Dairy Marketing

1
Dairy Marketing

• Dr. Roger Ginder
• Econ 338
• Fall 2007
• Lecture 21

2
Example of Central Market Order Pooling
3
Producer Settlement Fund

• A fund that is used to collect and disburse funds
  to handlers to equalize blend price paid to
  farmers and the classified value of milk used
• Fluid distributing plants typically pay into the
  fund
• Higher fraction of milk bought has class one
  value (above blend price)
• Lower fraction in Class II, III and IV
• Other supply plants may pay into or draw from the
  fund depending on product mix and fluid provided
• Pay in if fluid and Class II uses are high
• Draw out if Class I II are low relative to
  Class III IIIa

4
Producer Settlement Fund

• Cooperative association plants typically draw
  from the pool
• Handle large quantities of milk
• Perform balancing function
• Process more Class III and IIIa products
• Cooperatives typically have lower performance
  requirements in recognition that
• They are farmer owned patronage organizations
• They perform balancing functions in the market
  when supplies are high

5
Table 6.2. Computation of an example marketwide
pool Hiland Mid-Am
Kraft Total market Handler (cwt) () (cwt) ()
(cwt) () (cwt) () Producer receipts Class
I 38,400 96 0 0 25,000 50 63,400 36 Class
II 400 1 5,500 6 0 0 5,900 3 Class III
1,200 3 80,000 90 25,000 50 106,200 59
Class IIIa 0 0 3,500 4 0 0 3,500 2
Total 40,000 100 89,000 100 50,000 100 179,000
100 Transfer the total quantities over to next
chart and multiply by the class prices
6
Table 6.2. Computation of an example marketwide
pool (contd) Hiland
Mid-Am Kraft Total
market Handler /cwt /cwt
/cwt /cwt Class
I 556,800 14.50 0 14.50 362,500 14.50 919,300
14.50 Class II 5,040 12.60 69,300 12.60 0
74,340 12.60 Class III 14,400 12.00 960,00
0 12.00 300,000 12.01 1,274,400 12.00 Class
IIIa 0 36,750 10.50 0 36,750 10.50
Total Amt. Paid 576,240 40K 1,066,050
89K 662,500 50K 2,304,790 179K Average
classified value 14.41 11.98 13.25 12
.88 Note Classified prices (/cwt) used in
this analysis are as follows Class I 14.50
Class II 12.60 Class III 12.00 and Class
IIIa 10.50.
7
Table 6.2. Computation of an example marketwide
pool (contd) Hiland
Mid-Am Kraft Total
market Handler /cwt /cwt
/cwt /cwt Class
I 556,800 14.50 0 14.50 362,500 14.50 919,30
0 14.50 Class II 5,040 12.60 69,300 12.60 0
74,340 12.60 Class III 14,400 12.00 960,0
00 12.00 300,000 12.01 1,274,400 12.00 Class
IIIa 0 36,750 10.50 0 36,750 10.50
Total 576,240 40K 1,066,050 89K 662,500 50K 2
,304,790 179K Average classified
value 14.41 11.98 13.25 12.88 Note
Classified prices (/cwt) used in this analysis
are as follows Class I 14.50 Class II
12.60 Class III 12.00 and Class IIIa 10.50.
8
Payments made into the fund by handlers whose
pool obligation is greater than the blend Price
to be received by the farmers and handlers who
supply it.
Producer
Settlement
Fund Payments received from
the fund by handlers whose pool obligation is
less than blend Price to be received by the
farmers and handlers who supply it.
9
Table 6.3 Computation of an example producer
settlement fund Blend price paid Amount
paid Classified value Producer producers
(/cwt) producers () of milk () settlement
fund () Hiland 12.88 515,037 576,240 61,203
Mid-Am 12.88 1,145,957 1,066,050 (79,907) Kr
aft 12.88 643,796 662,500 18,704 Total
market 12.88 2,304,790 2,304,790 0
10
Payments made into the fund by handlers whose
pool obligation is greater than the blend Price
to be received by the farmers and handlers who
supply it.
Producer
Settlement
Fund Payments received from
the fund by handlers whose pool obligation is
less than blend Price to be received by the
farmers and handlers who supply it.
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Diversion to Class I Uses
12
Seasonality of Milk Production/Consumption 1990s
Commercial Production Disappearance
Surplus/ Mo. Bil. Bil
Deficit Bil. ________ __________
_____________ ________________ Jan-Mar 37.6 33.
5 4.1 (12.25) Apr-June 39.4 36.3 3.
1 (8.5) July-Sept 37.4 38.2 -1.8
(-4.7) Oct-Dec 36.6 37.3 -0.7
(-1.8)
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Supply Plant Pooling Incentive
Class III 1995 MW (3.5 BF) IA Blend
(Z1) Difference Jan 11.35 12.04 .69 Feb 11.79
12.14 .25 Mar 11.89 12.22 .33 Apr 11.16
11.90 .74 May 11.12 11.90 .78 June 11.42 1
1.78 .36 July 11.23 11.71 .48 Aug 11.55 12
.09 .54 Sept 12.08 12.30 .22 Oct 12.61 12.
83 .22 Nov 12.87 13.22 .35 Dec 12.91 13.25
.34 __________ Avg.
44 (Avg 93 51)
14
Balancing Requirements

