Dairy Marketing Dr. Roger Ginder Econ 338 Fall 2007 Lecture # 9

GRAIN PRODUCER FEED MILL LIVESTOCK PROD. SLAUGHTER PLANT MEAT PROCESSING PLANT RETAIL DISTRIBUTION FINAL CONSUMER Human Consumption Value Chain for Livestock--Pork

NEW APPROACH TO VALUE CHAINS GAIN EFFICIENCY BY ELLIMINATING FUNCTIONS IN THE CHAIN ELLIMINATE COSTS BETWEEN LEVELS IN THE CHANNEL CONVERT PROFIT CENTERS TO COST CENTERS IMPROVE PERFORMANCE OF THE CHANNEL---- LOWER COSTS

GRAIN PRODUCER FEED MILL LIVESTOCK PROD. SLAUGHTER PLANT MEAT PROCESSING PLANT RETAIL DISTRIBUTION FINAL CONSUMER Human Consumption Value Chain for Livestock--Pork

NEW APPROACH TO VALUE CHAINS IN OTHER CASES FIRMS SEEK TO IMPROVE QUALITY BY BETTER COORDINATING FUNCTIONS IN THE VALUE CHAIN IMPROVE PRODUCT QUALITY BY INFUENCING HOW FIRMS AT OTHER LEVELS OPERATE COMMUNICATE CONSUMER PREFERENCES MORE ACCURATELY

NEW APPROACH TO VALUE CHAINS SOME FIRMS IN THE CHAIN ARE ATTEMPTING TO BECOME “CAPTAIN” OR LEADER OF THE CHAIN CAUSE OTHER FIRMS IN THE CHAIN TO OPERATE IN A WAY THAT CREATES MORE VALUE For Example “Low Lin” Soybean Oil

INPUT SUPPLY PRODUCER ELEVATOR 1ST HANDLER GRAIN/OILSEED PROCESSOR REFINER FOOD MANUFACTURING RETAIL DISTRIBUTION FINAL CONSUMER Human Consumption Value Chain for Grains and Oilseeds Low Lin. Beans

WHAT DETERMINES WHO WILL BE A CAPTAIN? OWNERSHIP/ACCESS TO CAPITAL ACCESS TO KEY RESOURCES ACCESS TO PROPRIETARY TECHNOLOGY ACCESS TO CRITICAL KNOWLEDGE ACCESS TO CUSTOMERS

INCENTIVES ARE IMPORTANT The Incentives At Other Levels in the Value Chain Must be Aligned For Low Lin Soybeans This Was the Case –Food Manufacture Willing to Pay More –Syngenta and Other Genetics Companies Willing to Develop and Market the Genetics –Producers, Elevators, and Processors Willing to Segregate and Preserve Identity For Other Traits Incentives May Not Be So Well Aligned---Especially for “Input Traits” With No Clearly Visible Consumer Benefit

INCENTIVES ARE IMPORTANT Problems Can Arise With Input Innovations That Provide: –Producer or Processor Benefits –But No Visible Consumer Benefit At a Minimum Consumers Must Be Indifferent Toward Such Innovations If Consumers Oppose These Innovations The Value Chain Can Be In Conflict And Fail to Perform Effectively

INPUT SUPPLY PRODUCER ELEVATOR 1ST HANDLER GRAIN/OILSEED PROCESSOR REFINER FOOD MANUFACTURING RETAIL DISTRIBUTION FINAL CONSUMER Human Consumption Value Chain for Grains and Oilseeds—Genetic Mod.

GRAIN PRODUCER FEED MILL MILK PRODUCER COOPERATIVE HANDLER MILK PROCESSING PLANT RETAILER FINAL CONSUMER Human Consumption Value Chain for Organic Milk--

Drug Manufacturer Vet. Or Animal Health Supplier MILK PRODUCER COOPERATIVE HANDLER MILK PROCESSING PLANT FOOD MANUFACTURER RETAILER Human Consumption Value Chain for Milk---BST

TASTE Time Consumer Value Hierarchy Source: Ron Olson, General Mills Consumer Values in Food Products 1960’s1990’s1980’s1970’s

TASTE CONVENIENCE Time Consumer Value Hierarchy Source: Ron Olson, General Mills Consumer Values in Food Products 1960’s1970’s1980’s1990’s

