Overview of the Dairy Industry

Presented by
Dr. Robert Cropp, Professor Emeritus
University of Wisconsin
Madison, Wisconsin
Council Member Biography

Dr. Robert Cropp is a Professor Emeritus at University

of Wisconsin and an agricultural economist. He has been
associated with the University of Wisconsin system for 41 years
where and has specialized in conducting research and providing
extension/outreach programs in dairy marketing, dairy policy and
agricultural cooperatives. Since 1974 he has prepared a monthly
dairy situation and outlook report. He also provides information
to dairy farmers and dairy companies on dairy price risk
management via futures, options and forward price contracts. He
also teaches undergraduate and graduate classes.

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Agenda
1. Why volatile and uncertain raw milk prices and dairy product
prices are now the norm.
2. How raw milk prices and dairy product prices are determined
3. What are the main drivers of raw milk and dairy product prices.
4. Regional shifts in milk and dairy product prices and implications
for milk processors.
5. Significance of international dairy trade.
6. Implications for milk processors of volatile milk prices and
changing market structure.

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Overview of the Dairy
Industry
Bob Cropp, Professor Emeritus
University of Wisconsin
Madison, Wisconsin
September 2007
 I will touch upon the following topics:
1. Why volatile and uncertain raw milk prices and
dairy product prices are now the norm.
2. How raw milk prices and dairy product prices
are determined
3. What are the main drivers of raw milk and
dairy product prices.
4. Regional shifts in milk and dairy product prices
and implications for milk processors.
5. Significance of international dairy trade.
6. Implications for milk processors of volatile milk
prices and changing market structure.
 From 1980 to 2006 milk production
Increased annually on the average
of 1.6% and commercial disappearance
2.1%

Source: USDA, AMS weekly “Dairy Market News reports and USDA NASS production reports.
From the 1970s to early 1990s the federal dairy price
support program provided stability to raw milk prices and
dairy product prices.
• The price of milk for manufacturing use is supported by the CCC
standing ready to purchase unlimited quantities of cheddar cheese,
butter and nonfat dry milk at specified prices.

• From 1950 to 1981 the support level was set by a parity formula.
Raw milk and dairy product prices were fairly stable.
• In 1981, due to growing milk surpluses and associated high
government costs Congress replaced the parity formula with setting
the support price based on milk surpluses and government cost.

• The support price was $13.10 per hundredweight in 1981 and has
been reduced to $9.90.
• $9.90 provides a very low safety net to raw milk prices and dairy
product prices. Price uncertainty and volatility is now the norm
for raw milk and dairy product prices.
Source: USDA, AMS weekly “Dairy Market News” reports.
Source: USDA, AMS weekly “Dairy Market News” reports.
Source: USDA, AMS weekly “Dairy Market News” reports.
Source: USDA, AMS weekly “Dairy Market News” reports.
Higher nonfat dry milk and dry whey prices
increased raw milk costs.

• Higher dry whey prices added $3.00 to the Class

III price—milk used to make cheese.

• Higher nonfat dry milk prices added $9.00 to the

Class IV price—milk used for nonfat dry milk and
butter.
Dairy farmers, milk plants and wholesale and retail
dairy/food companies need to manage price risk.

Risk management tools:

1. Class III, Class IV, Butter, Dry Whey futures
contracts.

2. Class III, Class IV, Butter, Dry Whey options

3. Cash forward contracts

Ten federal milk marketing orders price 68
percent of all Grade A milk. A major share of the
rest is priced under California’s state order.

• Under federal orders regulated milk plants must

pay for raw milk at least established monthly
minimum prices for four classes (uses) of milk.

• California state order operates similar

Source: USDA, AMS website, “federal milk marketing orders”.
Minimum prices established by USDA using
product price formulas.
• Product price formulas:
Minimum price = dairy product price – make allowance X
yield of product.
Class III price based on: cheddar cheese, butter and
dry whey prices.
Class IV price based on: nonfat dry milk and butter
prices.
Class II price is: Advanced Class IV price + $0.70 for
skim milk and same butterfat price as Class III & IV.
Class I price is: Higher of an advanced Class III or
Class IV price + a class I differential that varies for each
county of U.S. (where bottling plant located)
What are main drivers of raw milk and dairy
product prices?

1. Milk cow numbers—if numbers are increasing, prices

will decline and vice versa.
2. Milk per cow—normal increase is about 1.8% per year;
if more, prices decline; if less prices increase.
3. Total milk production—the market can absorb about
1.5 to 2.0% more milk per year; if greater, prices
decrease; if lower, prices increase.
4. Commercial disappearance—on the average an
annual increase of about 2.0%
5. Commercial stocks
6. International trade
U.S. milk production continues to shift
regionally and becoming increasingly
concentrated.

• Has implications for existing milk plants.

