How Milk Pricing Works
Milk and dairy products are the leading commodity group in California agriculture, with a value of more than $7.6 billion in 2011. This level of output establishes California as the largest dairy state in the country and a world leader in production. Due to significant changes in the marketplace in recent years and months, interest in the milk pricing structure in California is increasing.
- Why is milk pricing regulated?
- What is CDFA's role in setting milk prices?
- What factors determine the milk price?
- Why does California have its own pricing system separate from federal orders?
- What are the different regulated classes of milk?
- Why are different classes of milk priced differently?
- Why are California prices different than other parts of the U.S.?
- How does the milk pool work?
- What is make allowance?
Long-standing inequities in the milk market spurred the California Legislature to establish pricing regulations in 1935. While much has changed in the dairy industry since then, many of the characteristics of milk, marketing of dairy products and related economic conditions that justified regulation in the 1930’s have remained the same:
- Milk is a perishable product and must be harvested daily
- No other regulations would be in place to assure an adequate supply of milk
- Production is highest when demand for fluid milk is at a seasonal low, largely due to the fact that a significant amount of fluid milk is consumed by children at school. Milk production is at its highest when schools adjourn for summer vacations.
- Milk continues to be viewed as a necessary food item, particularly for children.
Without economic regulation, a strong potential exists for volatility. The swings in milk prices between the highs and lows would likely to be much greater without the stability offered by regulation.
CDFA is the regulatory agency charged with balancing the needs of dairy farmers producing milk on the farm, manufacturers taking milk from the farm and converting it into dairy products, and consumers looking for a reliable supply of reasonably priced products. In order to perform this duty, the Department monitors conditions in the dairy marketplace and establishes the minimum price that must be paid by processors to producers.
CDFA carefully monitors prices for butter, cheese, powdered milk and whey at the Chicago Mercantile Exchange and also considers economic factors that affect farmers, processors and consumers. These factors include the costs associated with the production of milk, such as feed, labor, utilities, and veterinary care; and the costs associated with the manufacturing of dairy products; such as labor, utilities, packaging, and administrative activities. CDFA also considers supply and demand in markets where dairy products are sold to provide fair and reasonable prices to consumers.
After California regulated dairy prices in 1935, the federal government followed two years later with a national system to provide stability in the dairy industry for farmers, processors and consumers. At that time, California was isolated on the West Coast, far away from the major population centers of the country. Dairy markets of the era were local in nature - products were not transported long distances. That geographic separation brought significant differences in market conditions that supported California staying out of the federal system and continuing with its own program.
Dairy products are grouped into classes based on similar manufacturing processes and/or product make-up.
- Class 1 - fluid milk.
- Class 2 (cultured products) - yogurt, sour cream, cottage cheese, buttermilk, and egg nog.
- Class 3 (frozen products) - ice cream and frozen dairy desserts.
- Class 4a - butter and dried milk powders.
- Class 4b - cheese and whey protein powders.
This depends on the type of product. Fresh, perishable dairy products such as fluid milk, sour cream, yogurt, cottage cheese, and whipping cream do not have a long shelf life. As a result, manufacturers of these products tend to require specific amounts of high quality milk to meet the current demand for their products. As a result, milk used for these products (classes 1 and 2) tend to carry a relatively higher price that reflects the manufacturing requirements and immediate consumer demand.
Other dairy products such as butter, cheese, and dried milk products have a longer shelf life and are storable for longer time periods. When the fluid milk supply exceeds demand, excess milk (classes 4A and 4B) is used to manufacture these storable products. This dynamic drives these milk prices lower.
Prices usually differ because of supply and demand for milk and manufactured milk products. If producers provide less milk than required by processors to meet demand for these products, competition develops among processors, resulting in higher milk prices. If milk production outpaces the demand for milk and higher valued finished dairy products, much of the milk ends up in lower value ones like butter, nonfat dried milk powders and cheese, with producers receiving a correspondingly lower price for their milk. As demand fluctuates within states and regions, milk prices vary as well.
California processors pay for milk based according to its class (1,2,3,4a and 4b). All of those monies are blended together (or pooled) and then paid out equitably to dairy farmers. Blending (or pooling) the milk revenue allows for a more even distribution of revenues back to producers.
Make allowance is the cost processors incur to manufacture a particular dairy product and is part of the formula for establishing minimum milk prices. Make allowance includes labor, utilities, packaging, and administrative activities.