Farming Magazine - August, 2012

FEATURES

Milking for Profits

Have you considered value-added and niche markets?
By John Hibma

Milk pricing and the balance of the national milk supply will again be the main focus for the U.S. dairy industry during 2012. With favorable weather conditions during the first quarter of the year, milk production habitually runs the risk of outpacing domestic consumption and the wild card of exports is never a sure bet to help remove milk from the pipeline. Many dairy farms across the nation will again be faced with financial challenges as milk prices will not be matching the highs of 2011.


The Smyth family produces, processes and bottles whole milk, 1 percent, skim, half and half, heavy cream, butter, chocolate milk, two flavors of kefir, five flavors of yogurt, as well as eggnog during the holidays.
Photo courtesy of Smyth's Trinity Farm.

The vast majority of dairy farms are paid for their milk based upon federally mandated milk pricing orders. Under this system a very small variation in total milk supply can result in significant swings in milk prices. Since 2000, the volatility of milk prices has resulted in historically high prices as well as intolerably low prices. Along with the milk price volatility, increases in production costs have left many dairies deep in debt or short of cash when milk prices do not cover operating costs. Few dairies have been unaffected by the recent economic turmoil.

The U.S. dairy industry continues to march down the path of larger dairy herds producing more milk per cow. While the average herd size in the nation remains well below 200 cows, nearly two-thirds of the milk produced in this country currently comes from dairies milking 500 or more cows. At the same time, though, over half of U.S. dairy farms are milking fewer than 100 cows.

During the past decade, herds numbering less than 100 cows have been reduced by about 40 percent. Herds numbering between 100 and 200 cows have diminished by about 20 percent. Herds numbering between 200 and 500 cows have remained nearly the same, and dairies milking over 500 cows have increased by almost 20 percent. As the overall costs of production continue to increase, dairies receiving bottom-of-the-barrel milk prices when the milk supply is long must improve economies of scale in order to stay in business. More often than not this requires expansion or capital investments that improve efficiencies. In many cases, smaller dairy farms are unable or unwilling to invest or take on debt to expand and choose to exit the business.

During the past decade there has been an annual exodus of between 3 and 5 percent of the nation's dairy farms, amounting to more than 20,000 dairy farms. During that same time period dairy cow numbers in the nation have remained nearly the same. At the beginning of 2012 there were about 3,400 dairies milking over 500 cows out of a total of about 51,000 dairies nationwide.

The dairy industry walks a very tenuous line between balanced and unbalanced supply and demand. Along with that, the heavily regulated pricing of milk is slow to react to market signals. Economist Kenneth Bailey wrote in 1997, "Dairy is the most regulated and complicated agricultural industry in the United States. The current foundation for milk pricing was created out of marketing conditions during the first four decades of the [20th] century. Federal milk pricing orders and the dairy price support program were developed to ensure an adequate income level for farmers ... In the intervening years court cases, the interstate highway system, and improvements in milk production, processing and transportation technology all affected the milk pricing system" (Marketing and Pricing Milk and Dairy Products in the United States; Kenneth W. Bailey, 1997; Iowa State University Press).

The milk pricing system that's in use today was developed with good intentions at a time when dairy products were transported only short distances and there were many hundreds more dairy farms with smaller herds. However, these same programs that were intended for good and have often been tweaked due to changing market conditions have often contributed to the volatility in milk prices. Due to the continuing increase in total milk production, milk prices over the past few decades have not kept up with overall inflation. As we so clearly saw with a worldwide recession in 2009, when money for milk disappeared, milk prices tumbled down to numbers that hadn't been experienced since the 1970s. The vast majority of dairy farmers who exit the dairy business do so because of a collapsing milk price.

Dairy farming across the U.S. is a highly regionalized industry. Dairy farms can be found in every state. Regardless of what part of the country a dairy may be located, it has been well documented that management style plays a significant role as to whether a dairy, large or small, will be successful. Even though animal husbandry and the maximizing of both milk and milk components are a central facet of a successful dairy farm, other factors such as the prudent management of debt and assets also contributes to whether a dairy farm will survive an economic downturn. A dairy farm of any herd size, when properly managed, can be successful ... until the price of milk crashes. Even though it's a difficult pill to swallow, there should be no argument that it's only proper economics and business policy for this industry to operate within the constraints of supply and demand.

By only producing milk and not engaging directly in the processing and marketing of dairy products, dairy farms have essentially relinquished a portion of the retail dollar. The chasm separating the dollars that the dairy farmer gets for his milk at the farm compared to the price that a retail store gets for dairy products continues to widen. Increasing numbers of dairy farmers - particularly those who have not succumbed to paralyzing cynicism - recognize that the only way to keep their dairy farm from going broke is to seek out alternatives that will "add value" to the milk they produce and put that added value in their own pocket.

The concept of dairy farms adding value directly to the milk they produce through processing and selling their own dairy products is certainly not a new one. In Enfield, Conn., Mike Smyth began milking cows in 1984, and then began processing and marketing his milk in 1995. Smyth came from a dairy farming background and has a college degree in milk manufacturing. When he took over the dairy from his parents in 1984, he did so with the intention of eventually bottling and retailing his dairy products under his Trinity Farm brand (www.smythstrinityfarm.com).

