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1208 PD: Can you count on co-ops to protect your margins?

Ben Yale Published on 15 August 2008

The Federal Milk Marketing Orders are a collective enterprise designed to work for the benefit of the whole, not a few.

But in recent years, it is the few who are succeeding and, in the process, undermining the very value of the collective effort.

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The USDA announced on June 20, 2008, a proposed order that will reduce blend prices in the 10 federal marketing orders by approximately 20 to 30 cents. Such a reduction in producer income is staggering. Even by USDA’s own estimates, the rule will reduce producer income $1.5 billion dollars over the next nine years, with the biggest losses in the first year. Looking at this result, one has to wonder how a supposed pro-producer program has turned once again on the producers it is supposed to protect. By the time this article goes to print the time for producers to comment will have passed, but it still remains a wake-up call to all to be vigilant as producer income remains challenged.

Now is the time for producers to prepare themselves for the next onslaught against their prices. Producers must first, as individual milk producers, understand the collective pricing system that determines their livelihood. With that understanding, they can more fully participate as members of the collective through their cooperatives or individually.

Twenty cents per hundredweight (cwt) is a lot of money to lose. Producers, with their size, investment, cash flow needs and huge risks, cannot afford such losses. Since milk is generally priced through milk orders, they must understand completely milk orders. After all, milk orders are about money, producers’ money, your money. Milk orders dictate virtually how much money producers will receive on all of their milk even in areas where milk orders do not exist. Though there are various premiums or other incentives, those are still relatively small amounts and, even then, those are based on the FMMO blend price. In simple terms: Higher milk order formula prices, more money for producers. Lower prices, less money. This is the money that pays you for investment in the land, buildings, milking parlor and the cows; pays you for the labor, energy, feed and other expenses needed to produce the greatest food; and it pays you for all of your talents, energy and risk. Too little money and there is nothing left for you. Milk orders largely dictate what is yours. This time, the USDA said you, not your suppliers, landlord or feed salesman, get less. Just because the government has reduced milk prices does not mean that everyone else will reduce their demands. Something will have to give, and it is your profits. By this rule, the USDA took some or all of your profits and transferred them to milk buyers. Milk orders are that basic, and that important.

Now, the very mention of milk orders causes eyes to roll, expressions to glaze, conversations to change to other topics or desires to do anything else suddenly overwhelms participants in the discussion. This is because producers, like so many others, see milk orders as too complicated or confusing to be understood. To be true there are times when orders have results that are not readily foreseen by the untrained eye. For example, increases in Class I location prices can reduce producer income; small differences in yields (like fractions of points) result in big changes in value; or other similar mysteries.

There are also many times when the results are obvious from the start, even to the untrained. Reducing minimum prices will result in reduced producer income. That is easy to see. But there are those who benefit from lower producer income and use the “complicated” and “confusing” label to hide even the clearest cause and effect to convince producers that reduced income is in their best interest. The rulemaking proceeding that led to this recent reduction in your income is an example of that.

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The proposed rule raises make-allowances, raises them a lot for cheese and butter. Increases in make-allowances result in reduced minimum milk prices. Minimum prices for milk combine to produce blend prices for producers. It only follows that when minimum milk prices go down, blend prices also go down, and with them, lower producer income. The milk orders do not make money – they price milk, collect the proceeds, blend what is collected and pay what they blended. Not a penny more.

Make-allowances are part of the end-product formulas which establish the component prices of butterfat, protein, non-fat solids and other solids. End-product formulas are simple: Product price less allowance for manufacturing times yield, or P.A.Y. The complete formulas on how these are computed for component prices of protein, butterfat, non-fat solids and other solids are on the USDA AMS Dairy Program site under Milk Marketing Order Statistics and Price Formulas.

There is a lot of dissatisfaction in the current pricing system – producers, cooperatives and processors alike. A number of proposals to fix, or even replace the system, were made. After holding two rule-makings, five hearings, weeks of testimony, thousands of pages of transcript, dozens of witnesses and hundreds of pages of exhibits, the USDA ultimately chose to leave the system alone and, for make-allowances, to rely on a report of California’s manufacturing prices issued after the hearing.

But it is not so much that the USDA chose to use those values not in the voluminous hearing record; it is why it did, that is important to producers. The hearing process was driven to reach a result of higher make-allowances because some cooperatives joined non-cooperative plants to demand lower producer prices. That is correct, there were producer-owned cooperatives that actively, and successfully, sought to reduce their members’ income. While it is understandable that private plants want cheaper milk, it does not make sense for cooperatives to agree unilaterally to reduce the income of their members. Producers do not need milk orders to reduce their milk price.

But among the most vocal champions of higher make-allowances for cheese plants were some cooperatives who owned their own cheese operations. These cooperatives were not making as much from their plants as they wanted. After the plant sold the cheese it made for what the market would bear and after all of the expenses were paid, there was not enough left over to cover the minimum class III prices.

Most cooperative plants account (they do not technically sell milk to themselves) for the milk at the Class III price. To cover this situation, the cooperatives reblended the “losses” just as if they had sold discounted milk to other plants. Depending on the amount of milk sold at that price and the prices other milk was sold by the cooperative to bottling and other plants, the net income to producers might have been less than the blend prices.

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The management of the cooperatives saw the issue not as net income to producers, but the appearance of profitability at the plants – their members’ milk cost too much! The solution was to lower the value at which the milk was priced in the books. That meant lowering the Class III price. By lowering the Class III price, the plant would account for lower cost of raw product and be profitable!

For example, if the Class III price had been $16 per cwt and the plant could only net $15.90, there was a 10-cent loss. But by increasing the make-allowances so that the Class III price for the same milk at the same plant would be $15.70, the plant was instantly profitable by 20 cents. Such schemes have bad results. To reduce the Class III price at that co-op or those co-ops’ plants in that milk order meant that the Class III price had to be reduced for every plant in every order. And because Class III sets Class I prices, the price of milk sold to bottlers gets reduced as well. All because one cheese plant is unprofitable. Now every producer in the milk marketing system receives less income.

The financial problem for one co-op in one or more of its plants is now spread to all producers in all of the orders and for all of the milk which they sell, with the costs multiplying. The total producer income lost from the rule probably exceeds the gross sales of the troubled plants, but it makes no difference; that is what some co-ops wanted and the USDA complied. But because a few wanted to manipulate the collective to their advantage, they forced all producers, who benefit from the power of the collective, to unnecessarily discount all of their milk.

To be sure, non-co-op plants asked for the reduced prices. Why not? But without support from producer-owned cooperatives, it never would have gone as far as it did. The reason this got this far was because the members and the co-op’s board, all of which are producer members, did not fully comprehend the effect of the management proposal and supported it. Had those producers understood that, they would not have permitted their board to authorize its management to push the USDA to raising make-allowances, reducing every producer’s income. Beyond that, had their neighbors understood what was going on, then they could have lobbied their friends in the coffee shop to press the board to be concerned first about total producer income, not a plant.

The milk marketing orders are a collective effort. The collective efforts of the whole benefit the whole. Banding together to promote the advantages will result in a compounding of good. At the same time, when some use the collective power of the milk orders to protect selfish inefficiencies, the losses, too, are compounded over the whole collective, threatening its usefulness and existence. The understanding of why this can and did happen is the job of every producer and every producer’s job to protect against more unwarranted assaults on their income. PD

Ben Yale for Progressive Dairyman

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