Dairy Marketing

Dr. Roger Ginder

Econ 338

Fall 2009

Lecture #20

Example of Central Market Order Pooling

Types of Plants In FMMO’s

1. Non Pool Plants---Not Regulated

2. Pool Plants ---Regulated Under FMMO

---Distributing Plants

---Supply Plants

----Farmer Owned Cooperatives

POOLING REQUIREMENTS FOR A DISTRIBUTING PLANT1. Use minimum percent of Grade A milk in

Class I

2. Use minimum percent of Grade A milk in Class I sales within that FMMO area

• Regulated under order where its Class I sales are the largest

• Most become regulated automatically

• No real choice in the matter

POOLING REQUIREMENTS FOR A SUPPLY PLANT

Ship minimum percent of Grade A milk to pooled distributing plant

– Shipping a minimum percent of milk to a distribution plant (requirements are usually higher in fall)

– The minimum percent is usually lower for FMMO’s closer to Wisconsin

– Minimum percent required can be changed (within limits) by market administrator

– Some FMMO’s have automatic qualification in spring if the plant had qualified in prior fall

– Coops often qualify all their plants as a unit

Alternative Pooling Procedures

1. Stricter shipping requirements, call provisions

+ Those who share in Class I sales are those who “perform”

- May result in uneconomic shipments

2. Supply balancing or standby pool payments (use part of Class I differential for payment)

Producer Blend Price is the Weighted Average Price to be paid to producers.

To calculate it:

Class I percent utilization x Price of Class I

Plus Class II percent utilization x Price of Class II

Plus Class III percent utilization x Price of Class III

Table 6.4. Computation of the July 1994 uniform blend price for the Southwest Plains marketing area

Utilization Receipts Price Value

(%) (cwt) ($/cwt) ($)

Class I 37.87 1,226,392 14.28 17,512,878

Class II 14.63 474,113 11.95 5,665,652

Class III 40.09 1,325,177 11.41 15,120,274

Class IIIa 6.57 213,099 10.13 2,158,689

Weighted average price 12.49 40,474,189

Add location adjustment 867,858

Add 1/2 ending fund reserve 166,587

Less new reserve .04252 140,830

Uniform blend price at 3.5% butterfat 12.77 41,367,804

Source: Market Administrator, Southwest Plains Marketing Order.

Producer Settlement Fund

• A fund that is used to collect and disburse funds to handlers to equalize blend price paid to farmers and the classified value of milk used

• Fluid distributing plants typically pay into the fund

• Higher fraction of milk bought has Class I value (above blend price)

• Lower fraction in Class II, III and IV

• Other supply plants may pay into or draw from the fund depending on product mix and fluid provided

• Pay in if fluid and Class II uses are high

• Draw out if Class I & II are low relative to Class III & IIIa

Producer Settlement Fund

• Cooperative association plants typically draw from the pool• Handle large quantities of milk

• Perform balancing function

• Process more Class III and IIIa products

• Cooperatives typically have lower performance requirements in recognition that

• They are farmer owned patronage organizations

• They perform balancing functions in the market when supplies are high

Concept of Pooling

Pool

Handlers

Producers

Handlers withmilk value higherthan market averagePay into the pool

Handlers withmilk value less thanmarket average drawfrom the pool

Handlers pay producersthe same price regardlessof how they use the milk they receive

Table 6.2. Computation of an example market wide pool

Hiland Mid-Am Kraft Total market

Handler (cwt) (%) (cwt) (%) (cwt) (%) (cwt) (%)

Producer receipts

Class I 38,400 96 0 0 25,000 50 63,400 36

Class II 400 1 5,500 6 0 0 5,900 3

Class III 1,200 3 80,000 90 25,000 50 106,200 59

Class IIIa 0 0 3,500 4 0 0 3,500 2

Total 40,000 100 89,000 100 50,000 100 179,000 100

Table 6.2. Computation of an example market wide pool (cont’d)