TASTE CONVENIENCE HEALTH BENEFITS Time Consumer Value Hierarchy Source: Ron Olson, General Mills Consumer Values in Food Products 1960’s1970’s1980’s1990’s2000’s

CONSUMER VALUE TRENDS IT IS GENERALLY ACCEPTED THAT THE FOOD MANUFACTURER CANNOT IGNORE THE LOWER ITEMS IN THE VALUE HEIRARCHY MUST BE ABLE TO PROVIDE ALL THREE

NEW APPROACH TO VALUE CHAINS TRAITS FOR PROCESSORS AND FOOD MANUFACTURERS –HIGHER LEVELS OF DESIRED COMPONENTS –IMPROVED PROCESSING EFFICIENCY –IMPROVED FUNCTIONALITY IN FOOD MANUFACTURING –PRODUCT SAFETY

NEW APPROACH TO VALUE CHAINS NO LONGER VIEW QUALITY OF PRODUCTS AS STARTING AT FRONT DOOR OF PLANT 0R STORE VALUE CLEARLY DEFINED, SHARED, AND UNDERSTOOD BACK THROUGH THE SUPPLY CHAIN SUPPLY CHAIN INTERCONNECTED WITH INFORMATION SHARED FROM RAW PRODUCT SOURCES THROUGH BACK DOOR OF PLANT

NEW APPROACH TO VALUE CHAINS REQUIRES RADICAL CHANGES IN RAW PRODUCT PROCUREMENT –CONTRACT SPECIFICATIONS FOR SOME –UNDERSTANDING SUPPLIER COSTS AND CAPABILITIES –ESTABLISHING TOLERENCES AND TESTING PROTOCOLS –ARRIVING AT MUTUALLY ACCEPTABLE SOLUTIONS

GRAIN PRODUCER FEED MILL MILK PRODUCER COOPERATIVE HANDLER MILK PROCESSING PLANT FOOD MANUFACTURER RETAILER Human Consumption Value Chain for Milk—Food Safety

NEW APPROACH TO VALUE CHAINS CHANGES IN WHO SUPPLIES RAW PRODUCT –ESTABLISHING A LIST OF “APPROVED” SUPPLIERS –INSPECTING SUPPLIER FACILITIES –ESTABLISHING REQUIRED SUPPLIER DOCUMENTATION –MUCH SMALLER # OF SUPPLIERS

SOME DETERMINANTS OF A VALUE CHAIN’S SUCCESS FOCUS ON VALUE CREATION IN FINAL PRODUCT FOR CONSUMERS SHARING INFORMATION TO CREATE COST SAVINGS OR ADD VALUE EQUITABLE SHARING OF RETURNS FOR VALUE CREATION MUTUAL TRUST/COOPERATION AMONG PLAYERS

Pricing Raw Milk At The Farm Level

FUNCTION OF PRICE IN AN OPEN MARKET ECONOMY Allocative Function –Direct resources (Land, Labor, Capital) to the highest and best use, given the values tastes and preferences of consumers –Rations the use of resources so that the available supply fits the existing demand Income Distribution Function –For any given quantity produced of a product or service, a price increase raises (or a price reduction lowers) the level of the producers’ income y = price * quantity sold

FUNCTION OF PRICE IN AN OPEN MARKET ECONOMY –For any given quantity of product or service consumed, a price increase reduces (or a price reduction increases) the amount of other products the consumer can buy (i.e., income) If a consumer has $3.00 to spend on milk and strawberries and…. Milk = $2.00/galStrawberries = $1.00/# Milk = $1.00/galStrawberries = $1.00/# Income Distribution Function Continued

FUNCTION OF PRICE IN AN OPEN MARKET ECONOMY Competitive Price –Established by market forces –Supply and demand are dominant –Significant volume –Open access to market for buyers/sellers Administered Price –Established by non-market forces –May be legislated –May be set by government agency –May be set by other outside entity with ability to enforce

FUNCTION OF PRICE IN AN OPEN MARKET ECONOMY Formula Price –Established by defining a fixed set of relationships - a formula –A formula price may include some market prices (i.e., competitive prices) –A formula price may include some administered prices (e.g., support) –Specifies relationships among a number of prices and/or product characteristics

