Dairy Marketing

1. Dairy Marketing Dr. Roger Ginder Econ 338 Fall 2007 Lecture #17

2. Over-Production and Low Prices • Have constantly plagued the dairy industry even before the Great Depression • Poor bargaining position for fresh fluid milk • High price elasticity --- especially for manufactured milk • Low price elasticity---for fluid and class II Products • Market orders were considered one of the possible strategies • The Great Depression Served as a Catalyst For Change

3. HISTORY OF FMMO’S • In the 1920’s farmer-owned cooperatives were attempting to deal with the perishable nature of fluid milk and price impacts of over-production on producer price • They developed a scheme that exploited the different price elasticity for milk going to fluid users • They attempted to establish a classified pricing program that charged a higher price to fluid users than the price charged to users in the manufacturing milk market • Thus when their member producers who delivered milk into the pool they received a “blended” price based on the relative amount of the pool going to each

4. Elasticity

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

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

7. DAIRY COOPERATIVE CLASSIFIED PRICING EXAMPLE Coop prices: Class I = $10.00 Class II = $ 8.00 Average use by coop customers: Class I = 50% Class II = 50% Use by Buyer “A”: Used by Buyer “B”: Class I = 90% Class I = 10% Class II = 10% Class II = 90% Average price received by coop and its members = “Blend” price = (.5 x $10.00) + (.5 x $8.00) = $9.00 Price paid by Buyer “A” = Price paid by Buyer “B” = (.9 x $10.00) + (.1 x $8.00) = $9.80 (.1 x $10.00) + (.9 x $8.00) = $8.20 Thus, there was an incentive and opportunity for Buyer “A” to buy milk directly from the producer.

8. PROBLEMS WITH DAIRY COOPERATIVE CLASSIFIED PRICING EFFORTS 1. Inability to verify milk weights, tests and usage. 2. Inability to force all producers and milk buyers to comply with their pricing plan. 3. Efforts failed when deflation forced prices down during the Great Depression in the 1930’s

9. ALTERNATIVES FOR DEALING WITH EXCESS SUPPLY PROBLEMS IN AGRICULTURE • Information provision • How much is being produced • What expected prices will be • Supply control • Demand expansion • Cooperatives • Marketing orders

10. HISTORY OF FMMO’S • By 1933 the Agricultural Adjustment Act (AAA 1933) was passed • Permitted “marketing agreements” • Voluntary agreements among processors, handlers, coops, processors • Supreme Court found AAA of 1933 unconstitutional • In 1935, the AAA of 1935 enabled the first “orders” to be formed • Permitted secretary of ag to establish orders • Gave powers currently used in FMMO’s today • Classified pricing • Market wide pooling • Checking of weights and tests • Enforcement of base/surplus plans • Providing market information • Block voting by cooperatives

11. Market Orders Take Advantage of Differing Elasticity of Demand In Different Product Markets They make it possible for farmers to use price discrimination between markets with different elasticity

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

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

14. FEDERAL MARKETING ORDER Definition: A regulation, issued by the Secretary of Secretary of Agriculture, that requires the commodity involved to be marketed in accordance with procedures spelled out in the regulation. Legal Basis: Agricultural Marketing Agreements Act, 1937 A U.S.D.A. regulation that requires Grade A milk buyers to pay specified minimum prices for Grade A milk depending on how that the milk is used.

