2010 STATE OF THE INDUSTRY
Dairy Industry Still Has Challenges Ahead

by John S. Hibma

Where are we going?

Since the complete collapse of milk prices for U.S. dairy farmers in 2009, the two questions dominating the industry have been: “How can we get the milk price back up?” and “What must we do to keep this from ever happening again?” Frequent oversupply of milk keeps its value lower for longer periods of time, making it increasingly more difficult for dairy farmers to remain in business. This time around the hurt has gone much deeper than ever before, and even the most cynical and stoic of dairy farmers are now agreeing that there should be limits placed on milk production.

Photo by Bob M. Montgomery.

The U.S. dairy industry is a vital contributor to the country’s economic health. Dairy products account for many billions of dollars of consumer spending, and dairy farming is a major source of jobs in many allied industries. Over the years, however, completely unregulated growth and the emergence of an increasingly vibrant, but erratic, global economy along with the regional aspects of producing milk have added to the increasing complexity of marketing and pricing of dairy products.

As with many other sectors of agriculture and agribusiness that have had to become more efficient, dairy farming finds itself being forced to adjust to increasing price volatility, fluctuating world currencies and markets, and continually increasing costs of production. An undisciplined dairy industry quickly produces more milk when the price of milk is high to capture more profit. Ironically, when prices drop, dairy farmers are also forced into a position of producing more milk in an effort to maintain cash flow.

Historically, dairy farmers have had little time or interest in marketing the product they produce, and therefore little to say about the price they should receive. The majority of dairy farms in the U.S. today produce milk for the wholesale market and acquiesce to the position of a “price taker.” Fiscal policies, political climates, subsidies, inflation and recession have all contributed to the cyclical nature of the industry, with the result being a farmer who finds himself much more frequently challenged to remain in business.

In a fairly short period of time, the U.S. dairy industry has found itself drawn into a global dairy market. The value of the U.S. dollar and trade policy, things that the average dairy farmer seldom thinks about, have had a profound impact on increasing the value of dairy products in this country, encouraging even more production. Adding to the frustrations and challenges for the U.S. dairy farmer is a federally mandated pricing system that’s often too slow in adjusting to the market dynamics of supply and demand and the timely valuation of dairy products. And, last, but certainly not least, is the industry’s own resistance to self-regulate its production in a way that would help soften the burden of the financial roller coaster that comes with cycles of production.

In the U.S., it takes only a small percentage of milk (2 or 3 percent up or down) to move the price of milk 20 to 30 percent. In recent years, we’ve seen milk prices fluctuate much more than that, dropping to levels that, for the majority of dairy farms, makes it impossible to remain in business. Market volatility continues to increase with the high prices getting higher and the low prices getting lower. Each time the cycle repeats itself, the distress to the industry gets more severe, but, amazingly, just as soon as the price of milk rises to new heights, those who survive quickly forget their most recent troubles.

According to Robert Wellington, economist for Agri-Mark Dairy Cooperative, the U.S. dairy industry must develop a plan to effectively manage that percentage of milk in a way that will not send the price crashing when the milk supply outpaces the demand. He supports a federally mandated Marginal Milk Pricing program that will strongly encourage, if not force, dairy producers to reduce their production under certain circumstances.

The program would essentially reduce the price paid to the dairyman to a very low value on a set amount of milk if and when the milk price falls below a predetermined level, such as $16 per hundredweight, for example. The amount of milk affected by the lower price on an individual dairy would be tied to the dairy’s historical base some time in the past. The initial proposal from Agri-Mark is that each farmer’s base will be their milk production for the same month one year prior. The program will trigger in and out as farm prices move, and a farm’s base will be fixed until milk prices recover.

“The problem that we have is that the dairy farmers are so efficient that, with just a little bit of price incentive, they always overshoot with production. We hope that this marginal milk pricing will give farmers the idea that when the base [price] kicks in, they will correct the problem by tightening up the milk. We need to work hard to find a way to align supply and demand so that it will give them a price that will cover their cost and give them a reasonable return,” said Wellington.

The program will address the immediate pricing problem and then “trigger out,” allowing the dairy farmer to do what he wants in the free market as long as milk prices remain high to capture profits in an expanding market. But, as soon as there’s a pricing problem, excess milk will be penalized with that milk being taken out of the system, allowing for supply and demand to realign.

“This will have to be a mandatory program passed by Congress,” said Wellington. “If it was voluntary it would have very little impact, because you could never be sure that your neighbor is doing the same thing.”

Milk pricing and revenue distribution in this country is complex. Because the industry is so vast and varied, for the majority of dairy farmers the revenue generated from the value of all milk is pooled together, and dairy farmers then receive an average price known as a “uniform” or “blend” price. Wellington explains that we have a national market for our manufactured dairy products, and the value of those manufactured products is used to set the price for fluid milk. That’s why a producer in the Northeast who has the potential for a 100 percent fluid market must accept a lesser value for his milk based upon butter, powder and cheese produced elsewhere in the country.

Unfortunately, with that structure, when the prices collapse for butter, powder and cheese, the price of fluid milk collapses as well, which Wellington agrees, is absurd. Along with the supply management proposal being prepared, Wellington is also proposing changes in the federal marketing orders that will provide a long-overdue floor for Class 1 milk.

As the dairy industry struggles with its current oversupply problem and record-low milk prices, it also has to stay ahead of the increasing competition from other food and beverage products at the same time. Emphasizing the agro-economic importance of a region and the clever, value-adding of farmstead products are a couple of ways that farmers can continue to survive. The dairy industry must become more sophisticated and market-savvy in recognizing how best to market dairy products.

Because the economics of milk production in this country are so highly regionalized, costs of production in one area of the country are different than in others. Regions, such as the Northeast for instance, that do not lend themselves well to large-scale dairy farming are much better suited to smaller herd sizes and diversification. Even though costs of production tend to be higher nearer the populated areas, being in closer proximity to the larger population centers makes it possible to command a higher price for dairy products.

Photo by Bob M. Montgomery.

“The nature of the environment that our farmers operate in [the Northeast], actually allows us to have stronger demand and better markets and what we need to do is capture the money to cover our higher costs,” said Wellington.

More recently, in an attempt to capture a higher price for the milk they produce, more dairy farmers are marketing their milk outside of the federal pricing structure through private labeling and niche marketing. There are currently four farmer brands of milk being marketed in the Northeast: The Farmers Cow in Connecticut, Rhody Fresh in Rhode Island, Hudson Valley Fresh in eastern New York and Our Family Farms in western Massachusetts. By adding value, each of these co-ops are capturing more of the retail dollar rather than settling for the blend price coming from the marketing orders. On an increasing number of dairies, farmstead dairy products from cows, goats and sheep; raw milk and organically certified milk have gained a foothold and are all growing in their niche markets.

Wellington sees the worldwide demand curve for milk continuing to rise, even though there was a blip last year caused by the recession. Demand for dairy products will continue to be cyclical, but that shouldn’t scare dairy farmers away from taking advantage of growing markets. Interest in locally produced products that can help support regional faltering agricultural economies is growing rapidly. Those types of markets are the ones that smaller, diversified farms can move into and quickly take advantage of. The future well-being of the U.S. dairy industry will depend upon a combination of entrepreneurial marketing talent along with a sensibly structured supply management program. Dairy farming throughout our country can continue to be an economic powerhouse.

The author is a dairy nutritional consultant and works for Central Connecticut Farmer’s Cooperative in Manchester, Conn. Comment or question? Visit www.farmingforumsite.com and join in the discussions.