1. Dr. Roger Ginder Econ 338 Fall 2007 Lecture #21
Dairy Marketing
Dr. Roger Ginder
Econ 338
Fall 2007
Lecture #21

2. Example of Central Market Order Pooling

3. 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 one 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

4. 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

5. Table 6.2. Computation of an example marketwide pool
Hiland Mid-Am Kraft Total market
Handler (cwt) (%) (cwt) (%) (cwt) (%) (cwt) (%)
Producer receipts
Class I 38, , ,400 36
Class II , ,900 3
Class III 1, , , ,
Class IIIa , ,500 2
Total 40, , , ,
Transfer the total quantities over to next chart and multiply by the class prices

6. 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, , ,
Class II 5, , ,
Class III 14, , , ,274,
Class IIIa , ,
Total Amt. Paid $ 576, K $ 1,066, K $662, K $2,304, K
Average
classified value
Note: Classified prices ($/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.

7. Table 6.2. Computation of an example marketwide pool (cont’d)
Hiland Mid-Am Kraft Total market
Handler $ $/cwt $ $/cwt $ $/cwt $ $/cwt
Class I 556, , ,
Class II 5, , ,
Class III 14, , , ,274,
Class IIIa , ,
Total 576,240 40K 1,066,050 89K 662,500 50K 2,304, K
Average
classified value
Note: Classified prices ($/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.

8. 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
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.

9. 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 , , ,203
Mid-Am ,145,957 1,066,050 (79,907)
Kraft , , ,704
Total market ,304,790 2,304,790 0

10. 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
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.

11. Diversion to Class I Uses

12. Seasonality of Milk Production/Consumption 1990’s
Commercial
Production Disappearance Surplus/
Mo Bil. # Bil# Deficit Bil.# %
________ __________ _____________ ________________
Jan-Mar (+12.25%)
Apr-June (+8.5%)
July-Sept (-4.7%)
Oct-Dec (-1.8%)

13. Supply Plant Pooling Incentive
Class III
1995 MW (3.5 BF) IA Blend (Z1) Difference
Jan
Feb
Mar
Apr
May
June
July
Aug
Sept
Oct
Nov
Dec __________
Avg ¢
(Avg ‘93 = +51¢)

14. 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
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

15. 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
Orders may impose “ Minimum Performance Requirements” that must be met in order to become part of the pool

16. Market Conflicts During Periods When Supply is Short
Consider the following Market Players:
Westhoff and Welpers’s Pool Butter and Non-Fat Dry Inc.
Simon and Sheehan’s Fabulous Fluid Milk Co.
Strein and Koppes Luscious Low Fat Milk Co.
Kaitlin and Kaitlin’s Non-Pooled Better Butter Inc.
Jaschen, Brucker and Raun’s Blocks and Barrels O’ Non-Pooled Cheddar
Grade A and Grade B producers
J.Tekippe Market Order Administrator
Blend Price in pool = $12.75
Class III price = $ & Class IV price = $11.50

17. 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.
Offering the blend price instead of the Class III or Class IV price gives them an advantage in the procurement market over those who are not pooled
Pool Riders attempt to “have the best of both worlds” at no additional cost or inconvenience to themselves
So who doesn’t? What is wrong with trying to be more competitive?

18. Pool Riding Problem
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 Producer Settlement Fund
Quantity available for Class I use may actually decline as a result of the reduced price incentive
Affects competitive position of non-pool Grade A Class III/IV plants adversely when a competing firm rides the pool WHY?

19. 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
Diversion provisions require them to give up supply to distributing plants for packaging Class I products

20. 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 (e.g. the East and Southeast
Failure to perform cans mean financial penalties or in some cases expulsion from the pool

21. 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 capacity

22. FMMO Seasonal Pricing Plans
2. 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
Gears amount that is pooled in the spring to what has been provided in the fall when it is most needed

23. Allocation to Pool Class I Producers

24. 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

25. 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
Local handlers cannot bring in outside milk and use it for Class I or II products at the expense of those producers pooled on the order
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

26. 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¢-45/¢cwt.)
Permits local handlers to bring milk into the order from outside the boundaries at a lower transport cost
Rationale: Cheaper to take water out before shipping
Under FMOs reconstituted milk is down allocated and subject to a compensatory payment

