Navigating the Dairy Industry

Here’s how farmers plow forward to improve their dairy business.

With more than 9 million dairy cows in this country, the U.S. dairy industry continues to produce more milk each year, now exceeding 20 billion gallons of milk annually. Roughly three-fourths is manufactured into powder, cheese, butter, yogurt, and other soft products. Consumption of fluid milk continues to decline as it must compete in the marketplace with other beverages such as soft drinks, juices, energy and protein drinks, and water. There is no self-regulation within the industry to balance supply with demand. Attempts at supply management programs are mostly met with disdain.

Despite a continuing drop in the per capita consumption of fluid milk, Americans are consuming more yogurt, cheese and ice cream, which has resulted in a 20 percent per capita increase in consumption of all dairy products during the past 40 years. During that same time period, however, milk production in the U.S. has increased more than 60 percent – from around 130 billion pounds to more than 212 billion in 2016.

A look at trends

Domestically, the dairy industry continues to produce far more milk than can be consumed. In the past decade, our dairy industry has been able to aggressively tap into the international markets, which has kept the milk price from completely crashing. In 2014, dairy farmers were paid record-setting prices due to expanding export sales. However, as recently as 2015, exports to China, our largest export customer, lagged due to a slowdown in their economy, resulting in a significant decrease in U.S. milk prices from the previous year. Economics and weather conditions in the southern hemisphere also contributed to the price volatility over that short period of time.

At the beginning of 2017, exports are recovering and the U.S. Dairy Export Council reports that about 14 percent of the milk produced in the U.S. is now going to exports, which is equivalent to one day per week of milk production. Around the world, a growing middle class is consuming more dairy products as their standard of living improves. However, although the extra demand for U.S. dairy products has helped buoy milk prices, the U.S. dairy producer must still remain competitive in what is a very competitive world market for dairy products.

Back in the U.S., the negative publicity regarding saturated fats found in dairy products is showing signs of relinquishing. Recent research is showing that milk fat is not the troublemaker it was purported to be for so many years. Butter sales have improved during 2016, and cheese and yogurt consumption continue to grow and lead the dairy categories. Still the industry walks a very precarious line between supply and demand when only a small swing of 1 to 2 percent movement of over-supply takes several dollars per hundred-weight away from the dairy farmer.

Dairy farms in the Northeast U.S. find themselves at an even greater disadvantage with higher operating costs in one of the most densely populated regions of the country. Conventional economic theory suggests that in a region where supply lags behind demand, prices should be higher. According to Economist Bob Wellington, the prices received by New England dairy farmers have little to do with the supply of milk produced in the region relative to the demand by the consumer.

Milk pricing throughout the country is complex, with 10 Federal Marketing Orders dictating the prices paid to the majority of dairy farms. In addition, California has its own milk pricing order that has been putting cheaper dairy products into the marketplace. Prices for milk are set based on regular surveys by the U.S. Department of Agriculture of manufactured dairy products – cheese, butter, powdered milk and whey – as they are traded on the Chicago Mercantile Exchange. Local supply and demand has no bearing on what dairy farmers in New England are paid for their milk. Ironically, the swell in the popularity of yogurt and cheese has actually decreased the price paid to dairy farmers.

During the past two decades, milk pricing has been a roller coaster ride for the U.S. dairy farmer, with as many years of prices being below the cost of production as above. As a result, dairy farms continue to go out of business at an average rate of more than 4 percent per year. More than 40,000 dairy farms have exited the industry since 2000 – a total decline of more than 50 percent. Ironically, total cow numbers have remained nearly the same, meaning the dairy farms that remain today are milking more cows and those cows are producing more milk over their lifetime.

The trend is likely to continue and for the foreseeable future there will be more periods with milk prices unable to cover operating costs. Dairy farmers who are paid the federally mandated milk prices face an uphill battle as they strive to maintain optimal milk production and keep their cows healthy while, at the same time, continually looking for ways to produce milk more cheaply.

Alternative solutions

Simply put, in light of nonexistent supply management and unpredictable volatility, the only way dairy farms can remain in business today is to either milk more cows, thereby improving efficiencies through greater economies of scale and lowering the cost per unit of output, or find niche markets that allow them to increase revenues through value-added marketing – or a combination of the two. Dairy farmers must be aware that making changes will likely come with a price tag and must be carefully considered, because the changes made today will probably affect their financial well-being for years to come.

Throughout the Northeast, dairy farmers have been faced with the question for many years of how to keep their businesses from failing in a volatile economic environment. All dairy farmers must face the reality of a difficult situation and assess if they have what it takes to keep milking cows – and be willing to make the inevitable changes that will need to be made. The decisions they make must be based on their individual talents and personal preferences of what they are willing or not willing to do.

In South Hadley, Massachusetts, Steve McCray decided he had to make the investment in processing his own milk in an effort to keep the dairy from failing. McCray’s father, Don, began the dairy at that location in 1955. Steve took over the operation when Don passed away in 2005. After the disastrous year of 2009 and knowing that relying on federal milk pricing was likely to put the dairy out of business, Steve began planning in earnest to process and market the milk produced by his 50 cows.

This was not the McCray family’s first venture into value-added – they had been making ice cream and selling it at their farm stand since the 1980s. The McCray dairy is one of the earliest dairies in the region to delve into agritourism as a way to supplement farm income. Today, along with the free petting zoo for children of all ages, their country-style storefront houses a small diner and bakery. Just outside is a miniature golf course open during the summer months and they also hold various farm-related events throughout the year – encouraging the non-ag public to learn about farming.