• Seasonality creates the need for some plants to
  serve the balancing function in the market
• Having the plant capacity to take and process all
  the product in the peak or flush season means
  that there will be excess plant capacity at some
  times of the year
• What problems does this cause?
• Some plant capacity will be under utilized during
  the short supply parts of the year
• In many cases this means that some plants may
  even have to be shut down for some period of
  time
• Fixed costs of these plants continue even though
  they are not operating
• No one wants to be the one who performs
  balancing function
• No one wants to give up milk to the Class I
  distributing plant

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Performance Requirements

• One purpose of Class I premiums is to ensure an
  adequate supply of fluid products for consumers
• Pooling is a means used to share the Class I
  premiums among those providing milk for Class I
  uses
• Most Class III and IV plants in the market order
  would prefer to be pooled since pay prices are
  higher
• It is necessary to make sure that those who pool
  in the order perform or actually contribute to
  the supply available for Class I uses in the
  order when it is needed
• Orders may impose Minimum Performance
  Requirements that must be met in order to become
  part of the pool

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Market Conflicts During Periods When Supply is
Short

• Consider the following Market Players
• Westhoff and Welperss Pool Butter and Non-Fat
  Dry Inc.
• Simon and Sheehans Fabulous Fluid Milk Co.
• Strein and Koppes Luscious Low Fat Milk Co.
• Kaitlin and Kaitlins Non-Pooled Better Butter
  Inc.
• Jaschen, Brucker and Rauns Blocks and Barrels
  O Non-Pooled Cheddar
• Grade A and Grade B producers
• J.Tekippe Market Order Administrator
• Blend Price in pool 12.75
• Class III price 12.00 Class IV price
  11.50

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Pool Riding Problem

• Some Grade A Class III/IV manufacturing plants
  attempt to be pooled so as to share in the
  proceeds from Class I sales
• Want to be more price competitive for producer
  milk while, at the same time, having no or very
  little incentive or intent to supply milk for
  Class I needs.
• Offering the blend price instead of the Class III
  or Class IV price gives them an advantage in the
  procurement market over those who are not pooled
• Pool Riders attempt to have the best of both
  worlds at no additional cost or inconvenience to
  themselves
• So who doesnt? What is wrong with trying to be
  more competitive?

18
Pool Riding Problem

• Pool riding reduces incentive for providing Class
  I sales by increasing the quantity of Class III
  milk in the pool. This reduces blend price for
  all producers because the Class III milk draws
  from the Producer Settlement Fund
• Quantity available for Class I use may actually
  decline as a result of the reduced price
  incentive
• Affects competitive position of non-pool Grade A
  Class III/IV plants adversely when a competing
  firm rides the pool WHY?

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Performance Requirements

• Market orders can impose requirements to ensure
  that those in the pool actually provide milk when
  it is needed for fluid purposes
• At the times of the year that supplies are down
  and demand is high class III plants that are
  allowed into the pool must be willing to divert
• Diversion provisions require them to give up
  supply to distributing plants for packaging Class
  I products

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Performance Requirements

• The amount of milk must be diverted or at least
  offered up varies according to the requirements
  specified in the order
• Performance requirements are generally more
  rigorous in areas where milk is less plentiful
  (e.g. the East and Southeast
• Failure to perform cans mean financial penalties
  or in some cases expulsion from the pool