Hiland Mid-Am Kraft Total market

Handler $ $/cwt $ $/cwt $ $/cwt $ $/cwt

Class I 556,800 14.50 0 14.50 362,500 14.50 919,300 14.50

Class II 5,040 12.60 69,300 12.60 0 74,340 12.60

Class III 14,400 12.00 960,000 12.00 300,000 12.01 1,274,400 12.00

Class IIIa 0 36,750 10.50 0 36,750 10.50

Total 576,240 40K 1,066,050 89K 662,500 50K 2,304,790 179KAverage classified value 14.41 11.98 13.25 12.88

Note: Classified prices ($/cwt) used in this analysis are as follows: Class I: $14.50; Class II; $12.60; Class III: $12.00; and Class IIIa: $10.50.

Table 6.2. Computation of an example marketwide pool (cont’d)

Hiland Mid-Am Kraft Total market

Handler $ $/cwt $ $/cwt $ $/cwt $ $/cwt

Class I 556,800 14.50 0 14.50 362,500 14.50 919,300 14.50

Class II 5,040 12.60 69,300 12.60 0 74,340 12.60

Class III 14,400 12.00 960,000 12.00 300,000 12.01 1,274,400 12.00

Class IIIa 0 36,750 10.50 0 36,750 10.50

Total 576,240 40K 1,066,050 89K 662,500 50K 2,304,790 179KAverage classified value 14.41 11.98 13.25 12.88

Note: Classified prices ($/cwt) used in this analysis are as follows: Class I: $14.50; Class II; $12.60; Class III: $12.00; and Class IIIa: $10.50.

Table 6.3 Computation of an example producer settlement fund

Blend price paid Amount paid Classified value Producer

producers ($/cwt) producers ($) of milk ($) settlement fund ($)

Hiland 12.88 515,037 576,240 61,203

Mid-Am 12.88 1,145,957 1,066,050 (79,907)

Kraft 12.88 643,796 662,500 18,704

Total market 12.88 2,304,790 2,304,790 0

Producer

Settlement

Fund

Payments received from the fund by handlers whose pool obligation is less than blend Price to be received by the farmers and handlers who supply it.

Payments made into the fund by handlers whose pool obligation is greater than the blend Price to be received by the farmers and handlers who supply it.

Producer Blend Prices

Were Also

Adjusted by Zone Prior to Year 2000

(same as for Class I prices)

Sac

Li nn

Lee

Ida

Ta ma

Cl ay

Kossut h

Jasper

Lyon

Page

StoryrJones

Fayett e

Adair

Bent on

Wapello

Pocahontas

Osceola

Jefferson

Audubon

Washington

Buena Vista

Black Hawk

Appanoose

Cerro Gordo

Van Buren

Muscatine

Dickinson

Des Moines

Winnebago

Montgomery

Eastern South Dakota#76, 5-1-65

Upper Midwest#68, 6-1-76

Iowa Marketing Area, #79, 5-1-7(and corresponding zones)

Federal Milk Order Marketing Areas in Iowa as of January 1, 1978

III

I

IIPoweshiek

Polk

BooneGreeneCarroll

Crawford

Plymouth

O’Brien

Woodbury

Monona

Harrison Shelby

Wright Franklin

FloydChickasaw

WebsterHardin

Louisa

Emmet

Palo AltoHancock

Worth Mitchell Howard WinneshiekAllamakee

BremerButler

HamiltonGrundy

BuchananDelaware

Dubuque

Jackson

Clinton

Guthrie Dallas Johnson

Marshall

Pottawattamie

Mills

Fremont

Madison WarrenMarion Mahaska Keokuk

Adams Union ClarkeLucas

Monroe

Taylor Ringgold

Cherokee

Calhoun

Decatur Wayne Davis

Henry

Scott

Humboldt

Clayton

Cedar

Sioux

Cass

Iowa

HANDLERS REPORTING UNDER ORDER 79

Pool Plants Pursuant to Section 1079.9(a)

Zone 1 No Location AdjustmentAnderson-Erickson Dairy Co. Des Moines, IARoberts Dairy Co. Des Moines, IA

