DAIRY INDUSTRY OVERVIEW

1

• Dairy Marketing
• Dr. Roger Ginder
• Econ 338a
• Fall 2007
• Lecture 2

2
DAIRY INDUSTRY OVERVIEW
1. GRADES OF MILK 2. FEDERAL MILK MARKETING
ORDERS 3. MILK PRICES PRE-2000 CLASS I, II, AND
III BLEND MW VS. POST 2000 CLASS
I,II,III,IV 4. DAIRY PRICE SUPPORT
PROGRAM 5. USDA PROPOSED RULE FOR ORDER
REFORM 6. MILK COMPONENTS AND COMPONENT
PRICING 7. SUPPLY, DEMAND
3
GRADE A MILK

• THE ONLY GRADE OF MILK THAT IS ELIGIBLE FOR USE
  IN FLUID PRODUCTS.
• IT IS PRODUCED UNDER STRICTER SANITARY INSPECTION
  REQUIREMENTS THAN GRADE B MILK (PMO-1993)
• GRADE B CAN ONLY BE USED IN MANUFACTURED DAIRY
  PRODUCTS SUCH AS BUTTER, CHEESE, OR POWDER
• SOME GRADE A MILK IS USED FOR THE PRODUCTION OF
  MANUFACTURED PRODUCTS

4
FEDERAL MARKETING ORDER

• DEFINITION
• A REGULATION, ISSUED BY THE SECRETARY OF
  AGRICULTURE, THAT REQUIRES THE COMMODITY INVOLVED
  TO BE MARKETED IN ACCORDANCE WITH PROCEDURES
  SPELLED OUT IN THE REGULATION.
• LEGAL BASIS AGRICULTURAL MARKETING
  AGREEMENTS ACT, 1937

5
MOST COMMODITIES ARE NOT MARKETED UNDER MARKETING
ORDERS
1. Grains 2. Hay and Forages
3. Hogs and Cattle 4. Poultry and
Eggs 5. Sheep and Goats 6. Timber and
Forest Products
6
OTHER COMMODITIES ARE MARKETED UNDER MARKETING
ORDERS
1. GRADE A MILK (98 OF TOTAL) FEDERAL ORDERS
(75-80) STATE ORDERS (18) 2. ALL FRUITS AND
NUTS (50 OF TOTAL) NUTS) (100 OF
TOTAL) TART CHERRIES (100 OF TOTAL) OLIVES
(100 OF TOTAL) CRANBERRIES (100 OF
TOTAL) CITRUS FRUIT (95 OF TOTAL) 3. VEGETABLE
S (15 OF TOTAL)
7
SOME COMMODITIES ARE MARKETED UNDER MARKETING
ORDERS
WHY??
8
SOME COMMODITIES ARE MARKETED UNDER MARKETING
ORDERS
WHY?? Large Multi-Year Investments In
Establishing Groves and Orchards (Fruits
Nuts) Extremely Perishable (Milk) Potential
for Hold-Up Problem
9
MILK MARKETING ORDER
A USDA REGULATION THAT REQUIRES GRADE A MILK
BUYERS TO PAY SPECIFIED MINIMUM PRICES FOR GRADE
A MILK DEPENDING ON HOW THE MILK IS USED.
10
FMMOS Have Been in Transition Since 1995

• 19601995 Was a Relatively Stable Period
• 1995---2000 Was a Transition Period
• 2000 ---- A Major Reform Took Place
• Basing Points for Pricing
• Classes of Milk
• FMMO Boundaries
• Basic Formula Price

11
MINNESOTA WISCONSIN(M-W) PRICE

• A PRICE SERIES USED TO REFLECT THE AVERAGE PRICE
  PAID FOR GRADE B MILK PURCHASED BY MANUFACTURING
  PLANTS IN MINNESOTA AND WISCONSIN.
• It was replaced in mid 1995 by a modified formula
  price (BFP).
• The M-W uses monthly reports from 160-170 plants
  and a sub sample of 67 for pay prices they
  offered for the first half of current month.

12
MININUM CLASS PRICES UNDER MILK MARKETING ORDERS
1960-1995

• CLASS III MINNESOTA-WISCONSIN
• CLASS II CLASS III A FIXED DIFFERENTIAL
• CLASS I CLASS III A VARIABLE
  DIFFERENTIAL (THAT INCREASED AS THE
  DISTANCE AWAY FROM EAU CLAIRE, WI
  INCREASED).
• THUS, FEDERAL MILK MARKETING ORDERS IMPLEMENT
  CLASSIFIED PRICING, FORMULA PRICING, AND PRICE
  DISCRIMINATION FOR GRADE A MILK.

