Dairy marketing is like painting a barn

J. Craig Williams and Andrew Sandeen
Penn State University
In many ways, protecting your dairy’s milk price is similar to the process of painting a barn.

In many ways, protecting your dairy’s milk price is similar to the process of painting a barn. Let me explain.

Typically, the goal is to paint the whole barn, but with this analogy, we will focus on the process of climbing the ladder to paint whatever portion of the barn we have decided needs attention. How can we get more comfortable climbing the ladder one rung at a time until we successfully reach the top? We can either paint the barn one board at a time, or we can focus on one entire wall at a time.

Either way, there are easier spots on the barn to paint, such as the lower boards and more difficult spots to paint, such as the top of the end walls. Starting a new dairy risk management plan can be a similar experience.

Some dairy price programs are like painting the bottom boards; we are more comfortable with them and can easily decide what protection to purchase. These are important programs for some level of protection, even though they do not cover the entire barn.

New or more complicated risk management programs only seem to be reached from the top ladder rung. They are high in the air and we are not comfortable with them until we have some experience. Just like climbing a ladder, we probably need to focus on just taking it one rung at a time. We can purchase protection in smaller portions until we get more comfortable with how everything works. Even with slow, small steps, we can still get the barn painted a few boards at a time as we move up the ladder.

This ladder practice is one way to help make a dairy risk decision on a systematic basis and not all at once. By making dairy risk decisions on smaller units, you can spread the decisions across the year or quarter. Often, the fear of making dairy risk decisions at the wrong time, or fretting about when might be the right time, paralyzes dairy producers from making any decision at all. Smaller decisions will still get the barn painted and provide some protection.

There are plenty of professional barn painters who can help paint the barn, just as there are many dairy risk management professionals who can come alongside dairy farmers to help make some of these “harder to reach” decisions.

Here is an example of how this might have worked for Dairy Revenue Protection (DRP) coverage in the third quarter of 2020, comparing an approach of making independent decisions to a more methodical process with systematic ladder decisions. We will call these two strategies Independent and Ladder.

The Independent strategy, making independent decisions as the opportunity arises might purchase a DRP endorsement whenever the price and associated premium is ideal, while the Ladder strategy might purchase endorsements every two weeks on a defined day of the week. We also had the goal of protecting 50% of our milk for that quarter. We tracked our decisions from January to May 2020.

In this example: The Independent person did not make any purchase decisions in the early part of the quarter. To their defense, much of the industry sentiment at that time was that prices were going to hold. The Independent person did buy at the end of the quarter buying period made two decisions. Each purchase was 10% of their milk for that quarter (10,000 lbs.). They protected 20% of their milk production. They made protection decisions on May 26 and May 27th at the end of the period. They averaged 25 cents per Cwt coverage on a $16.53 and $15.70 guarantee. I am only using Class 3 price contracts for this example.

Independent Table

The Ladder person made purchasing decisions on every other Thursday/Friday. They made 11 DRP purchase decisions of 3250 lbs. each. They protected 35% of their milk production. They averaged 23 cents per cwt of a protection on a $16.42 and $15.60 guarantee. Some call this the 5% Ladder system, where if you make a purchase in 5% increments to your total protection, you are forced to make several decisions. Below I show the purchases in a table and a chart format.

Ladder Table
Ladder Chart

In summary, making dairy risk management decisions can be hard. This is just one example of setting goals for when to make a dairy risk management decision. The earlier part of the year 2020 was tough to make a DRP decision as the since the industry sentiment was that prices we going to hold. Both strategies did make some DRP purchases at the end of the May. The Ladder person opted to commit to making a decision every other Thursday or Friday. This ladder system provided them with a systematic system on their calendar to look at the dairy markets. In this example, the independent system covered 20% of their milk production and the ladder system covered 35% of their milk production.

It is true that in this case, the independent person ended up with a higher price floor at $15.63 guarantee at 23 cents. The ladder person ended up with a price floor of $15.60 at 24 cents. The actual quarter every day averaged $15.63 at 23 cents. In this case both decisions systems made very similar protection levels purchases.

Neither person made the goal of protecting 50% of their milk, but they are both starting to climb up the ladder. Keep learning, keep asking, and keep trying!

J. Craig Williams is a dairy team educator and Andrew Sandeen is an Extension educator with Penn State University.