27. Down Allocation
Local Order Other Source Milk
Milk (e.g., R-O Milk)
Quantity (cwt.) 10,000 1,000
UTILIZATION:
Class I 7,000 1,000
Class II 1,000
Class III 2,000
CLASSIFICATION:
Class I 8,000
Class III 1,000 1,000
LOCAL POOL
OBLIGATION:
Class I 8,000 x x 13.67
Class II 1,000 x x 12.52
Class III 1,000 x x 11.26
____________ _____________
= $133,314 ($13.314/cwt) vs. $ ($13.11/cwt)
Otherwise only 7000cwt. of class I and 2000cwt. of class III would be calculated

28. 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 I
Class I 7,000 1,000
Class II 1,000
Class III 2,000
CLASSIFICATION:
Class I 8,000
Class III 1,000 1,000
Subtract from Class III
LOCAL POOL
OBLIGATION:
Class I 8,000 x 13.67
Class II 1,000 x 12.52
Class 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.

29. ANOTHER APPROACH---COMPNESATORY PAYMENTS

30. Valley decision – compensation payment
Table Example computation of the uniform blend price from the Lehigh
Valley decision – compensation payment
Classified price ($/cwt) Use (cwt) Value ($)
Class I , ,000
Class III , ,000
Total pool milk 4, ,000
Uniform blend price
Assume: 500 cwt was brought in from outside the BFP for use in Class I.

31. the uniform blend price without compensatory payment
Table 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 , ,000
Class III , ,000
Total pool milk 4, ,000
Uniform blend price
Table Effect of a compensatory payment on 500 hundredweight of nonpool
milk on the uniform blend price
Classified price ($/cwt) Use (cwt) Value ($)
Class I , ,000
Compensatory payment (nonpool milk) ,000
Total pool milk 4, ,000
Uniform blend price
500
Forces pool Class I into Class III
Bottler compensates pool for outside milk

32. the uniform blend price without compensatory payment
Table 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 , ,000
Class III , ,000
Total pool milk 4, ,000
Uniform blend price
Table Effect of compensatory payment on 500 hundredweight of non-pool
milk on the uniform blend price in the order
Classified price ($/cwt) Use (cwt) Value ($)
Compensatory payment (nonpool milk) ,000
Total pool milk 4, ,000
Uniform blend price
Bottler has to pay class I price on 1,500 cwt plus a $4.00 /cwt. Pmt. for 500 cwt.

33. 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)

34. 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

35. Relatively Elastic Market Demand
Price
$/# P1 Po
Demand Qo Q1
Quantity
# of milk
Relatively Elastic Market Demand

36. Relatively Inelastic Market Demand
Price
$/# P1 Po
Demand Q1 Qo
Quantity
# of milk
Relatively Inelastic Market Demand

37. FMMO Effects 1. Increase Class I Fluid Prices Mean:
Production increase fluid milk
Consumption decrease but not much
2. Grade B prices may decline due to increased Grade A
3. CCC expenses may increase with higher production
4. Enhanced coop bargaining efforts are made possible
5. Enhanced equity among producer prices
6. Enhanced stability in the market
7. Assured adequate supplies of milk

38. 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)

39. CA Milk Classes Class Product I Fluid, Yogurt, 1/2 & 1/2
II Heavy cream, cottage cheese,
buttermilk, sterilized cream
III Frozen products including
ice cream
IVA Butter and nonfat dry milk
IVB Cheese

40. 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

41. 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

42. STEPS IN IMPLEMENTING OR AMENDING
A federal marketing order:
1. A proposal/request sent to USDA
2. A preliminary USDA investigation is made
3. A public hearing is held
4. A recommended USDA decision is issued
5. Filing of objections
6. Final USDA decision is issued
7. A producer vote is conducted
(2/3 Majority Required)

43. Past & Present FMMO Issues
1. Class I differential levels
2. Multiple basing points for establishing Class I differentials
3. Class II pricing levels
4. Reconstituted milk pricing
5. MW Price or Basic Formula Price (Class I mover)
6. Pooling requirements

44. What federal orders do not do:
1. Control production
2. Establish sanitary/quality production standards
3. Guarantee producers a fixed price
4. Set retail prices
5. Guarantee producers a mkt. for their milk
6. Require a handler to buy a specific quantity or buy it from a specific seller
7. Directly raise government (taxpaper costs) due to administration expenses