Dairy Marketing

Dr. Roger Ginder

Econ 338

Fall 2009

Lecture #19

KEY FMMO PROVISIONS OR REGULATIONS

1. Classified Pricing

2. Market-wide Pooling

3. Diversion to Higher Classes

4. Allocation of Milk from Outside

PRICING UNDER FEDERAL MILK MARKETING ORDERS (STEPS)

1. Determine minimum class prices that must be paid by handlers regulated by that order

2. Determine total dollar payment (obligation) required for each regulated handler

3. Determine blend or uniform price to be paid to producer

Classified Milk Pricing

• One price paid for milk in fluid uses• Other prices paid for various other uses• Justification for a higher fluid milk price

• More costly to produce grade A• More costly to transport fluid milk• Fluid milk has less elastic demand• Need to ensure adequate supply for fluid demand in fall

when production is down

• Classified pricing helps dispose of surplus milk in spring flush season by creating a lower price for manufactured products

• It assures diversion to Class I uses during the fall period• Helps to balance weekly bottling demands with supplies

FMMO CLASSES OF MILK USAGE/PRODUCTS

Class I = Fluid Products

Class III = Cheese

Class IV = Nonfat dry milk, Butter

Class II = Everything else(e.g., cottage cheese, yogurt, ice cream)

CLASS I DIFFERENTIALS PRIOR TO 2000

* Varied from order to order but generally increased with distance away from Eau Claire Wisconsin

* Rationale: Enables handlers located outside ofWisconsin to buy milk closer to Wisconsin at a lower price. Handlers can use the price savings to offset greater transport costs (assures consumers a supply, andat the same time protects producers in FMMO)

* Class I differentials (.20/cwt/10/mi) was nearly always less than actual transport cost

History of Class I Differentials

• Rationale for Class I Differentials• Encourage production for fluid in deficit areas• Pay for added transport costs to cover fluid needs in deficit areas

• Prior to circa 1961 Class I set by• Differential above manufacturing milk price• Complex economic indexes• Varied from order to order - no uniformity

• After early 1960’s, a single basing point system was used• Eau Claire, Wisconsin was base point• Covered all orders east of Rocky Mountains• 15¢/cwt for each 100 mi ($.0015/mi) until 1986

• Class I differentials are constant and BFP is the mover of Class I and Class II price

• Class I differentials were amended in 1986 • Approximate $.002/mi• Southeast and south of Eau Claire

Class I Pricing Prior 2000

Basic formula price (2nd preceding month)

+ Class I differential (varies by market) Plus BFP 2nd preceding month is equal to the Class I Price (this month)

+ 2 month lag on BFP base favored by some processors, but others complained

Class I Differentials

• Class I differentials were amended again in 2000

• Radical Change in the Basing Point mechanism on paper

• But a less radical change in the actual differentials paid

• Changed to a Multiple Basing Point System from the old Single basing point system

• No longer based on distance from Eau Claire Wisconsin• Instead defined by county• In most cases class I and II differentials were not reduced over what

existed before• In some cases they were increased

• Post 2000 Class I differentials are still constant and the BFP is still the mover of Class I and Class II price

CLASS I UTILIZATION PERCENTAGE

• The percent of total order milk supply (quantity) that is used in Class I products

• Varies greatly from order to order• Generally lower in upper midwest• Generally higher in east/southeast/northeast

• Larger Class I percentages generate larger blend prices as a rule

• BUT …When BFP increases rapidly and steeply an inverted price can result

• Inverted price less likely but still possible and has occurred under the post 2000 FMMO rules

OBSERVATIONS - CLASS I PRICING

It is a type of formula pricing

The Basic formula price is the “Mover” of Class I Prices and reflects competitive conditions

Class I differential is fixed and does not represent competitive forces

Now multiple basing point with county prices Effectively very similar to pre 2000 pricing in its

impact on producer prices for milk

Class II Differentials

• Rationale for Class II differential• Attract sufficient Grade A milk away from

manufacturing uses

• Covers transport costs in deficit areas

• At one time 10¢ was differential

• Later a formula price was used (complicated) --- scraped in 1995

• 1995-2000 used 30¢ differential

• After January 1, 2000 Orders use a 70¢ differential

• There was variation among orders – but not now

Class II Pricing Prior 2000

• Basic Formula Price (MW for 2nd preceding month) plus 30¢ / cwt. was equal to Class II Price (this month)

• Effective early 1995 the Class II price was announced 5th of preceding month

• Advanced pricing trial to see if could work for Class I

Marketwide Pooling

Marketwide Pooling

• All producers receive a uniform milk price

• Regardless of which plant received

• Adjusted for transport/zone charges

• Assures producers share equitably in high valued end uses

CHARACTERISTICS OF FMMO AREAS

Based on sales territory of competing distributing plants

• Based on where milk is sold not where it was produced

• FMMO areas have expanded as sales areas have expanded

• Change in distribution methods

• Improved transport at lower unit cost

• No. of FMMOs has declined to consolidations and mergers

• The provisions of 1995 Farm Bill (Fair Act) required even more accelerated consolidation

Region defined is typically:

1. Centered around fluid market(s) (not production areas)

- milk can be pooled from anywhere

- transport costs is the real issue

2. Few distribution route sales (or fluid product sales) crossing into other markets

3. A group of producers who “normally” serve that market(s) as a result of their location

POOLING REQUIREMENTS• Performance or qualification provisions for

participating as a pool plan

• Define clearly what a handler must do to become regulated or pooled on an order

• Ensure that Class I and Class II pricing differentials are distributed to producers who actually supply milk for fluid consumption or Class II uses

• Prevent plants with no commitment to fluid supply from sharing in Class I & II differentials and drawing milk from fluid suppliers.

TYPES OF FMMO MILK PLANTS(BUYERS OR HANDLERS)

1. By activitya. Distributing plant is a fluid handler, bottler, or

processor

b. Supply plant is a plant which ships a minimum amount of its milk to a qualified distributing

plant(1) Butter/powder or cheese plant(2) Reload or receiving stations

2. By regulation statusa. Regulated plant is the same as pooled or also called

qualified (Must follow FMMO provisions)b. Nonpool (unregulated) plant

• Not affected by FMMO provisions• Class III and Class IV

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. Individual handler pooling

+ Class I sales shared only with those who serve Class I market

+ Little incentive for supply area to expand beyond that which is needed for Class I sales

- Unequal price treatment of producers

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

4. Abandon intraorder Class I differentials. Assess all Class I purchases an amount equal to actual transportation costs.

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

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.