability standard certifier and producer provides a similar opportunity to gain skills related to the innovation and embark on steps to adoption without requiring an irrevocable commitment. The following section more thoroughly discusses the risk-minimization aspects of trialibility, as well as the role learning and experience from the sociological compatibility perspective plays within the risk minimization theory of contract design.Risk is inherent in all farming operations, and successful producers expend considerable effort to manage negative risk exposure. As one of the largest factors hindering producer participation in the biomass industry, farmers must have adequate means to address and minimize risk prior to market entry. The main categories of producer risk traditionally include yield/production, price, institutional, human/personal, and financial. Weather and technology are the primary components of yield risk. Price risk refers to uncertainty in input and output prices, and institutional risk arises from changes in agricultural policies and regulations . Farmers also face asset risk, the chance of loss of equipment, and contracting risk, which includes the threat of opportunistic behavior of contracting parties. Financial risk includes the business risks of obtaining and financing capital. Contracting is a commonly accepted tool in mitigating and sharing risk, and is a frequent topic in economic scholarship. Before discussing risk-sharing in the context of formal economic contract theory, however, this article explores two other risk management tools: learning and experience, and traditional agricultural risk management tools. High risk is not a new phenomenon for agricultural producers, but the difference for the producer in the biomass industry is that the traditional agricultural risk management tools are either unavailable or significantly diminished in this novel production milieu. Recall that an important principle from the Sociological-Compatibility perspective is that producers feel comfortable and familiar with using existing agricultural structures and practices. Therefore, the authors’ critique of the Risk-Minimization perspective begins by describing traditional agricultural management tools and their limits in the biomass context, with the goal of identifying opportunities to resurrect these traditional tools through contracting strategies.Farmers rely on a variety of risk management tools in traditional commodity agricultural production. Commonly used options include crop insurance, commodity market strategies, diversification, financial management, leasing, and adjusting cultural practices. Unfortunately, however, all these tools have limited availability in the current biomass production environment. For example, the Federal Crop Insurance Act provides for the development of policies for dedicated energy crops, but no policies are available currently for Miscanthus or switch grass— two promising bio-energy crops. Insurance products exist for corn grain, but current policies do not take into account the production and harvest of corn stover for bio-energy purposes. Similarly, commodity market strategies provide key risk management tools for producers to manage price risk, one of the larger risk exposures in agricultural production. Farmers can use existing commodity and futures markets to practice certain risk management strategies, such as hedging, futures, and options contracts, and forward pricing. As commodity markets do not exist for Miscanthus, switchgrass, or corn stover, biomass producers cannot take advantage of this important price risk management tool. As a second strategy, producers often diversify operations to manage production and price risk. Two types of diversification are common: enterprise diversification and geographic diversification. Enterprise diversification involves participating in more than one activity, such as growing multiple types of crops or using multiple cultural practices. Geographic diversification refers to spreading crop production over several non-contiguous locations to reduce catastrophic weather risk. Biomass contracts, as discussed below, however, may limit producer enterprise options for a variety of reasons. More importantly, the potentially high cost of transporting large quantities of biomass to the bio-energy conversion facility may further limit geographic diversification options. Leasing decreases financial risk by allowing producers to gain control over capital inputs without long-term payment commitments, and by increasing asset flexibility. However, this relatively simple strategy may have limited application in the biomass industry, as specialized equipment may be unavailable to lease or custom hire due to the infancy of the industry.