FEATURES


The Continuing Conundrum for Dairy

By John Hibma




Not every dairy farm needs to milk 1,000 cows, nor does every dairy farm have to process its own milk to survive.
Photo by jade/morguefile.com.

Dairy farming has a long and well-established history in the U.S. In many regions of America, the dairy industry makes a significant contribution to the well-being and resilience of local economies, and in some cases it defines a regional culture. Health professionals continue to be advocates of the excellent nutrition of dairy products. In 2012, total milk production in the U.S. surpassed 200 billion pounds - the most ever.

However, in spite of the continued growth of the industry and the popularity of dairy products, many dairy farms struggle to stay in business. The question that has been posed for many years is: Does U.S. milk pricing policy adequately stabilize the dairy industry, in light of the fact that year after year, many thousands of dairy farms must shut their doors?

As recently as 1980, there were more than 300,000 licensed dairy farms in the U.S. Statistics from the U.S. Department of Agriculture (USDA) show that the number of licensed dairy farms in the U.S. dropped below 50,000 in 2012. During 2012, every state except for Washington either lost dairy farms or kept the same number. In the past decade, total cow numbers have remained somewhat constant at around 9 million, but those cows are moving westward and into larger herds.

While the trend over the years has been for smaller dairies with 50 cows or less to be the ones calling it quits, more recently even the highly leveraged mega-dairies in the West have also been affected. Like all sectors of agriculture, unpredictable market dynamics and costs of production have drained equity from most dairy farms.

At the heart of dairy farm profitability is generating enough revenue from milk production to pay the bills. Dairy farming is capital-intensive. Operating costs have risen substantially in recent years, and market prices are increasingly more volatile. As dairy farms go out of business, they often leave a big hole in the local rural economy.

Because of unpredictable prices due to historically chronic overproduction and market dynamics worldwide, ongoing price volatility forces dairy farmers to operate with a cost-cutting mentality. While many dairy farms continue to prosper only through continued cost cutting and improved efficiencies, many more walk a fine line trying to keep bills current from one month to the next.

A second factor that has its roots in the cost-cutting mentality is the price of new technologies that are intended to improve efficiencies and economies of scale on dairy farms. However, the initial cost of implementing new technologies and oftentimes the required herd expansions is prohibitive for many dairy farms.

Prices received for dairy products in the U.S. have been tied to federal pricing legislation since the Great Depression era of the 1930s. Federal Milk Marketing Orders (FMMO), classified pricing and milk price supports have been the foundation of milk pricing policy and were developed to ensure that milk marketing and pricing were orderly and equitable. Since the average dairy producer is out of the "marketing loop" for dairy products, most of the milk in the U.S. is pooled so that dairy farmers receive an equitable price for the milk they produce, regardless of how it's used or where it's sold.

Milk pricing policy is designed to keep milk supply and demand balanced. Periodically, when dairy farm profit margins diminish or go negative due to oversupply or increased costs of production (COP), price supports and other aspects of pricing formulas are adjusted after the fact to allow dairy farmers to return to profitability. In the meantime, more producers have had to exit the business, and those who are left quite often produce more milk, which eventually creates another oversupply situation.

It's also important to note that until recently, the federal milk pricing policy of dairy products has been based solely on the market dynamics of supply and demand, with no consideration of COP. When milk prices are depressed, dairy farmers have to use their creativity to keep the business profitable, usually by adding more cows or finding additional places to cut costs.

During the 1980s, pricing policy underwent significant change as government supports were reduced. Pricing was adjusted to be more reflective of supply and demand, which created more volatility. Since the 1990s and into the first decade of the 21st century, the world markets have had greater impacts on domestic pricing. Milk produced in the U.S. must now compete in a world market, with those markets focused more on manufactured dairy products such as cheese and powdered milk.

The pricing of milk in the U.S. is dauntingly complex. The federal policy is based on the supply and demand of milk used for manufacturing and separates dairy products into three manufacturing classes (Class II, III, IV) according to their perceived market value. The price for fluid milk, on the other hand, is not based on supply and demand; instead it's tied to the supply and demand for manufactured products. However, a higher value is placed on fluid (Class I) milk.

