Dairy MarketingDr. Roger Ginder

Econ 338a

Fall 2007

Lecture # 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

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

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

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

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. VEGETABLES (15% OF TOTAL)

SOME COMMODITIES ARE MARKETED UNDER MARKETING ORDERS

WHY??

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

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.

FMMO’S Have Been in Transition Since 1995

• 1960—1995 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

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.

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.

CLASSES OF MILK ARE BASED ON THEIR USE IN DIFFERENT END PRODUCTS

---FMMO Milk Classes Before 1995

CLASS I CLASS II CLASS III

Milk used for beverage purposes

(e.g., whole milk, skim milk, flavored milk, cream)

Pour

*Split into Class III and IIIa after the mid 1990’s. Butter and NDFM powder moved to Class IIIa.

CLASSES OF MILK ARE BASED ON THEIR USE IN DIFFERENT END PRODUCTS

---FMMO Milk Classes Before 1995

CLASS I CLASS II CLASS III

Milk used for beverage purposes

Milk used for “soft” mfg. Products

(e.g., whole milk, skim milk, flavored milk, cream)

(e.g., ice cream, cottage cheese, yogurt, sour cream, dips)

Pour Spooned

*Split into Class III and IIIa after the mid 1990’s. Butter and NDFM powder moved to Class IIIa.

CLASSES OF MILK ARE BASED ON THEIR USE IN DIFFERENT END PRODUCTS

---FMMO Milk Classes Before 1995

CLASS I CLASS II CLASS III

Milk used for beverage purposes

Milk used for “soft” mfg. Products

Milk used for “hard” mfg. products

(e.g., whole milk, skim milk, flavored milk, cream)

(e.g., ice cream, cottage cheese, yogurt, sour cream, dips)

(e.g., butter, hard cheeses, nonfat dry milk, canned condensed or evaporated milk)

Pour Spooned Cut, Mixed or Canned

*Split into Class III and IIIa after the mid 1990’s. Butter and NDFM powder moved to Class IIIa.

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

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.

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 FMMO’s. 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

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

CLASSES OF MILK ARE NOW BASED ON THEIR USE IN DIFFERENT END PRODUCTS

CLASS I CLASS II CLASS III CLASS IV

Milk used for beverage purposes

(e.g., whole and reduced fat milk, skim milk, flavored milk, eggnog, fluid buttermilk

Poured

CLASSES OF MILK ARE BASED ON THEIR USE IN DIFFERENT END PRODUCTS

CLASS I CLASS II CLASS III CLASS IV

Milk used for beverage purposes

Milk used for “soft” mfg. Products and aseptic fluid prod.

(e.g., whole and reduced fat milk, skim milk, flavored milk, eggnog, fluid buttermilk

(e.g., cream, ice cream, cottage cheese, yogurt, sour cream, dips, cream cheese products, aerosol and whipping cream)

Poured Spooned

CLASSES OF MILK ARE BASED ON THEIR USE IN DIFFERENT END PRODUCTS

CLASS I CLASS II CLASS III CLASS IV

Milk used for beverage purposes

Milk used for “soft” mfg. Products and aseptic fluid prod.

Milk used for “hard” cheeses

(e.g., whole and reduced fat milk, skim milk, flavored milk, eggnog, fluid buttermilk

(e.g., cream, ice cream, cottage cheese, yogurt, sour cream, dips, cream cheese products, aerosol and whipping cream)

(e.g., hard American cheeses, hard Italian cheeses)

Poured Spooned Cut with a knife

CLASSES OF MILK ARE BASED ON THEIR USE IN DIFFERENT END PRODUCTS

CLASS I CLASS II CLASS III CLASS IV

Milk used for beverage purposes

Milk used for “soft” mfg. Products and aseptic fluid prod.

Milk used for “hard” cheeses

Milk used for butter and dry milk products

(e.g., whole and reduced fat milk, skim milk, flavored milk, eggnog, fluid buttermilk

(e.g., cream, ice cream, cottage cheese, yogurt, sour cream, dips, cream cheese products, aerosol and whipping cream)

(e.g., hard American cheeses, hard Italian cheeses)

(e.g., butter and butter based spread, whole milk powder, nonfat dry milk)

Poured Spooned Cut with a knife

Spread with a knifeMixed with water or fluid

THE GOVERNMENT’S 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 FMMO’S 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.

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.

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)

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

Questions?

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%Other 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%Residual 3,160 2.1%