1. Dr. Roger Ginder Econ 338 Fall 2007 Lecture #18
Dairy Marketing
Dr. Roger Ginder
Econ 338
Fall 2007
Lecture #18

2. CLASSIFIED PRICING UNDER FEDERAL MILK MARKETING ORDERS

3. Classified Milk Pricing
One price paid for milk in fluid uses
Other prices paid for various other uses
Justification for a higher fluid milk price
More costly to produce grade A
More costly to transport fluid milk
Fluid milk has less elastic demand
Need to ensure adequate supply in fall when production is down
Classified pricing helps dispose of surplus milk in spring flush season by creating a lower price for manufactured products
Also it helps to balance weekly bottling demands with supplies

4. Past

6. FMMO CLASSES OF MILK USAGE/PRODUCTS
Class I = Fluid Products
Class III = Cheese
Class IV = Nonfat dry milk, Butter
Class II = Everything else
(e.g., cottage
cheese, yogurt, ice
cream)

7. CLASS I DIFFERENTIALS PRIOR TO 2000
* Varied from order to order but generally increased with distance away from Wisconsin
* Rationale: Enables handlers
located outside of
Wisconsin to buy milk
closer to Wisconsin at a
lower price using the price
savings to offset greater
transport costs (assures
consumers a supply, and
protects producers inFMMO)
* Actual Class I differentials ( /cwt/10/mi) is really less than actual transport cost

8. Class I Differentials Rationale for Class I Differentials
Encourage production for fluid in deficit areas
Pay for added transport costs to cover fluid needs in deficit areas
Prior to circa 1961 Class I set by
Differential above manufacturing milk price
Complex economic indexes
Varied from order to order - no uniformity
After early 1960’s, a single basing point system was used
Eau Claire, Wisconsin was base point
Covered all orders east of Rocky Mountains
15¢/cwt for each 100 mi ($.0015/mi) until 1986
Class I differentials are constant and BFP is the mover of Class I and Class II price
Class I differentials were amended in 1986
Approximate $.002/mi
Southeast and south of Eau Claire

9. Class I Pricing Prior 2000 Basic formula price (2nd preceding month)
+ Class I differential (varies by market) Plus BFP 2nd preceding month is equal to the Class I Price (this month)
+ 2 month lag on BFP base favored by processors

10. Class I Differentials Class I differentials were amended again in 2000
Radical Change in the Basing Point mechanism, but a less radical change in the differentials paid
Changed to a Multiple Basing Point System from the old Single basing point system
No longer based on distance from Eau Claire Wisconsin
Instead defined by county
In most cases class I and II differentials were not reduced over what existed before
In some cases they were increased
Post 2000 Class I differentials are still constant and the BFP is still the mover of Class I and Class II price

11. CLASS I UTILIZATION PERCENTAGE
The percent of total order milk supply (quantity) that is used in Class I products
Varies greatly from order to order
Generally lower in upper midwest
Generally higher in east/southeast/northeast
Larger Class I percentages generate larger blend prices as a rule
BUT …When BFP increases rapidly and steeply an inverted price can result
Inverted price less likely but still possible and has occurred under the post 2000 FMMO rules

12. OBSERVATIONS - CLASS I PRICING
It is a type of formula pricing
The Basic formula price is the “Mover” of Class I Prices and reflects competitive conditions
Class I differential is fixed and does not represent competitive forces
Class I differential was a single basing point pricing system with Eau Claire as the base – now multiple basing point with county prices
Effectively very similar to pre 2000 pricing

13. Class II Differentials
Rationale for Class II differential
Attract sufficient Grade A milk away from manufacturing uses
Covers transport costs in deficit areas
At one time 10¢ was differential
Later a formula price was used (complicated) --- scraped in 1995
used 30¢ differential
After January 1, 2000 use 70¢
There was variation among orders – but not now

14. Class II Pricing Prior 2000
Basic Formula Price (MW for 2nd preceding month) plus 30¢ / cwt. was equal to Class II Price (this month)
Effective early 1995 the Class II price was announced 5th of preceding month
Advanced pricing trial to see if could work for Class I

15. Marketwide Pooling

16. Marketwide Pooling All producers receive a uniform milk price
Regardless of which plant received
Adjusted for transport/zone charges
Assures producers share equitably in high valued end uses

17. CHARACTERISTICS OF FMMO AREAS
Based on sales territory of competing distributing plants
Based on where milk is sold not where it was produced
FMMO areas have expanded as sales areas have expanded
Change in distribution methods
Improved transport at lower unit cost
No. of FMMOs has declined to consolidations and mergers
The provisions of 1995 Farm Bill (Fair Act) required even more accelerated consolidation

18. Region defined is typically:
1. Centered around fluid market(s) (not production areas)
- milk can be pooled from anywhere
- transport costs is the real issue
2. Few distribution route sales (or fluid product sales) crossing into other markets
3. A group of producers who “normally” serve that market(s) as a result of their location

19. POOLING REQUIREMENTS
Performance or qualification provisions for participating as a pool plan
Define clearly what a handler must do to become regulated or pooled on an order
Ensure that Class I and Class II pricing differentials are distributed to producers who actually supply milk for fluid consumption or Class II uses
Prevent plants with no commitment to fluid supply from sharing in Class I & II differentials and drawing milk from fluid suppliers.

20. TYPES OF FMMO MILK PLANTS (BUYERS OR HANDLERS)
1. By activity
a. Distributing plant is a fluid handler, bottler, or
processor
b. Supply plant is a plant which ships a minimum
amount of its milk to a distributing plant
(1) Butter/powder or cheese plant
(2) Reload or receiving stations
2. By regulation status
a. Regulated plant is the same as pooled or also called
qualified (Must follow FMMO provisions)
b. Nonpool (unregulated) plant
Not affected by FMMO provisions
Class III and Class IV

21. 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

22. 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

23. 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. Individual handler pooling
+ Class I sales shared only with those who serve Class I market
+ Little incentive for supply area to expand beyond that which is needed for Class I sales
- Unequal price treatment of producers
3. Supply balancing or standby pool payments
(use part of Class I differential for payment)
4. Abandon intraorder Class I differentials.
Assess all Class I purchases an amount equal to actual transportation costs.

24. 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

25. Example of Central Market Order Pooling

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

27. 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 one 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
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

28. Table 6.2. Computation of an example marketwide pool
Hiland Mid-Am Kraft Total market
Handler (cwt) (%) (cwt) (%) (cwt) (%) (cwt) (%)
Producer receipts
Class I 38, , ,400 36
Class II , ,900 3
Class III 1, , , ,
Class IIIa , ,500 2
Total 40, , , ,

29. Table 6.2. Computation of an example marketwide pool (cont’d)
Hiland Mid-Am Kraft Total market
Handler $ $/cwt $ $/cwt $ $/cwt $ $/cwt
Class I 556, , ,
Class II 5, , ,
Class III 14, , , ,274,
Class IIIa , ,
Total Amt. Paid $ 576, K $ 1,066, K $662, K $2,304, K
Average
classified value
Note: Classified prices ($/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.

30. Table 6.2. Computation of an example marketwide pool (cont’d)
Hiland Mid-Am Kraft Total market
Handler $ $/cwt $ $/cwt $ $/cwt $ $/cwt
Class I 556, , ,
Class II 5, , ,
Class III 14, , , ,274,
Class IIIa , ,
Total 576,240 40K 1,066,050 89K 662,500 50K 2,304, K
Average
classified value
Note: Classified prices ($/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.

31. 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
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.