The Dairy Industry… A Continuing Adventure

Editor’s note: This post was originally published in the 2015 Farming Ag Industry Guide and has been updated for accuracy.

Nationally, the trend toward larger herd size and more milk per cow continues while more milk is being produced on fewer dairy farms. And despite 2014 being a record year for milk prices and milk production, every region of the U.S. continued to lose dairy farms. The U.S. dairy industry continues to grow as the U.S. dairy industry continues to shrink!

The average herd size continues to climb indicating that a greater number of smaller herds are leaving the industry compared to larger ones. During 2014 the Northeast region of the U.S. had fewer dairy farms leave than the rest of the nation – less than 1 percent compared to the national average of 3.5 percent. This statistic is somewhat misleading, however, since Pennsylvania increased its total dairies by 170 – something that no other state in the nation did.

The average herd size for U.S. dairy farms rose to 204 cows in 2014. However, 32 states – nearly two-thirds of U.S. states – still have average herd sizes below the national average. Of the 45,344 U.S. dairy farms still remaining, more than 29,000 of them milk less than 204 cows. Yet, those 29,000 dairies produce less than half of the nation’s total milk – meaning that more than half of the milk produced in the U.S. is produced on about one-third of the dairies milking many hundreds and even thousands of cows.

Trend toward consolidation

Whether one approves or disapproves, the dairy industry continues to move toward consolidation with fewer farms milking more cows. Large dairies can attain cost advantages over smaller farms, due to their ability to benefit from economies of scale. With the vast majority of the milk produced in the U.S. being sold under a federally regulated pricing structure, a homogeneous product like milk forces many dairy farmers to seek greater economies of scale to cover increasing operating costs. This is accomplished primarily by producing more milk per farm.

Lacking any type of supply control – which is a very unpopular topic within the U.S. dairy industry – there should be no argument that the most accurate description of the U.S. dairy industry has been for many years, and will continue to be, “survival of the fittest.” The farmers with the financial resources to expand and the business acumen to manage debt and control operating costs will stay in business while the rest of them will not. Dairy farming with herds of cows numbering in the thousands has become a rich man’s business.

Dairy farms operate like any other business. They produce a product or service that must be sold in a marketplace. The vast majority of dairy farms in the U.S. have a ready purchaser of the milk they produce through a dairy processor. So getting the milk to market is seldom a problem. However these dairy farms have little or no control over the price they receive for their milk and when the national supply outpaces the demand for dairy products, the price drops – often to a level that does not cover operating costs. When the costs outpace the revenues, the dairy is like a leaky boat; it will eventually sink.

Advantages of small farms

Unfortunately, smaller dairy farms have a distinct disadvantage in economies of scale with labor, costs of production and assets. Data collected over many years by Farm Credit East, shows that smaller dairy farms require more man-hours of labor for the milk that’s produced. Net production costs are higher on smaller dairy farms, assets needed per cow are higher on smaller dairy farms and net earnings per cow are lower with smaller dairy herds. Dairy farms are heavily capitalized businesses with animals, buildings and equipment costing many thousands of dollars. A smaller dairy herd still needs expensive tractors and farming equipment regardless of how many cows are being milked. Repairs and maintenance must come out of cash-flow and profits, which, for a small herd, can take time to accumulate into the sums needed for large capital purchases. Clearly, the deck is stacked against the survival of smaller dairy farms.

This, however, certainly doesn’t mean that every dairy farm milking 50 or 100 cows must expand or face going out of business. It has been proven over and over again that dairy farm profitability is much more dependent upon superior management than on the size of a herd and how much milk is produced. Nevertheless increased labor efficiencies, lower net cost of production and a couple of million pounds of milk per year all help in making a dairy farm profitable.

Because dairy products are relatively easy to produce, it’s also easy to create an oversupply which drives down prices for all dairy farmers. Federal pricing policy was enacted many years ago to encourage the production of fluid milk. Over the years, the per-capita consumption of fluid milk has been declining, forcing more milk to be moved into manufactured products such as cheese and yogurt. Although the demand for manufactured dairy products remains strong, dairy farmers get paid less for that milk used for those products due to the way milk is priced.

How large farms profit

Large dairy farms can produce many millions of pounds of milk per year, and while their profits may only be pennies per gallon, they profit through advantageous economies of scale. Smaller dairy farms that are located in close proximity to urban areas tend to have higher production costs due to higher land values and other increased production and cost-of-living expenses. The lower milk prices that result from a federally regulated milk pooling system heavily influenced by significant amounts of manufactured dairy products contribute to those dairies failing. Many smaller dairy farms near urban areas are resorting to and benefiting by developing value-added niche markets for their products.

In much of the U.S., milk is categorized into four groups for pricing purposes. Milk used as beverages is referred to as Class I. Milk used in yogurt and frozen desserts is Class II. Class III is milk used in the manufacture of cheese and Class IV is milk used for the production of butter and milk powder. Each class is priced differently. All regions of the country have a different mix of how milk is used.

The chart on page 10 shows that nearly 50 percent of the milk produced in the U.S. during 2013 was used for cheese. Consumers now prefer cheese as their primary source of dairy products. Yogurt is close behind. Less than one-third of milk produced nationwide is now consumed as fluid. Regions such as the southern U.S. continue to market the majority of their milk as fluid and, consequently, are paid higher prices. Ironically, more dairies are leaving the South than any other region. States such as California and Idaho do not participate in the federal pricing program and are not included here. However, those regions consist of large dairies producing more milk that’s also used for manufacturing rather than for fluid usage. (See chart, page 10.)

Powerhouse that is the dairy industry

The U.S. dairy industry is an economic powerhouse that provides an immensely popular and nutritional food to millions of consumers both within the States and around the world. Nevertheless, dairy farming faces criticism from increasing numbers of people questioning the environmental sustainability of both animal agriculture in general and large dairy farms, in particular. Larger dairies, because they have greater challenges with managing manure and preventing excessive nutrient contamination of soils and waters, are under much greater scrutiny by state and federal environmental agencies. Smaller dairy farms have managed to stay under the radar so long as they don’t pollute.

Large or small, most U.S. dairies in the U.S. are family owned and operated and family businesses are the cornerstone of many rural economies. Still, those rural economies continue to say good-bye to their dairy farms. Dairy farmers fight an unending tug-of-war with profitability year after year. Congressional lobbying by the giant food processors make sure that the U.S. government maintains its choke-hold on milk pricing. The price volatility due to chronic over-supply along with the instability and the uncertainty in export markets keeps dairy farmers on an unsure financial footing.

Even though the trend for U.S. dairy farms is to grow larger in order to stay in business, a large dairy farm has no guarantee that it will be successful. Many have overleveraged their financial position and had to call it quits. Neither does being a smaller-sized dairy farm mean that it is doomed to failure. But it can’t be operated as just a “hobby farm” on weekends.

In order for dairy farmers to be successful they must be an excellent manager of both cows and money. They must decide what size herd best fits their management capabilities as well as their capacity to take on and manage financial risk in good times and bad. And it’s becoming increasingly more critical that dairy farmers know who, what and where the market is for the milk they produce as they decide how many cows to milk.