V'

COOPERATIVE EXTENSION

l>aiHUNIVERSITY OF CALIFORNIA

Volume 12, Number 8 August 1982

DAIRYMEN WHO HAVE LOST THEIR CREAMERY CONTRACT

Dr. John W. SiebertAgricultural Economics Extension

Every dair3^man knows how important it is to have a home for hismilk. Without a daily buyer it is impossible to stay in the dairybusiness. Today, due to a combination of increased milk production anddeclining fluid milk sales, several dairymen have lost their creamerycontracts. Others face the prospect of being cut off.

Every creamery manager knows how important it is to have plant andtransportation equipment operating at an efficient sales level. Lowsales make it impossible to pay the wages, interest, utilities and otherexpenses required to run a creamery. As competition for declining classsales gets tougher, resale margins get shaved. Only a very few creamer¬ies will prosper in such a down market. Many creameries will have theirsales level reduced.

Surplus milk production compounds this problem by requiring plant-to-plant and out-of-state shipment of milk. This surplus milk can tieup plant capacity and thus increase raw product cost. The environmentis set for dair3rmen to be cut off.

What Happens?

What happens when a dairyman gets cut off by losing his creamerycontract? The sequence of events goes something like this. First,notice is given that the creamery will no longer receive the dair3nnan*smilk after 90 days. Next, the dairyman searches for another buyer.

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Th« University of Californi* Cooperative Exteitsion in compliance with the Civil Rights Act of 1%4. Title IX of the Education Amendments of 1972. artd the Rehabilitation Act of 1973 does not discriminateon the basis of race, creed, religion, color, national origin, sex. or mental or physical handicap in any of its programs or activities Inquiries regarding this policy may be directed to Eugene D Stevenson.317 University Hall. University of California. Berkeley. California 94720.(415)642-0931

University of California and the United States [>epartment of Agriculture cooperating

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However, no grade A plant will take his milk. All plants are alreadyfull. Many plants are shipping surplus milk out-of-state.

The search continues but is now narrowed to two options. Thefirst option is shipping out-of-state and selling milk for approxi¬mately six dollars per hundredweight (cwt.) F.O.B. the dairy farm. Thisprice is calculated as follows. The out-of-state plant pays about$10/cwt., while the haul costs about $A/cwt. The net result is $6/cwt.at the farm.

The second option is to ship to a grade B plant in California.The grade B price is unregulated. Therefore, grade B plants do notpay very much, but at least they will buy milk. To give an example,the price being received by some dairymen who recently got cut off is$ll/cwt., with a 45-day wait on milk payment.

Once they have been cut off, dairy farmers with salable quotacontract and low debt obligations have chosen to sell out. Otherswith fewer assets and higher debt payments do not have this choice.Their only alternative to continued production is bankruptcy.

T'Jhat Can You Do?

Faced with the prospect of being cut off from a proprietary plant,dairymen have formed their own shipping cooperatives. This way thecooperative pays all extra costs involved in limiting milk deliveriesto the proprietary plant. In such a group, dairymen receive someprotection.

On an individual basis, every dairyman should strive to producemilk of the highest possible quality. This is because, in some cases,it has been the lowest quality dairymen who have been cut off. Also,it is very important for all dairymen to produce at or below thecontract production levels recommended by their creamery.

Winners and Losers

In the present surplus situation, creameries which buy milk directlyfrom dairymen would prefer to be short of milk. This is because anyshortage can be easily and cheaply made up by a plant-to-plant transfer.The result is that dairymen who ship to proprietary creameries are theones who get cut off.

The cooperatives are in much better shape. They are set up tohandle surplus milk with their butter, powder, and cheese manufacturingcapacity. They also specialize in tailoring milk to meet other buyers*on-call needs. Of course, when milk is short, the cooperatives* plantsare the first to go dry. But when milk is in surplus like it is now,the cooperatives and their members can do well. I^fhat a rever^l whencompared to the period before pooling. ^

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Before the beginning of pooling, class 1 sales were growingrapidly. Cooperatives tried hard to get and maintain a share of theclass 1 market. But they had a difficult time. In fact, every dairyfarmer struggled (some paid) for a larger piece of the class 1 market.The Pooling Plan was created to correct the class 1 inequity.