15. Federal Milk Market Order Agreements The FMMO is an agreement establishing marketing and payment rules: For milk marketing in a defined geographic area

16. Federal Milk Market Order Agreements The FMMO is an agreement among: U.S. Secretary of Agriculture For milk marketing in a defined geographic area

17. Federal Milk Market Order Agreements The FMMO is an agreement among: U.S. Secretary of Agriculture For milk marketing in Producers a defined (Individual geographic area votes)

18. Federal Milk Market Order Agreements The FMMO is an agreement among: U.S. Secretary of Agriculture For milk marketing in Producers a defined (Individual geographic area votes) Producer cooperatives (block votes)

19. Federal Milk Market Order Agreements The FMMO is an agreement among: U.S. Secretary of Agriculture For milk marketing in Producers a defined Grade A (Individual geographic area handlers votes) processors Producer cooperatives (block votes)

20. MARKETING ORDERS OBJECTIVES • To maintain or promote orderly marketing conditions. • To assure consumers of an adequate and steady supply of the product. (Mainly by reducing producer price and income risks) • To facilitate producer bargaining efforts. • To provide information about the commodity’s supply and demand conditions.

21. FMMO PROGRAM • The FMMO program was initiated to promote “orderly” marketing to benefit dairy producers, processors, and consumers in a time on National Emergency and Extreme Economic Disruption • In the post World War II period the U.S. had become a world power and was enjoying a period of “Economic Prosperity” • New FMMO’s were steadily being formed in 40’s and 50’s • Some began to question whether market orders were still relevant to their original goals and purposes • “Orderly markets” • Reliable fluid milk supplies • Stable Pricing

22. FMMO PROGRAM • The FMMO program is expected to promote “orderly” marketing and represent the interests of dairy producers, processors, and consumers • Secretary of Agriculture, Orville Freeman, appointed a blue ribbon committee in 1962 to examine the public interest aspects of milk marketing orders • Federal milk market order study committee • Chair, Edwin G. Nourse • Studied FMMO authority in AAA 1937 • Desirable equilibrium consistent with optimum allocation of nations resources

23. Nourse Committee Identified Four Broad Purposes in AAA 1935 and AAA 1937 • Bring all fluid distributors and handlers in a prescribed market area under regulatory authority of the order • Universal compliance • Uniform rules and procedures • Enforce uniform minimum prices among all handlers on milk used for the same purposes (this places handlers in a uniform competitive position and discourages price wars) • Provide uniform producer prices (market wide pooling) • Promote price stability by extending classified pricing to all handlers in the prescribed market

24. FMMO PROGRAM • Concluded that orders do indeed: • Extend uniform opportunities in the market to producers • Enforce uniform responsibilities on the entire market rather than on a certain subset of handlers • Provide for rational resource allocation • The committee report has provided an overall underpinning as the standard for many of the FMMO decisions and consequences with respect to • The public interest • Resource allocation • “Orderly” marketing

25. CONSOLIDATION TO F0RM LARGER ORDERS BEGAN IMMEDIATELY FOLLOWING THE GREAT DEPRESSION • Smaller Orders Were Being Combined to Form Larger Orders Covering More Geography • New Orders Were Steadily Being Formed And Tended To Be Larger Covering Wider Geographic Areas • Transportation Differentials Started to Become An Issue • The Use of One Differential For a Larger Area Was Questioned • The Nourse Report Addressed This Problem Directly Through A Recommendation For Intra-Order Zones

26. Location Adjustments Within Orders • Nourse report specified orders should: • Provide substantially equal prices to handlers within the order • Provide different Class I prices within the order to accomplish it • Major population centers where bottling plants are located pay the Class I price for fluid milk • Zones are established around these centers to account for transport cost differences from farm to the Population Center • Prices are reduced by cost of transport at points in the zones further from center • Zone charges effectively align Class I prices within and across orders

27. CONSOLIDATION TO FORM IOWA FMMO, 5-1-77 1. Cedar Rapids - Iowa City, 9-1-51 2. North Central Iowa, 11-1-57 3. Des Moines, 10-1-58 4. Quad Cities - Dubuque, 1-1-61 a. Dubuque, 10-1-36 b. Quad Cities, 12-1-51 (1) Quad Cities, 2-1-40 (2) Clinton, 10-1-44