Thirty years ago, Smyth recognized that in order for a dairy farm to remain small and support a family in a region that had limited land available for agriculture - the small state of Connecticut has one of the highest population densities in the nation - value had to be added to the milk that was produced every day. With a customer base literally at his doorstep, Smyth recognized an opportunity that would allow him to make a living without having to create a large dairy farm.

Today, the Smyth family produces, processes and bottles whole milk, 1 percent, skim, half and half, heavy cream, butter, chocolate milk, two flavors of kefir, five flavors of yogurt as well as eggnog during the holidays, all from about 30 Holstein cows that produce a little over a ton of milk per day. Currently a half-gallon of milk sells for $3.50. All of the Trinity Farm dairy products are sold through either the on-farm storefront, wholesale markets, nearby farmers' markets during the summer and fall as well as through a home delivery service.

Smyth has sold the business to his sons, Peter and Sam, and daughter, Anne. The next generation of the Smyth family is optimistic about their future in the dairy business and the untapped opportunities for growth. Peter stresses that with this type of dairy model, there are now three businesses to contend with: milk production, bottling and retail sales. People who are considering doing this must understand that the return on investment while building a bottling facility and developing a local business is slow. Smyth adds that it takes a high level of commitment as you learn to balance your milk supply - production as opposed to sales and the seasonal fluctuation. Excess milk production still gets paid the federal price.

Peter stresses that the quality of the products being offered must be an unquestionable priority if one hopes to be successful in a local dairy market. Farmers must have a completely different mindset going into this type of niche marketing as they begin dealing with the public. Customers are willing to pay premium prices for dairy products when they're confident of the sterling reputation and high quality standards of a local dairy producer.

In many communities across the country agriculture and agribusiness are a foundation of the local economy. The very presence of dairy farms adds economic value to a community. The exodus of dairy farms, both large and small, can often cause irreversible damage to rural communities. One of the more insidious aspects of especially smaller dairy farms disappearing from the landscape is that it becomes like a cancer that slowly eats away at the economic health of that region.

Even though the tendency for U.S. dairy farms is to grow larger in an attempt to take advantage of economies of scale, there are many dairy farms that are unable to expand in size. In Landaff, N.H., Doug and Debbie Erb were faced with just that dilemma because of their limited land base. Doug explained that they had tried the expansion route for a couple of years, bringing the herd size to 125 cows, but found that they weren't set up to realistically handle that many cows efficiently.

In 2006, the Erbs made the decision that would lead them to keep their dairy herd at about 80 cows milking and use some of that milk to produce a high-quality Welsh-style, aged raw milk cheese (http://landaffcreamery.com. Doug took classes at the University of Vermont to learn cheese making and spent time in England learning more about the craft. The cheese is made and molded in a modern creamery that was installed on the farm adjacent to the milking parlor.

The cheese is not aged at the farm, but is delivered to The Cellars at Jasper Hill, located in Greensboro, Vt. This facility provides "affinage," or aging expertise, for many types of cheeses and also provides help with distribution of artisan cheeses nationwide. This unique business model is working well for the Erbs.

The road to value added for the Erbs was not without its bumps along the way. They made their first batch of cheese in early 2009, just about the time milk prices tanked. Setting up their Landaff Creamery took a lot longer than they thought it would and cost a lot more than they had planned for. Even at the end of the 2010 they were not sure if they'd done the right thing.


The Erbs' Landaff cheese is provided affinage by The Cellars at Jasper Hill in Greensboro, Vt.

"This is not for the faint of heart," said Doug.

The Erbs are encouraged with the progress they've made in the past year, saying that the creamery now provides a significant addition to the farm income and has met their expectations for a value-added business. They also praise their milk co-op, Agri-Mark, for recognizing the need for members to create value-added businesses and for altering their policies to allow for members to use their milk for value-added products.

Many dairy farmers in this country will continue to receive a price for their milk based upon the pooling and transportation of milk, on complex formulas based on classes of milk usage, how much butter the government is storing, and how much commercial cheese gets traded in Chicago. For those dairies that produce milk primarily as a wholesale commodity and focus solely on economies of scales and the never-ending pursuit of efficiencies, these pricing schemes will continue to work for them - maybe. Doug opined that a 50 or 60-cow dairy farm can still exist if a dairy farmer has no debt and is willing to work seven days a week. However, if he's trying to bring in the next generation or take some money out for retirement, small herds relying on federal pricing don't generate enough revenue to do that.

Many of the dairies that milk less than 100 cows, which is still over half the dairies in the country, are at the greatest risk of being forced out of business due to price volatility and increasing costs of production, which eat up the little margin they may have left. While not every small dairy will have the opportunity to produce a value-added product, many more may find that this is, indeed, the right time for tapping into a niche market that will keep their dairy in business.

The author is a dairy nutritional consultant and works for Central Connecticut Farmer's Cooperative in Manchester, Conn.