Dairy Marketing Dr. Roger Ginder Econ 338 Fall 2009 Lecture #20

Example of Central Market Order Pooling

Types of Plants In FMMO’s 1.Non Pool Plants---Not Regulated 2.Pool Plants ---Regulated Under FMMO ---Distributing Plants ---Supply Plants ----Farmer Owned Cooperatives

POOLING REQUIREMENTS FOR A DISTRIBUTING PLANT 1.Use minimum percent of Grade A milk in Class I 2.Use minimum percent of Grade A milk in Class I sales within that FMMO area Regulated under order where its Class I sales are the largest Most become regulated automatically No real choice in the matter

POOLING REQUIREMENTS FOR A SUPPLY PLANT Ship minimum percent of Grade A milk to pooled distributing plant –Shipping a minimum percent of milk to a distribution plant (requirements are usually higher in fall) –The minimum percent is usually lower for FMMO’s closer to Wisconsin –Minimum percent required can be changed (within limits) by market administrator –Some FMMO’s have automatic qualification in spring if the plant had qualified in prior fall –Coops often qualify all their plants as a unit

Alternative Pooling Procedures 1.Stricter shipping requirements, call provisions + Those who share in Class I sales are those who “perform” -May result in uneconomic shipments 2.Supply balancing or standby pool payments (use part of Class I differential for payment)

Producer Blend Price is the Weighted Average Price to be paid to producers. To calculate it: Class I percent utilization x Price of Class I Plus Class II percent utilization x Price of Class II Plus Class III percent utilization x Price of Class III

Table 6.4. Computation of the July 1994 uniform blend price for the Southwest Plains marketing area UtilizationReceipts Price Value (%) (cwt)($/cwt) ($) Class I37.871,226, ,512,878 Class II , ,665,652 Class III40.091,325, ,120,274 Class IIIa , ,158,689 Weighted average price ,474,189 Add location adjustment867,858 Add 1/2 ending fund reserve166,587 Less new reserve ,830 Uniform blend price at 3.5% butterfat ,367,804 Source: Market Administrator, Southwest Plains Marketing Order.

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 I 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

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

Concept of Pooling Pool Handlers Producers Handlers with milk value higher than market average Pay into the pool Handlers with milk value less than market average draw from the pool Handlers pay producers the same price regardless of how they use the milk they receive

Table 6.2. Computation of an example market wide pool Hiland Mid-Am KraftTotal market Handler(cwt)(%)(cwt)(%)(cwt)(%)(cwt)(%) Producer receipts Class I38, , ,40036 Class II 40015, ,9003 Class III 1,200380, , , Class IIIa003, ,5002 Total40, , , ,000100

Table 6.2. Computation of an example market wide pool (cont’d) Hiland Mid-Am Kraft Total market Handler $$/cwt $$/cwt $$/cwt $ $/cwt Class I556, , , Class II5, , , Class III14, , , ,274, Class IIIa036, , Total576,24040K1,066,05089K662,50050K2,304, K Average classified value Note: Classified prices ($/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.

Table 6.2. Computation of an example marketwide pool (cont’d) Hiland Mid-Am Kraft Total market Handler $$/cwt $$/cwt $$/cwt $ $/cwt Class I556, , , Class II5, , , Class III14, , , ,274, Class IIIa036, , Total576,24040K1,066,05089K662,50050K2,304, K Average classified value Note: Classified prices ($/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.

