PA Dairy Summit tackles milk pricing: Bozic digs into Class I, FMMO system

Dr. Marin Bozic at the PA Dairy Summit Feb. 2

By Sherry Bunting, published in Farmshine, Feb. 11, 2022

LANCASTER, Pa. — “The Federal Milk Marketing Order (FMMO) system is built around Class I fluid milk… if no changes are made, they can just collapse, west of the Mississippi,” said Dr. Marin Bozic, a University of Minnesota associate professor of applied economics speaking to over 300 farm and industry attendees of the Pennsylvania Dairy Summit in Lancaster on Feb. 2.

Dr. Bozic showed how the U.S. is now exporting more milk on a solids basis than is being sold in the domestic beverage category. This development is sending shockwaves through a Federal Milk Marketing Order system in which only Class I fluid milk handlers are required to participate.

Fluid milk sales are declining and being overtaken by the increasing export category — leading processors to lose interest in FMMO participation, he said.

Class I fluid milk handlers are the only ones required to participate in FMMOs. It is voluntary for all others.

As markets shift, Bozic predicts continued reductions in producer price differentials, forecasting the average Northeast PPD to decline by more than 20% over the next eight years. 

He also cited the impact of inefficient milk movement stimulated by FMMO pool access provisions. This could also apply to state-regulated over-order premiums. Location-based Class I premiums can fuel inefficient movement of packaged fluid milk from more distant lower-cost-of-production areas. (When local milk is displaced, hauling costs go up.)

“What can we do to give FMMOs a new lease on life?” Bozic asked, observing that future reforms should prepare them to survive in a time when the U.S. is increasingly exporting more milk on a solids basis than in the beverage category.

Bozic said national hearings on FMMO changes could happen after the midterm elections but may not happen until after the 2023 Farm Bill, and NMPF and IDFA are working on their positions.

He referenced a working paper about modernizing U.S. milk pricing and how pricing is done in other countries. Bozic authored the paper together with Blimling and Associates, and it was released at the IDFA convention in January. It is available and anticipating feedback at https://www.idfa.org/wordpress/wp-content/uploads/2022/01/Modernizing_US_Milk_Pricing_Working_Paper_012522.pdf

Right now, he said, “Milk is being priced like it’s 1999, but it’s 2022.”

For starters, he said, the standard component test should be raised to reflect current national averages that are higher than in 1999. Butterfat, for example, stands at an average 4.0, but standard test is still 3.5. 

Bozic also predicted that over the next two years, the embedded make allowances in the pricing formulas will be increased. He said processors are already re-blending pay prices to accomplish a higher ‘make allowance’ internally. He cited New Zealand’s system that frequently updates manufacturing costs used to determine producer prices.

He was quick to point out that when make allowances are adjusted, it would be tools like the monthly Milk Check Transparency Report that Bozic is working on — along with some ideas for contract fairness — that would put processors on notice that they can’t just re-blend their pay prices on top of a make allowance adjustment. That would be double-dipping.

Answering questions about producer ‘cost of production’ and ‘cost-plus’ pricing, Bozic explained that in the UK, retailers are starting to use a ‘Fairness for Farmers’ label by doing a cost-plus contract model where they use accountants to measure dairy farm costs of production, along with a consumer price index, to price milk three months at a time. 

One key difference, however, is the interstate commerce clause in the U.S. Constitution makes it impossible to keep milk from areas with a lower cost of production from moving to undercut price structures in areas with a higher cost of production. Feed cost could be used, which is a bit more universal, but still varies by region. 

With dairy farms in the UK similarly sized with similar cost structures to farms in the Class I markets of the eastern U.S., such ideas are worth exploring, he said, noting that fluid milk prices in the UK are more stable.

This slide from a working paper co-authored by Dr. Marin Bozic and Blimling and Associates was discussed at the PA Dairy Summit. Dairy farmer Nelson Troutman noticed the fluid milk consumption graph showed the UK (lighter blue line under gray line) doing much better in per-capita fluid milk trends the past 15 years compared with the U.S. (red line), and he asked about it. Australia (gray line) is also doing better.

Referencing Bozic’s graph showing fluid milk consumption trends for various countries, Berks County dairy farmer Nelson Troutman asked about the notably different trend in the UK compared with the U.S. 