MILK PRICE CONCEPTS 12.Grade B price 13.Single basing point price 14.Multiple basing point price 15.Competitive price 16.Formula price 17.Administered price 18.Skim price 19.Butter fat price 20.Over order price 21.Protein Price 22.Prod. Price Differntial 1.M-W price 2.NASS price 3.CME price 4.Basic formula price 5.Support price 6.Blend price 7.Class I price 8.Class II price 9.Class III price 10.Class IV price 11.Grade A price

PRICING MANUFACTURING GRADE MILK Grade B prices were a critical component of milk pricing system (least common denominator) until Reflect total supply of Grade A and Grade B production available for storable products. Basis for federal price support programs Minnesota-Wisconsin Grade B prices historically used as the basis for pricing Grade A milk used for Class I & II products in Federal Milk Marketing Orders M-W was largely based on open market competitive prices not formula prices or Administered Prices

The Issue of the Minnesota-Wisconsin Price Series (M-W) M-W defined: The weighted average of Grade B milk prices paid by Minnesota and Wisconsin butter, milk powder and cheese plants. Used From 1961 –1995 (1999) to set minimum producer pay prices for Grade A milk in all federal milk marketing orders.

The Issue of the Minnesota-Wisconsin Price Series (M-W) Purpose: To establish a uniform minimum pay price in all federal milk orders for pricing Grade A milk used in manufactured dairy products. –Butter, non-fat milk powder and cheese are sold on national markets. –Minnesota and Wisconsin used because of the large percentage of its milk is used for manufacturing. –It also has the largest supply of Grade B milk, and the most vigorous milk plant competition.

Utilization of Milk, Wisconsin, 1993 UsePercent of Total Cheese86.5% Ice Cream0.6% Condensed milk2.0% Other manufactured1.3% Total Manufacturer90.4% Fluid (beverage)6.1% Shipped out-of-state2.1% (some to IA) Kept on the farm1.4%

Grade A of Milk, 1993 Grade AGrade B Wisconsin 90%10% Minnesota 86%14% United States 95%5% Basis for pricing 95% of U.S.milk

Class III Prices Used As the Class I and Class II Mover The Grade B Price Was Used To Set the Class III Price The Class I And Class II milk received a fixed Premium Above Class III milk When Class III ( a competitive price) Moved Up or Down the Class I and II Prices Moved Up and Down With it

FLUID MILK PRICING (Single Basing Point).002$/mi from basing point 1. Class I differential reflects the cost of transporting milk from basing point 2. Usually < hauling cost to prevent interorder movement 500 Miles $1.00

FLUID MILK PRICING (Single Basing Point).002$/mi from basing point 1. Class I differential reflects the cost of transporting milk from basing point 2. Usually < hauling cost to prevent interorder movement 500 Miles $1.00 $2.00 1,000 Miles

FLUID MILK PRICING (Single Basing Point).002$/mi from basing point 1. Class I differential reflects the cost of transporting milk from basing point 2. Usually < hauling cost to prevent interorder movement 500 Miles $1.00 $2.00 1,000 Miles 1,500 Miles +$3.00

FLUID MILK PRICING (Single Basing Point).002¢/mi from basing point 1. Class I differential reflects the cost of transporting milk from basing point 2. Usually < hauling cost to prevent interorder movement 500 Miles $1.00 $2.00 1,000 Miles 1,500 Miles +$3.00 2,000 miles +4.00

MINNESOTA - WISCONSIN PRICE SERIES The major price series used for 35 years to price Grade A milk used for manufacturing Average Grade B pay price in two states +Producing > 50% of B milk +Based on pay prices +Reported monthly Includes most quality, protein and competitive premiums paid Grade B farmers +Does not include deductions for hauling, etc. +Heavily influenced by cheese plants

MINNESOTA - WISCONSIN PRICE SERIES –Declining volume of Grade B milk made National Agricultural Statistics Service (NASS) to discontinue standing behind it –Replaced in mid 1995 by Basic Formula Price (BFP) –Really just adjusted M-W -----Stopgap Measure No series on BFP - really interim solution BFP closely tracks M-W Professionals will continue to refer to M-W for next several years Proposed rule replaced BFP on January 1, 2000

MANUFACTURING MILK PRODUCT MARKETS Three major product categories for Grade B milk –Cheese factories use majority –Butter-powder plants are also important Butter Non-fat dry milk –Production of these hard products creates by-products that also have value –Cheese plants can recover whey cream (used to make butter) whey proteins lactose –Butter-powder plants produce joint products cream produces butter and buttermilk powder skim produces nonfat dry milk