Zone II - $.07 Location AdjustmentRoberts Dairy Co. Iowa City, IASwiss Valley Farms Co. Cedar Rapids, IA

LocationAdjustment

Zone III (cents/cwt.)Associated Milk Producers, Inc. Arlington, IA -17.2Associated Milk Producers, Inc. Fredericksburg, IA -24Beatrice Cheese, Inc. Fredericksburg, IA -24Foremost Farms USA Cresco, IA -27.4Foremost Farms USA Lancaster, WI -25.7National Farmers Organization Dyersville, IA -18.9Stacyville Coop Creamery Stacyville, IA -25.7Swiss Valley Farms Co. Dubuque, IA -18.9Swiss valley Farms Co. Luana,IA -24Wapsi Valley Creamery Independence, IA -15.5

Pool Handlers Pursuant to Section 1079.9(b) or ©

Associated Milk Producers, Inc. New Ulm, MN

Foremost Farms USA Baraboo, WI

Mid-America Dairymen, Inc. Newton, IA

National Farmers Organization Ames, IA

Stacyville Coop Creamery Stacyville, IA

Swiss Valley Farms Co. Davenport, IA

HANDLERS REPORTING UNDER ORDER 79 (cont’d)

Diversion to Class I Uses

Example of Seasonality in Milk Production/Consumption

CommercialProduction Disappearance Surplus/

Mo. Bil. # Bil# Deficit Bil.# %________ __________ _____________ ________________

Jan-Mar 37.6 33.5 +4.1 (+12.25%)

Apr-June 39.4 36.3 +3.1 (+8.5%)

July-Sept 37.4 38.2 -1.8 (-4.7%)

Oct-Dec 36.6 37.3 -0.7 (-1.8%)

Supply Plant Pooling Incentive Class III

1995 MW (3.5 BF) IA Blend (Z1) Difference

Jan 11.35 12.04 +.69Feb 11.79 12.14 +.25Mar 11.89 12.22 +.33Apr 11.16 11.90 +.74May 11.12 11.90 +.78June 11.42 11.78 +.36July 11.23 11.71 +.48Aug 11.55 12.09 +.54Sept 12.08 12.30 +.22Oct 12.61 12.83 +.22Nov 12.87 13.22 +.35Dec 12.91 13.25 +.34

__________

Avg. +44¢

(Avg ‘93 = +51¢)

Balancing Requirements

• Seasonality creates the need for some plants to serve the “balancing function” in the market

• Having the plant capacity to take and process all the product in the peak or “flush” season means that there will be excess plant capacity at some times of the year

Balancing Requirements• What problems does this cause?

– Some plant capacity will be under utilized during the short supply parts of the year

– In many cases this means that some plants may even have to be shut down for some period of time

– Fixed costs of these plants continue even though they are not operating

– No one wants to be the one who performs “balancing function”

– No one wants to give up milk to the Class I distributing plant

Performance Requirements• One purpose of Class I premiums is to ensure an

adequate supply of fluid products for consumers

• Pooling is a means used to share the Class I premiums among those providing milk for Class I uses

• Most Class III and IV plants in the market order would prefer to be pooled since pay prices are higher

• It is necessary to make sure that those who pool in the order “perform” or actually contribute to the supply available for Class I uses in the order when it is needed

Market Conflicts During Periods When Supply is Short

• Consider the following Market Players:– Pooled Cheese, Butter and Non-Fat Dry Inc

– Fabulous Fluid Milk Co.

– Luscious Low Fat Milk Co.

– Non-Pooled Better Butter Inc.

– Blocks and Barrels O’ Non-Pooled Cheddar

– Grade A and Grade B producers

– Blend Price in pool = $13.75

– Class III price = $12.00 & Class IV price = $11.50

Pool Riding Problem Some Grade A Class III/IV manufacturing plants attempt to be

pooled so as to share in the proceeds from Class I sales

Want to be more price competitive for producer milk while, at the same time, having no or very little incentive or intent to supply milk for Class I needs.