Today we have a new contract problem. Dair3Tnen shipping to theircooperatives have a more consistent buyer for their milk than do dairy¬men shipping to proprietary firms. Through their patronage refunds,cooperative members have spent their own money to build butter, powder,and cheese plants. The U.S. government stands ready to buy theseproducts in unlimited amounts at the support price. Thus, for thepresent, a consistent growth market has been obtained even thoughclass 1 usage is declining (see table 1).

TABLE 1: MILK PRODUCTION AND CLASS 1 USAGE IN CALIFORNIA, 1979 TO 1981

Market & ManufacturingMilk Production

Class 1

UsageClass 1 as a %of Production

(1,000 lbs.) (1,000 lbs.) (%)

1979 12,488,652 6,292,820 50.311980 13,515,998 6,238,927 46.161981 14,186,603 6,189,750 43.63

Milk marketing in California has now come full circle. There wasonce a serious problem with unequal sharing of the class 1 market.Today there is a problem with unequal sharing of the class 4 market.Because no one thought the class 4 price would remain at a profitablelevel over an extended period of time, no one was able to predict thisnewer problem. However, this problem may not last long.

Surplus Solution

Pretend the support price dropped. This would result in less milkproduction because some poorly financed and overbase shipping dairymenwould go out of business. Furthermore, a few other dairymen mightreduce production by culling their lowest producing cows.

Most dairymen would still continue to produce at or near theirpresent levels until a tremendous drop in support occurred—say $l/cwt.or more. After a drop like that, the growth concerns of many dairymenwould be replaced by an effort to survive. First, the out-of-state milkshipments would dry up. Next, California butter, powder, and ^eese(class 4) plants would start to lose their milk supplies.

At that time the threat of additional dair3nnen losing their creamerycontracts would end. A lot of milk would be needed, but only the lowcost dair3nnan would survive to produce it.

The plan of the National Milk Producers Federation could also solvethe problem of producers being cut off. To do so, the penalty on excessproduction would have to be steep. Such a base plan would Impose extracosts for program administration and milk transportation. To the extentthat these new costs would be born by the creamery, the future ofproprietary shippers would still remain seriously threatened. Marketing(milk shipping) cooperatives would be a solution to this problem.

The Future

Currently in California we are resolving our own surplus problemin three ways:

1. Dairymen shipping to proprietary creameries are being cut off.

2. Many creameries have placed absolute limits on the quantity ofmilk they will pick up. At best this reduces milk productionor causes some milk to be refed to animals. At worst, itcreates a black market for milk.

3. Milk is being shipped out-of-state.

Who can look at these facts and think the dairy surplus situationis going to improve without some type of economic shock? With mostCalifornia dairymen still in an expansion mood, that shock could knockthe unprepared out of business.

Grain prices are fairly stable at low levels. Hay prices aresomewhat higher than last year. This leaves only the milk price as apossible problem.

A recent compromise bill introduced by Senator Paula Hawkins(R-Fla.) contains another support price reduction. If passed by Congressand signed by the President, the price reduction would be in the formof an immediate $0.50/cwt. drop. The way the bill is written, thisimmediate reduction could be followed by no more than an additional$0.60/cwt. price drop. This second drop would be at the discretion ofthe Secretary of Agriculture. Those dairymen who have been cut off mayrepresent just the tip of the iceberg.

John W. Siebert ^Extension Economist

CALIFOMIA CHEDDAR CHEESE SALES OPPORTUNITIES

Dr. John W. Siebert

Agricultural Econoinics ExtensionUniversity of California

Davis, CA 95616

Approximately 89 percent of the cheddar cheese consumed inCalifornia was imported from out-of-state during 1981. This amounttotaling 147,740,983 pounds of cheddar, may represent a substantialfree market growth opportunity for California dairymen.

Production

According to California Bureau of Milk Stabilization statistics,51,446,027 pounds of cheddar were produced in California during fiscal1981.* Of this amount, 33,636,000 pounds were sold directly to theCommodity Credit Corporation [3].

Taking the difference between these two figures leaves approximately17,810,027 pounds of California production available for consumption inthe state. The remainder of California's consumption is satisfied byimports of cheddar from other states.

