1. Dairy Marketing Dr. Roger Ginder Econ 338 Fall 2009 Lecture #19

2. KEY FMMO PROVISIONS OR REGULATIONS 1.Classified Pricing 2.Market-wide Pooling 3.Diversion to Higher Classes 4.Allocation of Milk from Outside

3. 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

4. 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

5. 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)

6. 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 of Wisconsin 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, and at the same time protects producers in FMMO) *Class I differentials (.20/cwt/10/mi) was nearly always less than actual transport cost

7. 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

8. Class I Pricing Prior 2000 Basic formula price (2nd preceding month) + Class I differential (varies by market) Plus BFP 2 nd preceding month is equal to the Class I Price (this month) +2 month lag on BFP base favored by some processors, but others complained

9. 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

10. 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

11. OBSERVATIONS - CLASS I PRICING uIt is a type of formula pricing uThe Basic formula price is the “Mover” of Class I Prices and reflects competitive conditions uClass I differential is fixed and does not represent competitive forces uNow multiple basing point with county prices uEffectively very similar to pre 2000 pricing in its impact on producer prices for milk

12. 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

13. 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

14. Marketwide Pooling

15. 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

16. 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

17. 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

18. 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.

19. TYPES OF FMMO MILK PLANTS (BUYERS OR HANDLERS) 1.By activity a.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 status a.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

20. POOLING REQUIREMENTS FOR A DISTRIBUTING PLANT 1.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

21. 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

22. 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.

23. 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

24. 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.