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Nailing down a milk price

Ben Yale Published on 07 October 2009

When we lived at our previous house, I wanted to build a garage. The building that was supposed to be our garage, a small barn-like 1930s-era building, ceased being a garage after a small earthquake shifted the foundation so that the sliding doors no longer opened wider than a few feet.

It wasn’t just that I wanted a garage; I wanted to build a garage.

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My wife objected to a “husband-built” garage, one where the work stopped somewhere between sheeting and finishing – no siding, no downspouts, no door, but full to the rafters with junk.

How, I do not know, but I overcame the objection and one Labor Day weekend began to build the new garage. Sometimes with help from family and friends, but often alone, I built it, nail by nail.

I used every available moment on the garage so that by the next spring the two-and-a-half-car garage was fully finished, inside and out. When I see that garage today I see it as wood, vinyl and shingles attached by a lot of nails, from small nails to hold drip strips, to large framing spikes, to even larger spikes for gutters.

Though I had a vision of a garage, its reality came from these thousands of pairing pieces together with a range of specialized nails.

Today we are facing the need to redo a 1930s-era pricing system. The industry has reached a point where the current structure within which we work, the pricing, support and other regulatory markets, have shifted out of sync with the industry we are or could be.

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Tremors from world markets, industry consolidation, transportation improvements, technology and economic recession have all served to make it impossible for those systems to fully open up and embrace what we are and what we can do. No one is happy.

The Secretary of USDA has announced the formation of a commission to look at the dairy industry. Proposals are made to change this or to change that. Some are raze-and-raise proposals (tear down and build anew). Others are tweaks or changes around the edges.

In the same way, I could not approach the garage with a single nail, regardless of size, and with one stroke build it; building, or even fixing, the dairy industry cannot be done by a single thing. But the desire for change is universal.

The focus of that change is on price. It is price where producers feel marketing orders. The feeling is not a good one. This is viewed as “the price” as if it were a singular thing.

As a consequence, the proposed fixes are to fix “the price.” This single number fails in the market place, not because it is a wrong number but it is as one number denying the variety in pricing and types of producers and products and market conditions.

During most of the last half of the 20th century, the price used by USDA reflected actual prices for milk. The USDA discovered the value of milk by surveying what plants in the Upper Midwest were paying for Grade B, an unregulated milk.

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That price, known as the Minnesota Wisconsin Series, or M-W, was a “competitive price” and it was market forces of many plants seeking milk from many producers in a sea of milk. Over the years the amount of Grade B milk declined as did the number of plants that purchased it.

What was once a sea of milk became a lake, then isolated puddles and has, in most cases, dried up altogether. The vibrant competition between handlers setting prices based upon a balance of what they could turn into profitable products, meeting competition for milk supplies and sustaining a supply of milk was no longer reliable due to too few transactions.

A temporary fix for the last years of the 1990s, the Basic Formula Price, was a modification of the competitive price in that it included both some competitive prices as well as adjustments for changes in commodity prices using end-product formulas.

Beginning in 2000, USDA followed California and adopted end-product pricing. Discovering the value of milk with end-product pricing begins with finished products. Product prices (such as cheddar cheese or butter) are reduced for allowance for manufacturing (sometimes called a “make- allowance”) and multiplied by the number of pounds of product from 100 pounds of milk or pounds of butter.

End-product pricing effectively discovers the lowest price that most, if not all, plants can purchase milk and profitably make product. After all, the theory goes, a plant cannot, over time, manufacture a product and market it profitably if it has to pay too much for the raw milk. There is only so much room for the manufacturer to “force” higher costs on its customers, who not only have the alternatives of other dairy products domestically or internationally – they also have to compete with alternative foods as well.

For example, the replacement of butter with vegetable butter in baked and other foods, replacement of cheese with meat on pizzas, water or soda pop for milk as a beverage. If this was the basis for setting a minimum size for nails, to be effective, it would have to be small enough that all uses could be done.

But the problem is this: Should all plants be given weight in this discussion? Is it appropriate to set a price low enough for even the inefficient plants?

Aside from depriving other producers with additional income, setting the lower prices does not save the plant. If all more efficient plants are profitable, lowering the minimum price for milk only makes them more profitable and more able to compete over the less efficient. Can you imagine building with an average or derived size of nail?

So what about using producer costs of production? In that way, producers are assured that they can afford to produce milk. It is the same question as end-product pricing, just the direction has changed.

Rather than asking how low the milk price should be, the question becomes how large it can be to make producers profitable. The real challenge to cost of production is deciding what the term “cost of production” means or includes. Some argue it is the total cost as an accountant would prepare of what it costs to produce milk including labor, feed, depreciation and implicit costs of manufacturing. Others say it is just the operating costs.

Accounting for the added value that comes from dairying in heifers, bull calves and cull cows should offset the costs. How is feed that is produced on the farm accounted for? Is it priced by market or actual cost to raise the prices?

But answering those questions leaves an even bigger issue. There is a broad range in cost of production based upon region, production model, breed, milking style and type of facility. ERS computes an average for 2008 nationally of about $24 per hundredweight.

For 2008 monthly cost estimates range from $14.11 per hundredweight in New Mexico to $21.81 in Wisconsin to $26.07 in Vermont. It is like some boards needing a 12-penny nail, but others needing a railroad spike. T

here is an unsolvable obstacle to the use of cost of production in price discovery. No matter where you peg the number, sufficient milk above that line can and will be priced at higher profits, which will result in more production in those units.

If you use a weighted average, assuming it could be found, over half of milk would be produced at costs less than the average price and half would be at higher cost. It also means that milk below that line is unprofitable.

The profitable producers, especially the very profitable ones, will grow and grow. The result will be to displace the least efficient even faster. Though it is appealing to some, it probably is the fastest way public policy could weed out the higher-cost producers. In the end, there is no way to establish a price that fits all.

It needs to be done on a producer-to-buyer basis. The producer comes to the table with her or his costs, the buyer comes back with its value in the milk. To close the deal the producer has to get the costs down to meet the needs of the handler and the buyer has to add value to afford to purchase milk.

Over time both must recognize the needs of the other to establish a sustainable price. No two transactions will be the same. As such, when the government sets a price, it will necessarily be wrong most, if not all, of the time.

The answer to pricing policy lies more in the past by letting each buyer and seller come up with their price. Market forces will dictate that producers do receive cost of production, maybe not the costs the producers want, but enough and plants will get milk at an affordable price.

Nailing down a pricing policy will fail because there is no single nail that can truly represent the multiple types of transactions that take place. It is not just that end-product pricing or cost-of -production pricing formulas have inherent defects; rather it is because they represent the view that one price fits all.

Each seeks to solve the whole problem with a single solution, a single pricing formula. To rebuild our industry, it will take time and it will require the reliance on thousands of individual decisions, which will combine to create the new structure we need.

We do not want a “husband-built” or half-finished mess, but a finished means to take us to the future. PD

Ben Yale
Attorney at Yale Law Office

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