Consumption

The California Department of Finance has estimated that California'sJanuary 1, 1981 population was 23,992,900 people [l]. Recognize alsothat the U.S. Department of Agriculture has estimated that U.S. percapita consumption of cheddar in natural form was 6.9 pounds in 1980 £4].Multiplying these two figures together provides an estimate of totalcheddar consumption in California at 165,551,010 pounds.

Constimption of cheddar at this level is over 3.2 times the amountpresently produced in California. Conversations with major cheesebrokers and cheese buyers confirm that imports to this state aretremendous.

Imports to California

We can now estimate the size of these cheddar cheese imports. TotalCalifornia consumption is estimated at 165,551,010 pounds. Total Calif¬ornia production not sold to the Commodity Credit Corporation was 17,810,027pounds. Taking the difference between these two numbers we get an estimateof 147,740,983 pounds of cheddar cheese imported to California during 1981.This import level is equal to 89 percent of total California cheddar con¬sumption.

^Following Commodity Credit Corporation definition, the fiscal year 1981runs from October 1980 through September 1981.

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How large would imports have been if no California cheddar had beensold to the government? Recall again that total California consumptionis estimated at 165,551,010 pounds. Total California production was51,446,027 pounds. Taking the difference between these two numbers,we get an estimate of 114,104,983 pounds of cheddar. This amount vjouldhave been imported to California had no Califomia-produced cheddarbeen sold to the Commodity Credit Croporation.

All of the statistics discussed above have been summarized intable 1, Keep in mind that all discussion in this paper pertains tonatural cheddar cheese only.

Key Questions

Several key questions come to mind after a review of these sta¬tistics. For example, consider the following:

Why haven't Cattfomia datrymen se-lzed this market opportunity already?California is moving fast in expanding cheese production. 'The real roadblock is not low production capacity but is,instead, quality reputation. Established cheese companiessuch as Kraft and Schreiber dominate this trade. Currentlythese companies buy almost all their cheese from out-of-state.This is why the California Milk Advisory Board*s effort topromote a California cheese brand is so important.

Row can out-of-state cheese manufacturers compete when they have to payhigher shipping charges?

Freight costs approximately bq per pound for shipmentfrom Wisconsin to California. However, this dis¬advantage is more than offset by the fact that es¬tablished cheese manufacturers can receive 5 to 15cents per pound above the support price for cheese.Equally important is the fact that much of thecheddar imported into California is broken downbelow 40 pound block size. No large Californiacheese manufacturing plant has this capability.Therefore, competitors from out-of-state can sellto a larger number of customers in California.

Who buys cheddar cheese in California?

Cheddar cheese is purchased by supermarkets,restaurants, and institutions. Supermarketswhich do not have in-state facilities to cutand wrap cheese must buy all their cheddarfrom out-of-state. Even so, the buyer for onelarge California chain with cut and wrap fa¬cilities in this state stated that his company

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TABLE 1: CALIFORNIA CHEDDAR CHEESE PRODUCTION,CONSUMPTION, AND IMPORTS, OCTOBER 1980THROUGH SEPTEJIBER 1981

Production

1. California Production 51,446,027 lbs.

2. U.S. Commodity CreditCorporation Purchases 33,636,000 lbs.

3. Quantity Not PurchasedBy Commodity CreditCorporation (1-2) ' 17,810,027 lbs,

Consumption

4. California Population,January 1981 23,992,900 people

5. Per Capita Consumption ofCheddar, U.S. Average 6.9 lbs. per person

6. Implied CaliforniaConsumption (4X5) 165,551,010 lbs.

Imports to California

7. Implied Total Imports(6-3) 147,740,983 lbs.

8. Implied Total Imports ifNo Cheese Had Been Soldto Commodity CreditCorporation (6-1) 114,104,983 lbs.

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buys no California cheddar. Why? Because it is notavailable in the large quantity and high quality thathe seeks.

Restaurant and institutional buyers are not asdifficult to please. Many of them have the capacityto handle a 40 pound block of cheddar. Also, theappearance of the cheese is not as important to themsince it will be cooked. However, as a result of thisflexibility, the price these western buyers pay isonly about one cent per pound over support,

Uhy is so much Califomia oheddar sold to the government?