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FMMO Seasonal Pricing Plans

• 1. Louisville Type Plans
• Take money out of PSF in the spring Flush when
  supply is good
• Pay back in the fall to provide higher
  differentials to those who supply milk when the
  supply is tight
• Increase incentive to divert milk to Class III in
  spring
• Decrease incentive to divert milk to Class III in
  fall to use plant capacity

22
FMMO Seasonal Pricing Plans

• 2. Seasonal Base Plans (Base-Excess Plans)
• Base forming period in fall when production is
  low
• Sets the base for quantity that will receive the
  Class I price in spring for producers
• Base and a lower over-base price paid in spring
  for class I
• Gears amount that is pooled in the spring to what
  has been provided in the fall when it is most
  needed

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Allocation to Pool Class I Producers
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• Diversion Provisions
• Rules that specify the maximum proportion of a
  supply plants milk that can be diverted (away
  from a pool plant) directly from the farm to a
  non-pool plant and still be pooled in the order
• Allocation Transfer Provisions
• Accounting rules for determining how milk that is
  received from or shipped to a different source is
  classified and priced
• Down Allocation
• The assignment of milk to a utilization class
  less than the Class of product it was actually
  used to produce

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• Impacts -- Down Allocations
• Gives local order producer milk supplies priority
  on Class I sales, even if the milk they delivered
  wasnt used in Class I
• Local handlers cannot bring in outside milk and
  use it for Class I or II products at the expense
  of those producers pooled on the order
• Requires local handlers to pay local order Class
  I prices regardless of where milk is purchased
• Compensatory Payment
• A FMMO payment (equal to Class I P - Class III P)
  required of Pool handlers on other source milk
  allocated to Class I sales

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Reconstituted Milk

• Remove water thru evaporation or membrane
  filtration techniques (also known as reverse
  osmosis or R-O) then recombine water and solids
  to form fluid product (cost x 35-45/cwt.)
• Permits local handlers to bring milk into the
  order from outside the boundaries at a lower
  transport cost
• Rationale Cheaper to take water out before
  shipping
• Under FMOs reconstituted milk is down allocated
  and subject to a compensatory payment

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Down Allocation Local
Order Other Source Milk Milk (e.g., R-O
Milk) Quantity (cwt.) 10,000 1,000 UTILIZATI
ON Class I 7,000 1,000 Class
II 1,000 Class III 2,000 CLASSIFICATION Clas
s I 8,000 Class II 1,000 Class
III 1,000 1,000 LOCAL POOL OBLIGATION Class
I 8,000 x 13.67 7000 x
13.67 Class II 1,000 x 12.52
1000x 12.52 Class III 1,000 x 11.26
2000x 11.26 ____________
_____________

133,314 (13.314/cwt) vs. 131130
(13.11/cwt) Otherwise only 7000cwt. of class I
and 2000cwt. of class III would be calculated
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Down Allocation Local Order Other Source
Milk Milk (e.g., R-O Milk) Not
Computed in Pool Q (cwt.) 10,000 1,000 UTILIZA
TION Add to Class I Class I 7,000 1,000 Clas
s II 1,000 Class III 2,000 CLASSIFICATION Cl
ass I 8,000 Class II 1,000 Class
III 1,000 1,000 Subtract from Class III LOCAL
POOL OBLIGATION Class I 8,000 x 13.67 Class
II 1,000 x 12.52 Class III 1,000 x
11.26 ____________ 133,314
(13.314/cwt) Treats Non-Pooled Milk as if used
in lowest class and pushes pooled milk into
higher class thereby increasing the blend price
for pooled producers to receive.
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ANOTHER APPROACH---COMPNESATORY PAYMENTS
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Table 6.5. Example computation of the uniform
blend price from the Lehigh
Valley decision compensation payment Classifie
d price (/cwt) Use (cwt) Value () Class
I 14.00 2,000 28,000 Class III 10.00 2,000 2
0,000 Total pool milk 4,000 48,000 Uniform
blend price 12.00 Assume 500 cwt was brought
in from outside the order _at_ BFP for use in Class
I.
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Table 6.6. Effect of 500 hundredweight of
nonpool milk for Class I use on
the uniform blend price without compensatory
payment Classified price (/cwt) Use
(cwt) Value () Class I 14.00 1,500
21,000 Class III 10.00 2,500 25,000 Total
pool milk 4,000 46,000 Uniform blend
price 11.50 Table 6.7. Effect of a
compensatory payment on 500 hundredweight of
nonpool milk on the uniform
blend price Classified price (/cwt) Use
(cwt) Value () Class I 14.00 1,500 21,000 Cla
ss III 10.00 2,500 25,000 Compensatory payment
(nonpool milk) 4.00 500 2,000 Total pool
milk 4,000 48,000 Uniform blend price 12.00
500
Forces pool Class I into Class III
Bottler compensates pool for outside milk
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Table 6.6. Effect of 500 hundredweight of
nonpool milk for Class I use on
the uniform blend price without compensatory
payment Classified price (/cwt) Use
(cwt) Value () Class I 14.00 1,500 21,000 Cl
ass III 10.00 2,500 25,000 Total pool
milk 4,000 46,000 Uniform blend
price 11.50 Table 6.7. Effect of compensatory
payment on 500 hundredweight of non-pool
milk on the uniform blend price in the
order Classified price (/cwt) Use (cwt) Value
() Class I 14.00 1,500 21,000 Class
III 10.00 2,500 25,000 Compensatory payment
(nonpool milk) 4.00 500 2,000 Total pool
milk 4,000 48,000 Uniform blend
price 12.00 Bottler has to pay class I price on
1,500 cwt plus a 4.00 /cwt. Pmt. for 500 cwt.
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Other Possible Adjustments to Producer Price
1. BF Differential 2. Protein Differential 3. Othe
r Solids Differential 4. Quality (somatic cell
count) 5. Hauling 6. Insurance 7. Coop Membership
Fee 8. Advertising 9. Government Assessments
(Taxes)
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Price Discrimination