Table 6.3 Computation of an example producer settlement fund Blend price paidAmount paidClassified value Producer producers ($/cwt)producers ($) of milk ($)settlement fund ($) Hiland ,037576,24061,203 Mid-Am12.881,145,9571,066,050(79,907) Kraft ,796662,50018,704 Total market12.882,304,7902,304,7900

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. 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 Blend Prices Were Also Adjusted by Zone Prior to Year 2000 (same as for Class I prices)

Sac Linn Lee Ida Tama Clay Kossuth Jasper Lyon Page Story r Jones Fayette Adair Benton Wapello Pocahontas Osceola Jefferson Audubon Washington Buena Vista Black Hawk Appanoose Cerro Gordo Van Buren Muscatine Dickinson Des Moines Winnebago Montgomery Eastern South Dakota #76, Upper Midwest #68, Iowa Marketing Area, #79, (and corresponding zones) Federal Milk Order Marketing Areas in Iowa as of January 1, 1978 III I II Poweshiek Polk BooneGreene Carroll Crawford Plymouth O’Brien Woodbury Monona Harrison Shelby WrightFranklin Floyd Chickasaw Webster Hardin Louisa Emmet Palo Alto Hancock Worth MitchellHowardWinneshiek Allamakee Bremer Butler Hamilton Grundy Buchanan Delaware Dubuque Jackson Clinton GuthrieDallasJohnson Marshall Pottawattamie Mills Fremont Madison Warren Marion MahaskaKeokuk AdamsUnionClarke Lucas Monroe Taylor Ringgold Cherokee Calhoun DecaturWayneDavis Henry Scott Humboldt Clayton Cedar Sioux Cass Iowa

HANDLERS REPORTING UNDER ORDER 79 Pool Plants Pursuant to Section (a) Zone 1 No Location Adjustment Anderson-Erickson Dairy Co.Des Moines, IA Roberts Dairy Co.Des Moines, IA Zone II - $.07 Location Adjustment Roberts Dairy Co.Iowa City, IA Swiss Valley Farms Co.Cedar Rapids, IA Location Adjustment Zone III(cents/cwt.) Associated Milk Producers, Inc.Arlington, IA-17.2 Associated Milk Producers, Inc.Fredericksburg, IA-24 Beatrice Cheese, Inc.Fredericksburg, IA-24 Foremost Farms USACresco, IA-27.4 Foremost Farms USALancaster, WI-25.7 National Farmers OrganizationDyersville, IA-18.9 Stacyville Coop CreameryStacyville, IA-25.7 Swiss Valley Farms Co.Dubuque, IA-18.9 Swiss valley Farms Co.Luana,IA -24 Wapsi Valley CreameryIndependence, IA-15.5

Pool Handlers Pursuant to Section (b) or © Associated Milk Producers, Inc.New Ulm, MN Foremost Farms USABaraboo, WI Mid-America Dairymen, Inc.Newton, IA National Farmers OrganizationAmes, IA Stacyville Coop CreameryStacyville, IA Swiss Valley Farms Co.Davenport, IA HANDLERS REPORTING UNDER ORDER 79 (cont’d)

Diversion to Class I Uses

Example of Seasonality in Milk Production/Consumption Commercial ProductionDisappearance Surplus/ Mo. Bil. # Bil# Deficit Bil.# % _______________________________________________ Jan-Mar (+12.25%) Apr-June (+8.5%) July-Sept (-4.7%) Oct-Dec (-1.8%)

Supply Plant Pooling Incentive Class III 1995MW (3.5 BF)IA Blend (Z1)Difference Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec __________ Avg. +44¢ (Avg ‘93 = +51¢)

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

Balancing Requirements 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

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

Market Conflicts During Periods When Supply is Short Consider the following Market Players: – Pooled Cheese, Butter and Non-Fat Dry Inc – Fabulous Fluid Milk Co. –Luscious Low Fat Milk Co. –Non-Pooled Better Butter Inc. – Blocks and Barrels O’ Non-Pooled Cheddar –Grade A and Grade B producers –Blend Price in pool = $13.75 –Class III price = $12.00 & Class IV price = $11.50

Pool Riding Problem lSome Grade A Class III/IV manufacturing plants attempt to be pooled so as to share in the proceeds from Class I sales l 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. lPool 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 PSF lQuantity available for Class I use may decline as a result lAffects competitive position of non-pool Grade A Class III/IV plants adversely when a competing firm rides the pool WHY?