The federal government stands ready with an open-endedoffer to buy cheddar cheese at $1,395 per pound. Plantswhich sell to the government must be USDA inspected.Pa3rment terms are almost comparable to commercial market.

One large California cheese manufacturer sells the majorityof its product to the federal government based on anagreement it has with one of the nation's largest cheesecompanies. The situation is temporary because plansfor construction of California cutting, wrapping, andprocessing facilities are under consideration. Thistie-in approach is very sound in view of the dominantretail sales role of the nation's largest cheese companies.

What if the U.S. government stopped supporting the price of cheddarcheese?

The market price for cheddar would drop drastically.The drop could be as much as 30 cents per pound ofcheddar. At present a government pull out seems un¬likely. However, a cheese support price drop of eightpercent may occur if the administration's plan to changedairy price supports is passed by Congress. Such adrop would equal eleven cents per pound of cheddar.

Will the increased consumption of California cheese solve the milksurplus problem?

From the perspective of California dair3mien theanswer is yes. However, to the extent that newCalifornia cheese production displaces importsfrom out-of-state, the answer is no. This isbecause the displaced cheese would be purchasedby the Commodity Credit Corporation. Further¬more, to the extent that California butter andpowder will still be sold to the Commodity CreditCorporation, the answer is no.

The only cure to the surplus milk problem is less milkproduction and more consumption. Vigorous competitionbetween California cheeses and out-of-state cheese willexpand the demand for all cheese.

How is cheese priced?

The support price for cheddar cheese is $1,395 perpound. The going price for cheddar on the NationalCheese Exchange in Green Bay, Wisconsin, is two centsbelow this level. Such a lower free market price isdue to the fact that uninspected and off-grade cheeseputs downward pressure on the price of commercial sales.

Most cheese supply contracts are priced at a specifiedlevel above or below the National Cheese Exchange price.At present, the market is static with no price movementon the National Cheese Exchange since November 1981.This static situation is due to the fact that thecheddar market is resting at support.

Summary

A considerable opportunity exists in cheddar cheese sales inCalifornia. At present the key to success is the continued stabilityof the support program because all cheddar cheese prices are restingat fixed levels relative to support. Up to an eight percent drop incheddar prices is likely if the administration's price support billpasses. However, passage is not certain and thus the 1981 farm billmight remain in effect.

Looking to the future, wise dairymen and their cooperatives willdo well to view cheddar cheese as only one of many possible investmentswhich can be made in the dairy industry. If cheddar were in short supply,and if the price seemed headed higher, I would feel very differently.

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References

[1] California Department of Finance. Population ResearchUnit. Population Estimates for California Cities andCounties. May 1, 1982. p. 7.

[2] California Milk Advisory Board. Cheese Production andConsumption Facts. (An excellent report.)

[3] U.S. Department of Agriculture, Agricultural Stabilizationand Conservation Service. 1981-82 Dairy Program. ASCSCommodity Fact Sheet, April 1982, Table 10.

[4] U.S. Department of Agriculture. Economic ResearchService. Dairy Outlook and Situation. DS-386,September 1981, p. 19.

June 21, 1982

THE MAKE ALLOWANCE ... OR HOW DAIRY PRICE SUPPORTS ARE PAID

Dr. John W. Siebert

Agricultural EconoTiiics ExtensionUniversity of California

Davis, CA 95616

Changes in dairy price supports are now receiving serious con¬sideration in Congress. Such changes will affect almost every dairy¬man's milk check and almost every creamery's cost of milk. Now is thetime to understand the make allowance and how price supports are paidout.

Storability the Key

The support price exists to guarantee a stable supply of freshfluid milk. Should commercial demand drop below supply, the federalgovernment stands ready with an open-ended commitment to buy milk.

The government's offer to purchase does not extend to fluid milkitself. Instead it pertains only to the storable or hard products:butter, nonfat dry milk (powder), and cheddar cheese. Accordingly,it is the creamery that receives the support payment directly. Thefarmer receives the support payment indirectly.

Butter and Powder

The support price for milk is currently $13.10/cwt. This level wasset in October of 1980 by Congress. In order to assure that dairymenreceive this price, the United States Commodity Credit Corporation(CCC) does the actual purchasing of butter, powder, and cheese fromcreameries.