While worldwide consumption of dairy products continues to grow on an absolute basis, fluid milk utilization in this country has remained fairly constant at plus or minus 50 billion pounds since the 1940s, even though the U.S. population has increased by around 180 million people. This indicates that per capita consumption of fluid milk has steadily declined for over a half-century in the U.S. Virtually all of the increased milk production in this country has gone into manufactured dairy products, with cheese taking the largest share. Today, manufactured dairy products represent about 75 percent of the total milk utilization, as opposed to less than 60 percent in the 1940s.

The challenge for the U.S. dairy industry and policymakers is to continue to provide prices to dairy farmers that allow them to pay the bills as they compete with world prices. This must be accomplished while they continue to produce milk that's used primarily for manufacturing purposes - lower value - and expect to be paid a higher value in order to cover increasing operating costs.

The price paid to dairy farmers has trended upward in recent years, due to increased demand for milk protein. Dairy prices have managed to stay in the range of $18 to $20 per hundredweight (cwt) of milk over the past several years. However, the prices of purchased feedstuffs - which account for 30 to 50 percent of dairy farm expenses - have increased significantly. These increasing costs effectively negate any increase in profit margins the higher milk prices bring.

Recent dairy cost studies in Connecticut, Vermont and Maine help elucidate the critical situation that dairy farmers find themselves confronted with. In Connecticut, the total operating costs for January through September 2012 varied from $16.46 to $23.16 per cwt. For Vermont, those same costs varied from $20.24 to $26.01 per cwt over the same time period. For Maine, the costs were between $22.54 and $29.04 per cwt.

These numbers reflect only operating costs and do not include allocated overhead costs such as labor, opportunity costs of unpaid labor, replacement costs for machinery, etc. When the additional overhead costs are included, the total cost of operating dairy farms in the Northeast comes to over $30 per cwt for each of these states.

Data from the USDA for the 23 leading dairy states show that for 2011, total production costs averaged nearly $24 per cwt. With the higher feed costs experienced nationwide in 2012, this value will undoubtedly be even higher for 2012.

Operating costs vary from region to region in the U.S., but it's clear that the "real" cost of dairy farming is not being covered by the prices received by way of federal pricing.

There is little to suggest that this will change in the immediate future, unless current dairy policy is revised, and prices will continue to fall short of keeping dairy farmers in business. Higher production costs will continue to force the weaker farms out, favoring and necessitating the need for larger herds that can maintain better economies of scale as the only way to remain viable. At the same time, processors and handlers, in their attempt to improve efficiencies and profits, are enlarging plants and consolidating FMMOs while continuing to pay dairy farmers minimum prices.

And it's clear that large herds with improved economies of scale can't always turn a profit either. Under the existing federal milk pricing policy, dairy farmers across the country who have managed to remain in business until now will find it increasingly difficult to remain dairy farmers with the continuing cycle of more down years than up years, regardless of herd size.

For the most part, dairy farmers operate their businesses in an economic environment called "perfect competition," which is defined as many producers of one homogeneous product with no one producer being large enough to affect the price. There are few barriers for entry into the market, and it's easy to flood the market with too much product, which results in low prices for everyone.

Even though much of the ill that befalls the dairy industry is the result of chronic overproduction, the dairy industry doesn't really have a production problem. It has a marketing problem. We know how to produce the milk; however, we don't know how to market it very well. This is largely because the dairy industry has treated milk like a commodity that must be sold, for the most part, on a wholesale basis. Dairy farmers who market milk by way of FMMO do not capture much, if any, of the potential added value of the milk they produce.

In recent years, there has been growth in specialized niche markets, such as farmstead cheese, yogurt and raw milk, that command a premium price. However, these markets are usually limited to small dairy farms that are in close proximity to large population centers where people tend to have more disposable income. These entrepreneurial farmers spend as much, if not more, time marketing their dairy products as they do producing them, and they tend to have higher production costs. Even though supply and demand for dairy products is considered to be fairly inelastic - meaning that consumers who consume dairy products purchase them at just about any price - dairy products tend to be purchased by that portion of the population with higher disposable incomes.



Statistics from the USDA show that the number of licensed dairy farms in the U.S. dropped below 50,000 in 2012. During 2012, every state except for Washington either lost dairy farms or kept the same number.
Photo by d3designs/morguefile.com.

