Milk Pricing: Reform starts with farmer/processor relationship
With lingering memories of record-large milk check deductions, seemingly every group tied to dairy is now exploring options for milk pricing reform. Edge Dairy Farmer Cooperative has put together a comprehensive blueprint on federal milk pricing reform that it says is both flexible and fair for the farmer and milk processor.
Mitch Davis of Davis Family Dairies, a member of Edge Dairy Farmer Cooperative’s (Edge) board of directors who served on a multi-state task force about milk pricing reform, and Dr. Marin Bozic, a dairy economist who serves as an adviser to the Edge board, went in-depth on Edge's priorities and contracting principles during a recent Dairy Stream podcast.
The discussion focused on strengthening the farmer-processor relationship that increases transparency, fairness and competition, and gives farmers a reasonable amount of price certainty.
Davis says the events unfolding during the pandemic showed serious flaws in the Federal Milk Marketing Order (FMMO) system, established back in the 1930s to aid farmers facing low milk prices. One glaring example was negative Producer Price Differentials (PPDs) that cost dairy farmers over $1.4 billion in unpaid component value for June-Aug milk in 2020, according to the USDA.
Negative PPDs occur when the component value of milk (value of butterfat, protein and other solids) in the FMMO pool exceeds the classified value of milk in the pool. In 2020, the component value of milk approached all-time highs due to the impact of the cheese price on the protein price.
Then, because the higher-of was eliminated in the 2018 farm bill, the Class I price of milk did not entirely benefit from higher cheese prices. As a result, PPDs dropped to historic negatives and a significant volume of milk was de-pooled (making the PPD more negative).
"(The call to pricing reform) came about due to the magnification of weaknesses in the federal order system, especially with the negative Producer Price Differentials (PPDs)," Davis said. "That really opened people's eyes to the magnitude of issues, so we started out with a taskforce which included Edge and dairy stakeholders and eventually other stakeholder groups. We have a good start, but it's going to take a lot more work and dialogue."
Davis says the relationship between producer and processor is synergistic, where each must understand the challenges and concerns of one another as it relates to the area of the milk sale transaction and the federal order.
"The producers and processor need each other. It doesn't help the processor to have unsuccessful and unprofitable producers and vice versa," Davis said. "It has to be an equitable and functional relationship. I think there's plenty of motivation for both parties to proceed with good quality, sincere and candid discussions to get something that can be made more functional for both."
The FMMO system has both plusses and minuses says Bozic. While the system helps to place a check on the market power of buyers and aids in price discovery by setting a benchmark on how processors pay their respective producers, they are no longer relevant in today's landscape.
"Federal orders definitely have a role to play and will continue to have a role to play in our system. However, we just need to recognize that the market situation that we had 25 year ago when we had out last major reform, we're just not there anymore," Bozic said. "If federal orders are to remain relevant in all parts of the country, we need a more flexible system that gives each federal order the authority to operate its milkshed in a way that is sensible for that order."
The only way that FMMOs do not become irrelevant to the cheese-producing Upper Midwest is the return to the core principles of federal orders , Bozic said.
"All dairy farmers should enjoy a uniform benefits approach - no more cross-subsidization between manufacturers, and no more negative PPDs,” he said. "That's where flexibility comes in. How do we update the federal orders? How do we tweak the rules so that farmers can have a meaningful and effective risk management strategy so they're not blindsided by a $4 negative PPD like they were in 2020?"
Laying a new foundation
To accomplish this, Bozic says the industry needs to go beyond FMMOs to set a new foundation for success and trust between farmers and processors. Current markets driving milk outside the FMMO system point to a need for a standard set of “contracting principles” to build a more fair and equitable pricing system.
"The relationship between the producer and processor is more complicated. It's no longer you ship me milk, I pay you for that milk and we're done," he said. "As we impose more requirements on dairy farmers, we also need to give the farmers some new rights that we have perhaps been taken for granted so far."
Broader, deliberate change
Moderator Mike Austin says many dairy groups across the country have raised the topics of Class I movers and the make allowance in discussions around pricing reform.
"I use the metaphor that you need to change the oil in a vehicle every 5000 -7000 miles, but then every 100,000 miles you have to change the timing belt. Most of these other groups say we need to only change the oil. But what about the timing belt? If we want to take this car another 100,000 miles, just changing the oil won't get us there.
"If we only change make allowances the way some groups would likely want us to, we would see the Class III price drop $1.00/cwt. That's a lot of money. And for dairy farmers to accept such a change, they need to know that really is necessary and its the best possible reform package. In my mind, that's a standalone issue," said Bozic, stressing the need for a broad and open debate. "It needs to be part of a broader, deliberate change to give a new lease of life on federal orders and ensure fairness and contracting between producers and processors for the next decade."
Edge has listed priorities that would achieve a workable solution for both farmers and milk processors:
- A more flexible system that gives each federal order the authority to operate its milkshed in a way that is sensible for that order.
- A standard set of “contracting principles” to make the pricing system more fair and equitable and strengthen trust between farmers and processors.
Eliminate the federal order?
In the event the industry would eliminate the FMMO system, Bozic says Edge has the only fully developed proposal to address a "world like that".
"Presently, anytime a processor depools, those federal orders do not exist for the farmer that is depooled. There is nothing at that point in time anymore that would ensure fair treatment of the producer, and sometimes there isn't even a written contract between a producer and processor that would govern those situations," he said. "So, depooling is an example of federal orders going away before our very eyes, bit by bit, month by month."
He said Edge's proposal will address situations where a processor is depooled or when federal orders "just go away".
While the plan represents building blocks for a new structure, both Bozic and Davis says there is much to be discussed among many stakeholders including national groups representing processors, cooperatives and producers.
"We will need to have a national dialogue, and that the ideal of consensus is a noble one. And I hope it can be reached," Bozic said.
Before any proposal can be implemented, Davis says there are some legislative hurdles to clear.
"The 'Fairness in Contracting' would need to become federal legislations, either in the Farm Bill or some other form," he said. "The 'Flexibility of Orders' is really just a sentence or two that can be added to the enabling statute that underpins federal orders. And then all the nitty-gritty details can be figured out later at a hearing. But without that language in the federal statutes, our hands are tied. Even if USDA wanted to implement everything that Edge has proposed, they just don't have the authority under the current federal statute."
While Davis has been on both sides of the processor/producer coin, he understands that in order to make progress it will take stakeholders on both sides of the transaction to listen and learn from one another and understand the potential challenges they face.