Formula Price Contracts as an Alternative to Forward Integration by Farmer Cooperatives

Firms may seek contractual alternatives to vertical integration in order to achieve transactional economies or adjust for market imperfections. Blair and Kaserman have shown that under fixed-proportions production technology. Firms within bilateral and successive monopoly market structures can use formula price contracts to achieve results economically equivalent to integration. This paper examines whether formula price contracts are a viable alternative to forward integration for farmer cooperatives. Analysis of a three-stage vertical market structure indicates that the conditions under which a cooperative assembler can use a formula price contract are more restrictive than those for an investor-owned firm.