WCMA Notes: Rationale Builds for Milk Price Reforms

Submitted by John Umhoefer, WCMA Executive Director

An out-of-whack value for “other solids” in milk; a new report updating the cost of producing dairy products – the rationale is building to reform milk pricing in federal milk marketing orders.

The other solids value in the milk price paid by cheese manufacturers is back in the spotlight after 15 years. Rising prices for dry whey have pushed the other solids portion of the Class 3 milk price to $2.99 per hundredweight in January and $3.41 in February, levels not seen since the spring of 2007.

Upper Midwest cheese manufacturers told WCMA in recent weeks that revenue from the sale of skimmed wet whey or skimmed, ultrafiltered wet whey is not sufficient to cover this order-mandated value for other solids. These measured words are not exactly the same words they used to state this fact.

As noted in this space last month, Wisconsin Cheese Makers Association has gathered dairy manufacturer members to review classified pricing and pooling in federal orders to recommend fixes for this creaking, 80-year-old system for pricing and marketing fresh milk. The use of dry whey prices (gathered weekly by USDA) to set a value for the other solids in fresh milk has been patently unfair to most cheese manufacturers since orders were updated with component pricing in January 2000.

Why? Because most cheese manufacturers don’t produce dry whey. They must pay dairy farmers the value of dry whey, but they don’t make dry whey.

It’s noteworthy that the most recent USDA survey of dry whey prices – leading to a near record-high value for other solids in milk – gathered data on dry whey prices from only 14 businesses. There are hundreds of cheese manufacturing businesses in the U.S., but clearly not many sites produce dry whey.

Alongside this flaw in valuing other solids in milk, USDA introduced another problematic element in milk pricing with its January 2000 reforms: make allowances – the dairy processor’s share of the value of dairy products. Make allowances are a necessity in pricing formulas that base the value of milk on the full price of finished dairy foods.  But since their introduction, make allowances have been updated only once in 22 years. During that generation of time, the cost of labor, energy, stainless steel, packaging, ingredients – basically everything – has risen, while make allowances remain frozen at values updated in 2008.

Today, the opportunity is here to bring these aging make allowances up to date, and initiate a slew of other milk price reforms.  In mid-February, USDA released a cost of processing study led by Dr. Mark Stephenson at the University of Wisconsin. The study can play a key role in developing updated make allowances for cheddar cheese, butter, whey and nonfat dry milk used in federal milk pricing formulas.

Stephenson found 10 cheddar cheese plants willing to participate in this cost study. Fourteen butter plants participated as well as 29 nonfat dry milk plants and eight dry whey plants.  Together, this included eight plants from the northeast U.S., 25 from the Midwest and 24 in western states.

The cost of processing study included categories for processing labor, utilities, packaging, general and administrative and other non-labor and non-utility processing costs. Expenses related to sales and marketing — which vary widely among dairy products – were excluded.

Return on investment (ROI) is the final element in each processing cost calculation in the study. Participants were asked to provide their market value of assets. A rate for the ROI was pegged at Moody’s Baa corporate bond index over the last three years: 4.62%.

The study produced an average cost of processing for low-cost plants and an average cost of processing for high-cost plants. For cheddar, low-cost plants pegged total costs at $0.1454 per pound and high-cost plants at $0.3792, and the all-plants average was $0.2476 per pound. The current federal order make allowance for cheddar, set in 2008, is $0.2003 per pound. The study notes that high-cost plants spend more than 2x on the cost of labor, indicating less automation in these generally smaller operations.

Butter manufacturers in lower cost plants averaged a cost of processing at $0.1151 per pound while higher cost operations averaged $0.2289. Together, all butter plants in the survey faced a cost of processing of $0.1411 per pound. The current federal order make allowance for butter, set in 2008, is $0.1715.

Dry whey is produced for $0.1895 by lower costs plants in the study and higher cost plants averaged $0.3502 per pound. The average for all plants in the survey was $0.2650 per pound. The current federal order make allowance for dry whey, set in 2008, is $0.1991 per pound.

Nonfat dry milk was produced for $0.2128 by low-cost plants in the survey while higher cost plants averaged $0.4323 per pound. Overall, the plants averaged $0.2933 per pound to make a pound of nonfat dry milk.  The current federal order make allowance, set in 2008, is $0.1678 per pound.

This data will be years old before USDA replaces today’s tired make allowances. But newer data is better than old, and as the industry contemplates reform, ideas such as regularly scheduled surveys to replace make allowances, or on-going monthly updaters using government labor or energy data, could be proposed.

The rationale for practical repairs to federal order pricing is clear, and has been for some time.