Pool riding reduces incentive for providing Class I sales by increasing the quantity of Class III milk in the pool. This reduces blend price for all producers because the Class III milk draws from the PSF

Quantity available for Class I use may decline as a result

Affects competitive position of non-pool Grade A Class III/IV plants adversely when a competing firm rides the pool WHY?

Performance Requirements• Market orders can impose requirements to ensure that

those in the pool actually provide milk when it is needed for fluid purposes

• At the times of the year that supplies are down and demand is high class III plants that are allowed into the pool must be willing to divert (give up) supply to distributing plants for packaging Class I products

Performance Requirements• The amount of milk must be diverted or at least offered

up varies according to the requirements specified in the order

• Performance requirements are generally more rigorous in areas where milk is less plentiful– Tighter Supplies in the Fall

– Fewer cwt. of milk are available nearby

FMMO Seasonal Pricing Plans

1. Louisville Type Plans

• Take money out of PSF in the spring Flush when supply is good

• Pay back in the fall to provide higher differentials to those who supply milk when the supply is tight

• Increase incentive to divert milk to Class III in spring• Decrease incentive to divert milk to Class III in fall to use

plant capacity2. Seasonal Base Plans (Base-Excess Plans)

• Base forming period in fall when production is low• Sets the base for quantity that will receive the Class I price in

spring for producers• Base and a lower over-base price paid in spring for class I

Allocation to Pool Class I Producers

Diversion Provisions Rules that specify the maximum proportion of a supply

plant’s milk that can be diverted (away from a pool plant) directly from the farm to a non-pool plant and still be pooled in the order

Allocation & Transfer Provisions Accounting rules for determining how milk that is

received from or shipped to a different source is classified and priced

Down Allocation The assignment of milk to a utilization class less than the

Class of product it was actually used to produce

Impacts -- Down Allocations• Gives local order producer milk supplies priority on Class I sales,

even if the milk they delivered wasn’t used in Class I.• Requires local handlers to pay local order Class I prices regardless

of where milk is purchased.

Compensatory Payment• A FMMO payment (equal to Class I P - Class III P) required of

Pool handlers on other source milk allocated to Class I sales

Reconstituted Milk• Remove water thru evaporation or membrane filtration techniques

(also known as reverse osmosis or R-O) ; then recombine water and solids to form fluid product (cost x 35¢/cwt.)

• Rationale: Cheaper to take water out before shipping• Under FMOs reconstituted milk is down allocated and subject to a

compensatory payment

Down Allocation

Local Order Other Source Milk Milk (e.g., R-O Milk)

Quantity (cwt.) 10,000 1,000

UTILIZATION:Class I 7,000 1,000Class II 1,000Class III 2,000

CLASSIFICATION:Class I 8,000Class II 1,000Class III 1,000 1,000

LOCAL POOL

OBLIGATION:Class I 8,000 x 13.67 7000 x 13.67Class II 1,000 x 12.52 1000x 12.52Class III 1,000 x 11.26 2000x 11.26

____________ _____________ = $133,314 ($13.314/cwt) vs. $131130 ($13.11/cwt)

Otherwise only 7000cwt. of class I and 2000cwt. of class III would be calculated

Down Allocation

Local Order Other Source Milk Milk (e.g., R-O Milk)

Not Computed in Pool

Q (cwt.) 10,000 1,000

UTILIZATION: Add to Class IClass I 7,000 1,000Class II 1,000Class III 2,000

CLASSIFICATION:Class I 8,000Class II 1,000Class III 1,000 1,000

Subtract from Class IIILOCAL POOL

OBLIGATION:Class I 8,000 x 13.67Class II 1,000 x 12.52Class III 1,000 x 11.26

____________= $133,314 ($13.314/cwt)

Treats Non-Pooled Milk as if used in lowest class and pushes pooled milk into higher class thereby increasing the blend price for pooled producers to receive.