The "locally produced" niche marketing model, even though it's popular, covers only a small portion of the dairy products consumed in this country. The U.S. dairy industry is a multibillion-dollar behemoth that must continue to support many thousands of farmers and help keep struggling local economies alive. A dairy industry with a healthy future must continue to focus on consumers in the millions rather than the mere thousands that locally produced, value-added products may reach.

Those millions exist beyond the borders of the U.S. As domestic dairy markets mature, the potential for increased export of U.S. dairy products is the one bright spot for the industry. As standards of living improve around the globe, populations tend to consume higher-quality protein, which includes dairy products. Unfortunately, the current pricing policy inhibits significant export of U.S. dairy products.

According to Rabobank International, economic growth in net importing countries has been a key driver of dairy trade. However, Rabobank also notes that: "The [U.S.] price support program has limited the U.S. dairy industry's product adaptations and specifications that have become global norms. With the government as a 'backstop' customer, producers and processors have less need for commercial capabilities. In this way, the support program has incented the U.S. dairy industry to be a residual supplier of global ingredients at lower values and narrowed the channels where U.S. dairy commodities satisfy primary customer needs."



Virtually all of the increased milk production in this country has gone into manufactured dairy products, with cheese taking the largest share.
Photo by PDPhotos/pixabay.com.

Essentially, the U.S. dairy industry - and this is a marketing issue - has been slow to change its position of participating in export markets only when it has excess milk to "dump." More prudently, dairy should be marketed as "high-quality" and "value-added" to position U.S. dairy farmers as reputable suppliers with a reputable product. The future success of the U.S. dairy industry will depend heavily on the growth of international markets, not on the continued fiddling with domestic milk classifications and price fixing.

Here is what the CATO Institute wrote about federal milk policy in 2007: "Consider the illogic of federal dairy policies. They jack up milk prices for millions of families at the same time that other programs, such as food stamps, aim to reduce food costs. And although federal law generally prohibits cartels, a federal dairy cartel enforces high milk prices. ... Marketing orders limit competition. ... On top of marketing orders, Congress added a dairy price-support program in 1949. This program helps to keep prices high by guaranteeing that the government will purchase any amount of cheese, butter, and dry milk from processors at a set minimum price. ... In 2002, Congress added an income support program for dairy farmers, which distributes cash payments whenever prices fall below target levels. Perversely, this program causes overproduction and thus downward pressure on prices - in direct opposition to the price support program, which tries to raise milk prices.

"To enforce artificially high prices, the government imposes import barriers on milk, butter, cheese, and other products. Without those barriers, consumers could simply purchase lower-priced foreign goods. Imports of cheese, butter, and dried milk are limited to about 5 percent or less of U.S. consumption."

It's certainly a valid argument that the federal pricing policy has never been perfect, and dairy farmers have had to learn to live with it. In fact, federal pricing policy has evolved, in part, to protect dairy farmers from themselves. Not having a federal pricing policy would demand that there be a supply management program in place - such as the one in Canada - that would regulate milk production in this country. However, a supply management program would almost certainly eliminate the possibility of continued international growth for the U.S. milk supply.

In short, the dairy farmers have accepted government regulation and price fixing in place of programs of self-regulation and deregulation that would result in survival of the fittest and chaos as market forces try to find equilibrium. In certain regards, government oversight and regulation have probably done more good than bad for the dairy industry by keeping it from destroying itself from within. However, at the same time, federal pricing policy has not resulted in a healthy U.S. industry in the 21st century.

Not every dairy farm needs to milk 1,000 cows, nor does every dairy farm have to process its own milk to survive. Dairy farming is a highly regionalized industry, and that regionality should be part of what determines milk prices and the economies of scale necessary for survival. In the future, dairy farms will need to focus on a specific market for the milk they produce.

New approaches to marketing dairy products as well as fair pricing are sorely needed. The milk pricing polices in place today have served their purpose at a time when the U.S. dairy industry was still growing and had little to do with world markets. There may always need to be some pricing policy in place to regulate domestic dairy markets, but the industry also needs to reduce its dependency on government subsidies. However, those policies should not hinder aggressive entry into the global markets that clearly present fresh opportunities for continued market growth and renewed profitability for U.S. dairy farmers.

The author is a dairy nutritional consultant and works for Central Connecticut Cooperative Farmers Association in Manchester, Conn.