• Has implications as to where to locate new

plants.
 Mil
USDA, NASS monthly production reports.
Source: USDA, NASS, “Dairy Products”
Source: USDA, NASS “Dairy Products”
Source: USDA, NASS “Dairy Products”
Source: USDA, AMS weekly “Dairy Market News” reports.
Cheese is the growth area in the dairy
industry.
• Fluid (beverage) milk has been flat

• Ice cream flat

• Butter flat

• Yogurt has grown

Per
 Pounds of Milk Used For Fluid (Beverage) and Cheese,
1985-2005
90
85 Fluid milk
80 Cheese

75
Billion Pounds

70
65
60
55
50
45
40
85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05
19

19

19

19

19

19

19

19

20
19

19

19

19

19

19

19

20

20

20

20

20
Source: USDA, ERS, “Livestock, Dairy and Poultry Outlook”
Source: IDFA, “Dairy Facts”
Growth in per capita cheese production is
expected to continue.
• From 2002 – 2005, per capita cheese consumption
increased at the rate of 0.47% annually.
• Per capita cheese consumption for 2006 – 2015 is
expected to increase at an annual rate of 0.82%; a
1.81% annual growth rate in total cheese demand.

• The increase growth rate is based on:

1. Continued growth is spending for food away from
home.
2. Growth in the size of Hispanic and Asian
populations
 International Trade is becoming more
important to U.S. Dairy Industry
Year Imports Exports
-----million pounds*------
2000 4,445 1,737
2001 5,716 1,601
2002 5,103 1,583
2003 5,040 1,974
2004 5,278 1,790
2005 5,071 2,006
2006 4,981 2,110
* Milk-equivalent, milk-fat basis
Source: ERS, USDA, “Livestock, Dairy and Poultry Outlook”.
Source: USDA, Foreign Agriculture Service.
Source: www.aae.wisc.edu/future
Source: www.aae.wisc.edu/future
Source: www.aae.wisc.edu/future
Source: USDA, AMS weekly “Dairy Market News” reports.
Source: USDA, AMS weekly “Dairy Market News” reports.
What has caused much higher U.S. and international
nonfat dry milk and dry whey prices?

1. Change in EU dairy policy—less domestic support to farmers and

reduce dairy export subsidies.
2. Milk production problems in New Zealand and particular Australia.
3. Lower value of the dollar
4. Elimination of U.S. surplus nonfat dry milk
5. Increased domestic demand for milk proteins.
6. Increased world demand with growing world economies
 Raw milk and dairy product prices will remain
volatile but will average higher due to:

1. Continuation of federal dairy policy of a low safety net

on milk and dairy product prices.

2. Higher feed costs due to bio-energy production--$0.75

to $1.00 higher milk production cost.

3. International markets will allow for continued growth in

U.S. exports of milk proteins as well as value added
products (ex. Cheese). Emerging economies in India,
China, Middle East and Latin America are big factors.
 Market Structure:
• Wal-Mart Stores Inc. is largest supermarket system with
18% of national supermarket sales; Top 3 supermarkets
(Wal-Mart, Kroger, Safeway) hold 40% of market share.
• This puts pressure on dairy and food suppliers—must be
price competitive, quality assurance, be able to meet
supply needs.
• Forces food and dairy suppliers to mergers and
acquisitions—tight margins; need to cut costs out of the
system.
• Smaller food and dairy suppliers may survive by serving
niche markets—organic products, grass based dairy
products, specialty cheese, etc.—selling to smaller food
stores, local restaurants
Wholesale and retail milk and dairy product price
increases/decreases lag changes in raw milk costs—
impacts margins of dairy processors.
• Result, when prices increase rapidly beverage milk firms (Dean
Foods) and cheese firms (Kraft) experience less favorable net margins
as their food ingredient and grocery store customers are reluctant to
increase prices.

• September 4th Danone announced it would be enacting price hikes in

its fresh dairy segment.

• Kraft experienced a 20.5% decline in operating income in its core

cheese division during second quarter of 2007 due to high milk costs.
Kraft has twice increased its price of cheese products.

• Eventually food ingredient customers (Starbucks, Pizza Hut) increase

their product prices and grocery stores do likewise.
Raw milk and dairy product costs will decline from their
current highs, but are projected to average higher in the
years ahead.
• Companies like Danone, Kraft, Cadbury and Fonterra
have commented that unprecedented lull in world milk
production is forcing them to review their strategies.

• There is increasing pressure on food and beverage

processors as a tighter milk supply resulting in higher
prices putting pressure on margins.
Due to increased milk and dairy product price
volatility both sellers and customers of milk and
dairy products will pursue more long-term price
contracts.
• Firms such as Kraft with cheese and Land O’Lakes with
butter are already doing this in response to customer
requests.

• It is harder for beverage milk companies like Dean

Foods to offer long-term price contracts on beverage
milk products due to federal milk marketing orders
setting minimum raw milk prices and no viable futures
contract to protect contract prices.
Other strategies in addressing high milk, dairy
product and dairy ingredient costs:

• Focus on more high-end added value products.

• Form strategic alliances to combine more traditional

dairy goods with the latest advances in dairy food
ingredients for food and nutritional products (example,
milk proteins).
– It is projected that the market for ingredients such as whey
protein concentrate could experience a 3 to 5 percent annual
growth to 2010.
– More advanced value added forums such as fractions and
derivatives could grow as much as 20 percent per year.