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 (give up) supply to distributing plants for packaging Class I products

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 –Tighter Supplies in the Fall –Fewer cwt. of milk are available nearby

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 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

Allocation to Pool Class I Producers

Diversion Provisions lRules that specify the maximum proportion of a supply plant’s 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 lAccounting rules for determining how milk that is received from or shipped to a different source is classified and priced Down Allocation lThe assignment of milk to a utilization class less than the Class of product it was actually used to produce

Impacts -- Down Allocations Gives local order producer milk supplies priority on Class I sales, even if the milk they delivered wasn’t used in Class I. 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 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¢/cwt.) Rationale: Cheaper to take water out before shipping Under FMOs reconstituted milk is down allocated and subject to a compensatory payment

Down Allocation Local OrderOther Source Milk Milk (e.g., R-O Milk) Quantity (cwt.)10,0001,000 UTILIZATION: Class I7,0001,000 Class II1,000 Class III2,000 CLASSIFICATION: Class I8,000 Class II1,000 Class III1,0001,000 LOCAL POOL OBLIGATION: Class I8,000 x x Class II1,000 x x Class III1,000 x x ____________ _____________ = $133,314 ($13.314/cwt) vs. $ ($13.11/cwt) Otherwise only 7000cwt. of class I and 2000cwt. of class III would be calculated

Down Allocation Local OrderOther Source Milk Milk (e.g., R-O Milk) Not Computed in Pool Q (cwt.)10,0001,000 UTILIZATION: Add to Class I Class I7,0001,000 Class II1,000 Class III2,000 CLASSIFICATION: Class I8,000 Class II1,000 Class III1,0001,000 Subtract from Class III LOCAL POOL OBLIGATION: Class I8,000 x Class II1,000 x Class III1,000 x ____________ = $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.

ANOTHER APPROACH--- COMPNESATORY PAYMENTS

Table 6.5. Example computation of the uniform blend price from the Lehigh Valley decision – compensation payment Classified price ($/cwt)Use (cwt)Value ($) Class I14.002,00028,000 Class III10.002,00020,000 Total pool milk4,00048,000 Uniform blend price12.00 Assume: 500 cwt was brought in from outside the BFP for use in Class I.

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 I14.001,500 21,000 Class III10.002,50025,000 Total pool milk4,00046,000 Uniform blend price11.50 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 I14.001,50021,000 Class III10.002,50025,000 Compensatory payment (nonpool milk) ,000 Total pool milk4,00048,000 Uniform blend price Forces pool Class I into Class III Bottler compensates pool for outside milk

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 I14.001,50021,000 Class III10.002,50025,000 Total pool milk4,00046,000 Uniform blend price11.50 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 I14.001,50021,000 Class III10.002,50025,000 Compensatory payment (nonpool milk) ,000 Total pool milk4,00048,000 Uniform blend price12.00 Bottler has to pay class I price on 1,500 cwt plus a $4.00 /cwt. Pmt. for 500 cwt.

Other Possible Adjustments to Producer Price 1.BF Differential 2.Protein Differential 3.Other Solids Differential 4.Quality (somatic cell count) 5.Hauling 6.Insurance 7.Coop Membership Fee 8.Advertising 9.Government Assessments (Taxes)

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

PoPo P1P1 QoQo Q1Q1 Demand Price $/# Quantity # of milk Relatively Elastic Market Demand

PoPo P1P1 QoQo Q1Q1 Demand Price $/# Quantity # of milk Relatively Inelastic Market Demand

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

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)

CA Milk Classes ClassProduct IFluid, Yogurt, 1/2 & 1/2 IIHeavy cream, cottage cheese, buttermilk, sterilized IIIFrozen products including ice cream IVAButter and nonfat dry milk IVBCheese

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

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 handler’s records Reports to the public on class prices, uses, and blend price Funding for services is not paid by tax dollars