One hundredweight (cwt.) of milk containing 3.67 percent fat willyield approximately 4.48 pounds of butterJi/ and 8.13 pounds of powder^/.The make allowance or margin to make these products from raw milk iscurrently set by CCC at $1.22/cwt. It has not been revised sinceOctober 1, 1978. Therefore, creameries will be paid $14.32/cwt. ofmilk purchased and processed into butter and powder:

$13.10/cwt. Farmer support price for 3.67 percentfat test milk (set by Congress)

+ $ 1.22/cwt. Butter and powder make allowance(set by CCC)

= $14.32/cwt. Sales value of butter and powder tocreamery

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How does the creamery receive this $14.32/cwt.? The CCC must setbutter and powder support prices so that if the processed products from100 pounds of milk are sold to the CCC, $14.32 is earned. Accordingly,the butter support is set at $1.49/lb. and the powder support is setat $0.94/lb. This works as shown below;

$ 1.49 X 4.48 lbs. of butter+ $ 0.94 X 8.13 lbs, of powder- $14.32 Sales to creamery from one cwt. of milk

processed into butter and powder

Cheese

One hundredweight of milk containing 3.67 percent fat will yieldapproximately 10.1 pounds of cheddar cheese^'. The make allowance toproduce or make this cheese from raw milk is currently set by the CCCat $1.00/cwt. Therefore, creameries will be paid $14.10/cwt. of milkprocessed into the cheddar cheese:

$13.10/cwt. Farmer support price for 3.67 percentfat test milk (set by Congress)

$ 1.00/cwt. Cheddar cheese make allowance (set by CCC)= $14,10/cwt. Sales value of cheese to creamery

Again the make allowance is used to be sure that the creamery canpay the support price for milk. This is accomplished by setting thecheddar cheese support price at $1,395 per pound:

$ 1.395 X 10.1 pounds of cheddar= $14.10 Sales to creamery from one cwt. of milk

processed into cheese

Inflation

Increasing costs at creameries cause an inability of these plantsto pay the support price. For this reason, frequent adjustments in themake allowance are necessary.

If such adjustments are not made, dairy farmers will re:ceive lessfor their milk. To the extent that the milk purchased by creameries isgrade B, the creamery can lower its producer payment by the amount ofinflation. However, grade A producers must receive a minimum price asrequired by marketing order.

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For federal milk marketing orders, this grade A minimum price isthe Minnesota-Wisconsin Manufacturing Milk Price, often called the "M-V7."The M-W is the average milk price paid by butter, powder, and cheeseplants in Minnesota and Wisconsin to grade B dairies. This price iscurrently averaging $0.37/cwt. below support because the make allowancehas not been increased:

$13.10/cwt.

- $12.73/cwt.

= $ 0.37/cwt. •

California

In California, milk purchased from grade A dairies must receivethe class 4 price if it is used to manufacture butter, powder, or cheese.This class 4 price is set by the California Bureau of Milk Stabilization.It is based on the higher of support or free market for butter andpowder. Unlike the Federal Order, the California class 4 price is notset by a grade B index of prices paid.

As a consequence of this difference in minimum price computation,[ frequent adjustments in the California make allowance are vital to

creameries. This is particularly true for proprietary creameries whichdo not have the milk pa3mient flexibility which cooperative ownershipprovides. Since October 1978, the time of the last federal make al¬lowance adjustment, California has raised its make allowance four times.

Curently in California, the class 4 price is $1.6524/lb. of milk fatand $0.7443/lb. of solids-not-fat. Using these component prices, we cannow determine the California price of one hundredweight of milk equivalentin test to the standard used in the Federal Order. This hundredweightwould have an analysis of 3.67 percent fat and 8.62 percent solids-not-fat:^'.It would cost $12.48 if purchased for class 4 usage in California.

It can now be seen that the support price shortfall is greater inCalifornia than in the federal order:

$13.10/cwt. Support price at 3.67 percent milk fat(set by Congress)

- $12.48/CT^. California class 4 price at equivalent test= $ 0.62/cwt. Support shortfall to dairymen in California

Although this may appear to be unfavorable to California dairymen, thetruth is exactly opposite. A low raw product cost allows Californiacreameries to handle the maximum amount of surplus milk possible. Giventoday's level of excess production—we need every bit of creamerycapacity available in order to prevent dumping.