McCray began bottling his milk in the summer of 2013 and today about 75 percent of the milk he produces is processed and sold through a distributor, 10 percent of the milk is retailed out of the store with the remainder going to the regional handler for the milk-order price. He says it was a good move and that he’s making more money than if he’d continued selling it all through the marketing order. Only just a few years in, McCray is optimistic about future growth potential with his location in central Massachusetts.

Currently at a national average of over 220 cows per herd, the average herd size across the country has more than tripled over the past quartercentury with the majority of the expansion happening in the western portion of the U.S. lending organization Farm Credit East, in its 2015 Dairy Herd Summary, tabulated financial data for 487 dairies in New York and New England. Of those 487 dairies, 78 milked 700 cows or more with the average herd size well over 1,000 cows. Herds milking less than 300 cows represented about 50 percent of the survey — meaning there are still many more smaller and midsize herds in the Northeast compared with thousand-cow herds. But each year a steady number of smaller herds continue to exit the industry.

Although the herd size of a dairy farm — whether it milks 100 cows or 1,000 cows — offers no guarantee as to whether the dairy farm remains successful year after year, the long-term trend is for herds to continually grow larger in order to stay in business. Largersize dairy herds sell more milk per cow and sell more milk per laborer (greater labor efficiency), resulting in greater net earnings per cow. They have fewer assets per cow with a greater asset turnover resulting in a significantly greater return on assets.

Ironically, for herds in the Northeast during 2015, herds with 100 to 300 cows — that group which contains the average herd size in the U.S. — had both negative earnings per cow and negative return on assets, while both smaller and larger herd sizes fared better.

However, the Farm Credit East summary noted that being large is no guarantee of profitability. Only 20 percent of the 78 large farms were in the top profit group for 2015.

As the U.S. dairy industry continues to struggle with volatility and a chronic over-supply of milk, paying close attention to debt per cow and cash flow and continually looking for niche markets that may offer revenue-increasing opportunities will be critical to staying in business during the next few years.

Enter robotics

Another challenge that all dairy farms eventually have to face is replacing aging equipment. Building dairy farms has never been inexpensive, but over the past couple of decades as profit margins spend more time on the low side, taking the steps to replace old barns and invest in new technology becomes more difficult to afford. In Hinsdale, New Hampshire, Beth Hodge and her family at Echo Farm began milking Jerseys and Shorthorns in the mid-1990s. After more than 20 years in a small parlor that had been built with used equipment, it was time to make some changes.

Doing her homework, Hodge found that the cost of upgrading her conventional milking parlor and barn would cost about the same as purchasing a robotic milking system; return on investment for either choice was equal. The family chose a robotic milking unit manufactured by Lely, an agricultural equipment company based in The Netherlands and well established throughout New England. While proudly showing off the robotic milker that went into action in November 2016, she says there’s no question they made the right decision in going with the new technology.

Hodge shares that one of the biggest challenges with a dairy herd of 100 cows was scheduling labor and trying to accommodate everyone’s needs – family and hired help – for days off and personal and family time and still get all the work done seven days a week. It’s a challenge faced by all dairy farms – big and small. For Echo Farm, even though the robot is milking cows nearly all day long and the equipment needs to be monitored frequently, having the twice-a-day milking routine go away has freed up a lot of time for everyone. That time can now be used to focus on the other half of the Echo Farm business – pudding.

The Hodges, too, saw the writing on the wall many years ago that they couldn’t expect the business to survive with the milk coming from 100 cows and a milk price that was never going to be dependable. Starting in 1997, the family saw an opportunity for marketing puddings made from their milk. Today, about 25 percent of the milk produced is being processed at the farm to make a multitude of flavored puddings that are sold throughout the state of New York and New England in stores and schools.

According to Hodge, in recent years the family found themselves getting bogged down on the production side as they struggled with rising production costs knowing that they needed to improve labor and production efficiencies. Investing in the new technology has helped everyone at Echo Farm renew their focus on growing the pudding business while still being able to have time for growing families and personal time. By the beginning of spring 2017, just four months with the robotics in place, Hodge says that they’re still working through the learning curve with the new equipment, commenting that Lely’s technical support is outstanding. Hodge has reluctantly had to trim her herd from 100 cows down to 60 to 65 cows to get all the cows through the robot twice per day.

Dairy farms that pursue the value-added business model generally have smaller herds and have the time to attend to processing – whether it be pasteurizing and bottling milk or making cheese, yogurt or pudding – and marketing of their products. Revenue generated per cow is going to be higher but labor and asset efficiencies tend to be on the low side with smaller herds. As an example, a dairy milking 100 cows with a 70-pound average will produce about 2.5 million pounds of milk per year. Considering that any size dairy needs several full-time employees to get all the work done – a dairy that produces less than 4 million pounds of milk per year will fall short of the recommended minimum benchmark of 1 million pounds of milk per year for each full-time employee. Investing in robotics is a step in the right direction to help increase labor efficiencies on dairy farms. Other capital assets are similar. The milking parlor, for example, that’s built for a smaller herd is usually underused and represents a less-than-efficient use of capital.

Bigger producers

Herein lies some of the justification for larger-size dairy herds. Costs for labor, equipment and leveraging of financial risk are spread out over many more millions of pounds of milk per year, resulting in greater economies of scale. Even though there’s an increasing number of smaller herds moving toward the value-added business model with on-farm processing and private label branding of products, the long-term trend in the industry continues to favor the move toward expansion to large herds. However, in either case, expanding herd size or investing in processing and marketing almost always requires taking on more debt. In a very competitive economic environment, it takes a special effort and willingness for dairy farmers to spend the money to expand or create their own brand and go head to head against the well-established dairy marketing giants.