“Why is their fluid milk not going down like here?” Troutman asked. “Over there, they talk about ‘the blue milk’ (a reference to the package color of whole milk in the UK). Is it because their whole milk is higher fat than ours? They don’t take it down to 3.25%, and I think their schools can still serve it. It’s no wonder fluid milk sales are falling here.”

Bozic responded to say he thinks “it’s atrocious that we make school kids drink milk without fat,” going on to mention new technology that can convert the lactose into a dietary fiber. 

“If that is successful,” said Bozic, “Then flavored milk (for schools) can be developed to have no additional calories (even with the full fat).”

In that aspect, Bozic talked about how to stimulate fluid milk brand innovation, promotion, and packaging investment in a regulated Class I pricing environment.

“We cling to the FMMO structure because we think that without it, milk pricing will be like the Wild West,” said Bozic.

“There’s some truth to that,” he acknowledged, noting that farms with fewer than 3000 cows are not sure if processors will want to work with them in the future, and the regulated pricing affords some structure for those small and mid-sized farms “to feel safe.”

In reality, however, Bozic said the Wild West is already happening, and it starts at the retail level, which then pushes losses through the system and milk all over the map.

He explained that the Class I price announcements give retailers a price in advance, and these pricing structures show them the costs of bottling, so they know how hard they can squeeze those bottlers, and they are squeezing them.

It’s within this context that Bozic put forth the idea of a fluid milk innovation premium or credit, where the Class I price could be lifted, maybe $2 per hundredweight, and processors could get this premium back — IF they innovate their brand packaging, marketing and promotion.

A key part of this concept is the cost of innovation would be within the Class I price. It would have to be earned, but would be protected from the retailer price squeeze.

“This could encourage fluid milk bottlers to do brand innovation and promotion, to invest in packaging, while making it not so easy for retailers to squeeze them to where they can’t do it,” said Bozic.

“Consumers would pay a little more for milk, but that’s fine,” he explained, citing research that shows the demand reaction to promotion is much larger than the demand reaction to price.

Outside of Pennsylvania, the 99-cent and $1.25, $1.50 gallons seen in supermarkets reflect Class I value loss that is not being borne solely by those discounting retailers. The losses are pushed back through the system, especially now that there is more cooperative ownership of Class I bottling plants, post-Dean. 

Cooperatives are not required to pay Class I minimums to their milk suppliers the way that private milk buyers must.

One attendee asked about the roughly $2.50 in make allowance equivalents that are, by default, subtracted from the Class I price. Could this money be used for innovation and promotion credits since Class I bottlers are not making cheese, butter, nonfat dry milk and whey that the make allowances pertain to?

Bozic replied that the make allowances aren’t extractable because they are “embedded” in the FMMO formulas that currently determine the value of milk components.

For producers in regulated Class I areas — namely the Northeast and Southeast — Bozic said it will be important for them to “lead the way” in an open debate on how fluid milk prices can be stabilized and how the other benefits of FMMOs in payment timeliness, weights and measures, price benchmarking and such can be preserved.

When asked specifically about going back to the ‘higher of’ for calculating the Class I base price, Bozic said: “In the Northeast and Southeast, Class I is still a big deal. If you want it, and if IDFA can’t make a strong argument against it, then go for it.”

More importantly, he said: “We need to build a grand coalition. Transparency is part of that. If building a broader coalition brings us back to discussion about the ‘higher of’, then maybe that’s part of it.”

But the bigger issue he alluded to is this: Doing nothing, and letting it all just happen, could lead to Federal Orders collapsing in other parts of the country, without enough Class I to keep them together, and the system could begin to unravel, anyway, without producer input as to what functions should be saved and how to save them.

Look for part two next week on other aspects of the milk pricing discussion, and more details about what Bozic is doing on Milk Check Transparency, including how producers can participate by writing to him at marin@bozic.io

Last week’s Farmshine (Feb. 4, 2022) had a brief overview of the discussion. Check it out here

2 thoughts on “PA Dairy Summit tackles milk pricing: Bozic digs into Class I, FMMO system

  1. Pingback: Milk pricing reform preview? Bozic unveils bold ideas, new transparency report at PA Dairy Summit | Ag Moos

  2. Pingback: Your milk check and fairness in contracts: Dr. Bozic urges transparency | Ag Moos

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