13
CLASSES OF MILK ARE BASED ON THEIR USE IN
DIFFERENT END PRODUCTS---FMMO Milk Classes
Before 1995
Split into Class III and IIIa after the mid
1990s. Butter and NDFM powder moved to Class
IIIa.
14
CLASSES OF MILK ARE BASED ON THEIR USE IN
DIFFERENT END PRODUCTS---FMMO Milk Classes
Before 1995
Split into Class III and IIIa after the mid
1990s. Butter and NDFM powder moved to Class
IIIa.
15
CLASSES OF MILK ARE BASED ON THEIR USE IN
DIFFERENT END PRODUCTS---FMMO Milk Classes
Before 1995
Split into Class III and IIIa after the mid
1990s. Butter and NDFM powder moved to Class
IIIa.
16
BLEND PRICE
AVERAGE GRADE A MILK PRICE PAID TO PRODUCERS WHO
ARE POOLED IN AN ORDER A WEIGHTED AVG. OF CLASS
I, II, AND III MILK PRICES WHERE THE WEIGHTS ARE
EQUAL TO THE UTILIZATION IN EACH CLASS PI (
CL. I) PII ( CL. II) PIII ( CL. III)
(PI QI) (PII QII) (PIII
QIII) ________________________________________
QT
17
BASIC FORMULA PRICE (BFP)1995-2000

• An adjusted M-W type price determined by a
  weighted average computed from prices of several
  manufactured products.
• An attempt to tweak the old M-W and make it
  better reflect the national market
• These products included Grade AA butter, nonfat
  dry milk, dry buttermilk, and cheddar cheese.

18
USDA PROPOSED RULE FOR FEDERAL MILK MARKETING
ORDER REFORM

• Federal Agricultural Improvement and Reform (Fair
  Act) 1996 made mandated for Secretary of Ag to
  reform milk marketing system. Several changes
  were required before April 1, 1999.
• Reduced number of FMMOs.
• Redefinition of classes of milk based on various
  uses.
• Replacement of the M-W basic formula price as the
  Class I and Class II mover
• 1995-2000 BFP is a stopgap replacement for
  competitive M-W Grade B pay price
• Does not include Grade A used for manufacturing
  purposes
• Establishment of Class I Differentials
• Single basing point vs multiple basing point
• Size of Class I differential
• Address quality adjustment issues

19
NEW BASIC FORMULA PRICE (After 1/1/2000)

• Class II (new 2000 definition)
• Class III (new 2000 definition)
• Class IV (new 2000 definition)
• Announced by USDA (first Friday or before 5th of
  the month)
• Applies to preceding month
• Synthetic or constructed price (no one receives)
• Reflects the value of a cwt of standardized milk
• Based on value of components in cheese/whey
• Butterfat
• Protein
• Other solids
• Values for components are derived from final
  product market values instead of market values
  for milk itself.
• Cheese
• Butter
• Dry whey

20
CLASSES OF MILK ARE NOW BASED ON THEIR USE IN
DIFFERENT END PRODUCTS
21
CLASSES OF MILK ARE BASED ON THEIR USE IN
DIFFERENT END PRODUCTS
22
CLASSES OF MILK ARE BASED ON THEIR USE IN
DIFFERENT END PRODUCTS
23
CLASSES OF MILK ARE BASED ON THEIR USE IN
DIFFERENT END PRODUCTS
24
THE GOVERNMENTS DAIRY PRICE SUPPORT PROGRAM

• THE PROGRAM INVOLVES GOVERNMENT PURCHASES OF
  MANUFACTURED DAIRY PRODUCTS (PAID FOR WITH TAX
  DOLLARS). THIS IS DONE IN ORDER TO SUPPORT
  PRODUCER LEVEL MANUFACTURING MILK PRICES
  (PRODUCTS THAT CAN BE MFG. WITH GRADE B MILK).
• THIS PROGRAM IS SEPARATE FROM THE FEDERAL MILK
  MARKETING ORDER PROGRAM -- ALTHOUGH IT IS OFTEN
  CONFUSED WITH THE ORDER PROGRAM.
• PRICE SUPPORTS AFFECT FMMOS SINCE THE BFP IS
  BASED ON THE CLASS III OR CLASS IV PRODUCT PRICES
• TRENDS OVER THE PAST 20 YEARS ARE TOWARD LOWER
  PRICE SUPPORTS.

25
AVERAGE MILK COMPOSITION
SOLIDS CWT Butterfat 3.67 lbs. Protein 3.2
lbs. Lactose 4.75 lbs. Ash/Minerals .65
lbs. WATER 87.73 lbs. Total 100.00 lbs.
26
COMPONENT PRICING ATPRODUCER LEVEL

• ANY PAYMENT PLAN THAT PRICES MILK ON THE BASIS OF
  VOLUME PLUS ONE MAJOR COMPONENT
• NOW THE MOST COMMONLY USED COMPONENT IS MILK FAT
  CONTENT (e.g., BUTTERFAT DIFFERENTIAL)

27
MULTIPLE COMPONENT PRICING AT PRODUCER LEVEL

• A payment plan that prices milk based on two or
  more component parts (e.g., skim milk, milk fat,
  total solids (TS), solids not fat (SNF), protein,
  lactose water)
• Possible components which could be used include
• Milk fat
• Protein
• Total solids (TS)
• Solids not fat (SNF)
• Lactose/Minerals/Ash
• Water

28
Questions?
29
MILK UTILIZATION (DEMAND)
Manufactured milk products Milk
lbs. Butter 24,993 16.5 Cheese American 29,
415 19.5 Other 20,456 13.5 Cottage 589 0.4
Canned and condensed milk 1,178 0.8 Dry whole
milk 1,130 0.7 Ice cream/frozen 12,063 8.0 Oth
er misc. mfg. uses 199 0.1 Total
manufacturing uses 90,691 60.0 Fluid milk
products 55,329 36.6 Used on farm 1,896 1.3 Resi
dual 3,160 2.1