Dairy Marketing Dr. 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 Was a Relatively Stable Period Was a Transition Period 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 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 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 ICLASS IICLASS 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 ICLASS IICLASS 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) PourSpooned *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 ICLASS IICLASS 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) PourSpoonedCut, 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 P I (% CL. I) + P II (% CL. II) + P III (% CL. III) = (P I Q I ) + (P II Q II ) + (P III Q III ) ________________________________________ Q T

BASIC FORMULA PRICE (BFP) 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,  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  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 5 th 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 ICLASS IICLASS IIICLASS 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 ICLASS IICLASS IIICLASS 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) PouredSpooned

CLASSES OF MILK ARE BASED ON THEIR USE IN DIFFERENT END PRODUCTS CLASS ICLASS IICLASS IIICLASS 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) PouredSpoonedCut with a knife

CLASSES OF MILK ARE BASED ON THEIR USE IN DIFFERENT END PRODUCTS CLASS ICLASS IICLASS IIICLASS 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) PouredSpoonedCut with a knifeSpread with a knife Mixed 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 SOLIDSCWT Butterfat3.67 lbs. Protein3.2 lbs. Lactose4.75 lbs. Ash/Minerals.65 lbs. WATER lbs. Total lbs.

COMPONENT PRICING AT PRODUCER 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 productsMilk lbs. Butter24, % Cheese American29, % Other20, % Cottage5890.4% Canned and condensed milk1,1780.8% Dry whole milk1,1300.7% Ice cream/frozen12,0638.0% Other misc. mfg. uses % Total manufacturing uses90, % Fluid milk products55, % Used on farm1,8961.3% Residual3,1602.1%