ANOTHER APPROACH---COMPNESATORY PAYMENTS

Table 6.5. Example computation of the uniform blend price from the Lehigh Valley decision – compensation payment

Classified price ($/cwt) Use (cwt) Value ($)

Class I 14.00 2,000 28,000

Class III 10.00 2,000 20,000

Total pool milk 4,000 48,000

Uniform blend price 12.00

Assume: 500 cwt was brought in from outside the order @ BFP for use in Class I.

Table 6.6. Effect of 500 hundredweight of nonpool milk for Class I use on the uniform blend price without compensatory payment

Classified price ($/cwt) Use (cwt) Value ($)

Class I 14.00 1,500 21,000Class III 10.00 2,500 25,000Total pool milk 4,000 46,000Uniform blend price 11.50

Table 6.7. Effect of a compensatory payment on 500 hundredweight of nonpool milk on the uniform blend price

Classified price ($/cwt) Use (cwt) Value ($)

Class I 14.00 1,500 21,000Class III 10.00 2,500 25,000Compensatory payment (nonpool milk) 4.00 500 2,000Total pool milk 4,000 48,000Uniform blend price 12.00

500

Forces pool Class I into Class III

Bottler compensates pool for outside milk

Table 6.6. Effect of 500 hundredweight of nonpool milk for Class I use on the uniform blend price without compensatory payment

Classified price ($/cwt) Use (cwt) Value ($)

Class I 14.00 1,500 21,000Class III 10.00 2,500 25,000Total pool milk 4,000 46,000Uniform blend price 11.50

Table 6.7. Effect of compensatory payment on 500 hundredweight of non-pool milk on the uniform blend price in the order

Classified price ($/cwt) Use (cwt) Value ($)

Class I 14.00 1,500 21,000Class III 10.00 2,500 25,000Compensatory payment (nonpool milk) 4.00 500 2,000Total pool milk 4,000 48,000Uniform blend price 12.00

Bottler has to pay class I price on 1,500 cwt plus a $4.00 /cwt. Pmt. for 500 cwt.

Other Possible Adjustments to Producer Price

1. BF Differential

2. Protein Differential

3. Other Solids Differential

4. Quality (somatic cell count)

5. Hauling

6. Insurance

7. Coop Membership Fee

8. Advertising

9. Government Assessments (Taxes)

Price Discrimination

• Definition:

Selling same product at different prices to different buyers

• Necessary conditions:

1. Seller control over price

2. Different buyer elasticities of

demand

3. Different buyers are separated

Po

P1

QoQ1

Demand

Price$/#

Quantity# of milk

Relatively Elastic Market Demand

Po

P1

QoQ1

Demand

Price$/#

Quantity# of milk

Relatively Inelastic Market Demand

FMMO Effects

1. Increase Grade A Prices Mean:

• Production increase fluid milk

• Consumption decrease but not much

2. Grade B prices may decline

3. CCC expenses may increase with higher production

4. Enhanced coop bargaining efforts are made possible

5. Enhanced equity among producers

6. Enhanced stability in the market

7. Assured adequate supplies of milk

State Milk Control/Order Provisions

1. Retail pricing (5 states)

2. Price filing requirements (monthly wholesale) (8 states including IA)

3. Limits on sales below cost (20 states including MN, WI)

4. Producer pricing (12 states including CA)

5. Producer base programs (7 states including CA)

CA Milk Classes

Class Product

I Fluid, Yogurt, 1/2 & 1/2

II Heavy cream, cottage cheese, buttermilk, sterilized

III Frozen products including ice cream

IVA Butter and nonfat dry milk

IVB Cheese

CA Pricing

Class prices determined by economic formula

E.G., Class I is a function of (production costs, butter/powder price, CA wages)

Producer prices = BF and Solids Not Fat prices for

1. Quota (Class I share)

2. Base

3. Overbase lower price

Market Administrator

• Agent of secretary of agriculture

• Charged with administering the order

• Ensures that handlers properly account for milk used in different classes

• Ensures that payment is made according to use

• Conducts audits of plants and handler’s records

• Reports to the public on class prices, uses, and blend price

Funding for services is not paid by tax dollars