28. Eastern South Dakota #76, 5-1-65 Upper Midwest #68, 6-1-76 Emmet L y o n Worth Mitchell Howard Winneshiek O s c e o l a D i c k i n s o n W i n n e b a g o Allamakee K o s s u t h O’Brien Sioux Palo Alto Hancock Floyd C l a y Chickasaw C e r r o G o r d o Clayton F a y e t t e Plymouth Butler Cherokee Humboldt Wright Franklin Bremer III B u e n a V i s t a P o c a h o n t a s Delaware Buchanan Dubuque B l a c k H a w k Woodbury Webster Hamilton Hardin Grundy I d a Calhoun S a c Jackson Crawford J o n e s B e n t o n L i n n Monona Greene Boone Story Marshall II r T a m a Carroll Clinton Cedar Poweshiek Shelby Guthrie Dallas Polk Johnson Harrison A u d u b o n J a s p e r Iowa Scott M u s c a t i n e W a s h i n g t o n Warren Pottawattamie Madison I Cass Marion Mahaska Keokuk A d a i r Louisa Western Iowa-Nebr. Mills M o n t g o m e r y Adams Union Clarke Monroe Iowa Marketing Area, #79, 5-1-7 (and corresponding zones) J e f f e r s o n D e s M o i n e s W a p e l l o Lucas Henry Fremont Taylor Ringgold Decatur Wayne Davis P a g e V a n B u r e n A p p a n o o s e L e e Federal Milk Order Marketing Areas in Iowa as of January 1, 1978

29. Intraorder Class I Location or Zone Adjustments = An amount that is deducted from the order Class I Price to determine an individual handler’s Class I Price e.g. Iowa order Zone 1 = 0 ¢ Zone 2 = 7 ¢ Zone 3 = 1.7 ¢/10 miles from closest of Ames, Marshalltown, or Cedar Rapids Chicago regional order 1 1/2 ¢/10 miles from City Hall Rationale: To encourage/permit efficient movement of milk for fluid purposes within an order

30. CONSOLIDATION TO FORM UPPER MIDWEST FMMO, 6-1-76 1. Duluth - Superior, 5-5-41 2. Minneapolis / St. Paul, 11-3-45 3. MN / ND, 11-1-67 4. SE MN / N IA, 5-1-69

31. FMMO CONSOLIDATION The Secretary of Agriculture is instructed to consolidate milk marketing orders from 33 to 10-14 within three years of the enactment of the Federal Agriculture Improvement and Reform Act of 1995 (FAIR ACT). (Passed in 1996)

32. Past

34. Source: California Department of Food and Agriculture, August, 2000.

35. Source: California Department of Food and Agriculture, August, 2000.

36. KEY FMMO PROVISIONS OR REGULATIONS Have been more or less the same since the AAA was passed Remained the same after the reforms dictated by the FAIR Act of 1995 were implemented Despite changes in boundaries and multiple basing points there is little fundamental change

37. KEY TOOLS USED BY FMMO’s TO CREATE “ORDERLY MARKETS” 1. Pricing 2. Pooling 3. Diversion 4. Allocation

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

39. 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

40. APPENDIX FOR SUPPLY AND DEMAND

41. Individual Supply/Demand vs. Market Supply Demand • The individual firms and consumers in the economy face supply and demand situations • The market supply and demand is the SUM of all individual supply and demand curves • Individual and firms may have different elasticity of demand than the consolidated supply and demand curves---especially in a market where there are large numbers of actors

42. Supply Demand Price Price Quantity Produced Q Quantity Consumed Q Inelastic Supply Individual Producer Inelastic demand Individual Consumer Price Price Supply P Demand P Quantity Produced Quantity Consumed Completely Elastic Demand Completely Elastic Supply

43. Supply Demand Price Price Quantity Produced Q Quantity Consumed Q Inelastic Supply Individual Producer Inelastic demand Individual Consumer Price Price Supply P Demand P Quantity Produced Quantity Consumed Completely Elastic Demand Completely Elastic Supply