Support price at 3.67 percent milk fat(set by Congress)

May M-W Manufacturing Milk Price at3.67 milk fat

Support shortfall to dairymen in Minnesota-Wisconsin

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Comparison

Table 1 presents a comparison of creamery gross margins in theFederal Order versus California. The gross margin is computed as thevalue of butter and powder at support minus the purchasing price of milk.A parallel calculation is presented for cheese. As can be seen in thetable, California margins were $0.25/cwt. higher in May 1982. Stateddifferently, California creameries paid $0.25/cwt. less for grade A milkpurchased to produce butter, powder and cheese. Remember that the pricepaid for grade B milk is unregulated in both markets.

Historically the California class 4 price has tended to be belowthe M-W price. This means that butter, powder, and cheese manufacturingfrom grade A milk has. been more profitable in California than it hasbeen in the Federal Order, This fact is one of the key reasons whyCalifornia maintains a healthy proprietary creamery industry which buysdirectly from farmers.

Table 2 presents an historical comparison of the California class 4price with the M-W price. As before, an adjustment has been made tobring the milk to equivalent tests. As can be seen, during 1981 theCalifornia class 4 price has averaged $0.10/cwt. below the M-W. Duringthe first five months of 1982, the California class 4 price has averaged$0.13/cwt. below the M-W. Without California's recent make allowanceincrease of $0.27/cwt., California raw product cost would have beenhigher than in the Federal Order.

Support Price Change

If the Secretary of Agriculture's plan to adjust the support priceis passed by Congress and signed by the President, then a drop in supportis likely. This would be accomplished by directly reducing the supportprices for butter, powder, and cheese. As a result, dairymen wouldindirectly receive less for their milk.

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Table 1: Creamery Gross Margins From Manufacture of Butter, Powderand Cheese, Federal Order and California, May 1982,One Hundredweight of Grade A Milk, 3.67 Percent Milk Fatand 8.61 Percent Solids-Not-Fat

Butter - Powder Cheese

Federal FederalOrder California Order California

Value of ManufacturedProduct at Support

($/cwt) ($/cwt) ($/cwt) ($/cwt)14.32 14.32 14.10 14.10

Purchasing Price ofMilk* 12.73 12.48 12.73 12.48

= Creamery Gross Margin 1.59 1.84 1.37 1.62

*In Federal Order, adjusted M-W price for May 1982.In California, adjusted class 4 price for May 1982.

Table 2: A Comparison of the California Class 4 PriceAnd the Minnesota-Wisconsin Manufacturing Milk Price.Basis of Comparison Is One Hundredweight at3.67 Percent Milk Fat and 8.62 Percent Solids-Not-Fat

Date

Minnesota-Wisconsin CaliforniaManufacturing Milk Class 4 Price,Price, Average Average Difference

($/cwt.)

1979 11.16

1980 12.16

1981 12.87

1982 (1st 5 months only) 12.11

($/cwt.)10.78

12.18

12.77

12.64

($/cwt.)

0.38

-0.02

0.10

0.13

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Footnotes

jL/ According to federal procedures, butter yield is figured on 1.22overrun. Thus, one hundredweight at 3.67 percent milk fat wouldyield 4.48 pounds of butter.

According to federal procedures, nonfat dry milk yield for onehundredweight at 3.67 percent milk fat is figured at 8.13 pounds.This corresponds to a solids-not-fat content of 8.62 pounds.See table 6 of Mathis and Anderson.

According to federal procedures, cheese yield for one hundred¬weight at 3.67 percent milk fat is figured at 10.1 pounds.See tables 5.8 and 6.1 of Van Slyke and Price.

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Bibliography

Mathis, A. G. and Anderson, E. D. Yield of Nonfat Dry Milk SolidsFrom a Unit of Milk. U.S. Department of Agriculture. MarketingResearch Report No. 126. June 1956.

U.S. Department of Agriculture, Agricultural Stabilization andConservation Service. 1981-82 Dairy Program, ASCS CommodityFact Sheet. April 1982.

Van Slyke, L. L. and Price, W. V. Cheese. New York: Orange JuddPublishing Company, 1949.