• Definition
• Selling same product at different prices to
  different buyers
• Necessary conditions
• 1. Seller control over price
• 2. Different buyer elasticities of
• demand
• 3. Different buyers are separated

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Price /
P1
Po
Demand
Qo
Quantity of milk
Q1
Relatively Elastic Market Demand
36
Price /
P1
Po
Demand
Qo
Q1
Quantity of milk
Relatively Inelastic Market Demand
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FMMO Effects

• 1. Increase Class I Fluid Prices Mean
• Production increase fluid milk
• Consumption decrease but not much
• 2. Grade B prices may decline due to increased
  Grade A
• 3. CCC expenses may increase with higher
  production
• 4. Enhanced coop bargaining efforts are made
  possible
• 5. Enhanced equity among producer prices
• 6. Enhanced stability in the market
• 7. Assured adequate supplies of milk

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State Milk Control/Order Provisions
1. Retail pricing (5 states) 2. Price filing
requirements (monthly wholesale) (8 states
including IA) 3. Limits on sales below cost (20
states including MN, WI) 4. Producer pricing (12
states including CA) 5. Producer base programs (7
states including CA)
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CA Milk Classes
Class Product I Fluid, Yogurt, 1/2 1/2 II Heavy
cream, cottage cheese, buttermilk, sterilized
cream III Frozen products including ice
cream IVA Butter and nonfat dry milk IVB Cheese
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CA Pricing
Class prices determined by economic
formula e.g., Class I is a function of
(production costs, butter/powder price, CA
wages) Producer prices BF and Solids Not Fat
prices for 1. Quota (Class I share) 2. Base 3.
Overbase lower price
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Market Administrator

• Agent of secretary of agriculture
• Charged with administering the order
• Ensures that handlers properly account for milk
  used in different classes
• Ensures that payment is made according to use
• Conducts audits of plants and handlers records
• Reports to the public on class prices, uses, and
  blend price
• Funding for services is not paid by tax dollars

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STEPS IN IMPLEMENTING OR AMENDING
A federal marketing order 1. A proposal/request
sent to USDA 2. A preliminary USDA investigation
is made 3. A public hearing is held 4. A
recommended USDA decision is issued 5. Filing of
objections 6. Final USDA decision is issued 7. A
producer vote is conducted (2/3 Majority
Required)
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Past Present FMMO Issues
1. Class I differential levels 2. Multiple basing
points for establishing Class I
differentials 3. Class II pricing
levels 4. Reconstituted milk pricing 5. MW Price
or Basic Formula Price (Class I mover) 6. Pooling
requirements
44
What federal orders do not do 1. Control
production 2. Establish sanitary/quality
production standards 3. Guarantee producers a
fixed price 4. Set retail prices 5. Guarantee
producers a mkt. for their milk 6. Require a
handler to buy a specific quantity or buy it from
a specific seller 7. Directly raise government
(taxpaper costs) due to administration expenses