CHAPTER 5

FRESH MILK

The area of greatest difficulty in ascertaining cost components and spread figures for fresh milk appears to be the establishment of the farm value of milk. In the past, ERS has used Class I minimum price, 18 established under the Federal Order system, as the base for farm value in the farm-to-retail spread for milk. However, the Class I minimum is not an accurate indicator of the price actually paid to farmers for fluid grade milk because of the prevalence of "over-order" payments (i.e., Class I milk sold at a price higher than Federal Order minimum). During periods of high demand and low supply, the Minnesota-Wisconsin price will rise very rapidly; the differential remains a relatively fixed sum because of the 2-month lag time in figuring the Class I minimum. Thus, in times of rapidly rising prices, a Class I minimum figured on the basis of a 2-month old MinnesotaWisconsin price will be artificially low. During these periods, "overorder" payments will be substantial and widespread, thereby rendering Class I minimum prices inaccurate.

Attempts to develop an alternative to the use of Class I minimum price presented problems, since no price series existed which reported prices actually received by farmers for fluid grade milk. However, a procedure for determining farm value was developed and finally adopted in May of this year. Previous spreads have been adjusted according to that formula and this new methodology will be used for the first time in the forthcoming spread analysis.

Three basic sets of data are utilized in this new methodology:

(1) The current Minnesota-Wisconsin price;

(2) "Milk eligible for fluid price" (i.e., a blend price reported by the Statistical Research Service of USDA); 19 and

(3) The percentage of all milk eligible for fluid price which is, in fact, used in manufacturing and the percentage of that milk which ends up being retailed as fluid milk. (These figures are provided by the Agricultural Marketing Service of USDA).20

18 Class I minimum is determined by adding a differential, for manufacturing grade milk, to the Minnesota-Wisconsin price in the free market.

19 This series represents the average price actually paid to farmers for all milk of such quality as to be usable for bottling purposes, inclusive of over-order payments.

20 To take a set of random numbers through the three-stage calculation will illustrate the methodology: Minnesota-Wisconsin price-$7.00 per cwt., blend price-$8.25 per cwt., and utilization percentages-70 percent fluid, 30 percent manufacturing. The value from manufacturing is determined by multiplying the Minnesota-Wisconsin price times the percent of manufacturing utilization. (1) $7.00 × 30 percent=$2.10 (value from manufacturing). Value from manufacturing is subtracted from the blend price to yield value from fluid; (2) $8.25-$2.10 $6.15 (value from fluid). Value from fluid is divided by percent o utilization to determine the price paid for fluid milk f.o.b. the first plant; (3) $6.15 70 percent=$8.79 (price per cwt. f.o.b. the first plant). The.calculated price per pound is multiplied by 4.39 to produce the price per one-half gallon and then the transportation charge is subtracted in order to derive the farm value. A degree of inaccuracy enters into the calculation of transportation charge: Data was collected directly from farmers, cooperatives and processing plants in 1972. The 1973 figures were updates of the 1972 data based on a smaller sampling. The farmer generally pays the most substan tial part of hauling expenses, but in some instances and/or areas, the cooperatives and processors may pay a considerable portion of that cost. To the degree that this occurs, the farm value of milk will be understated since the whole transportation charge is deducted from the f.o.b. first plant price paid to the farmer.

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A degree of inaccuracy enters into the hauling charge calculation. Data was collected directly from farmers, cooperatives and processing plants in 1972. The 1973 hauling charge figures were an update of the 1972 data based on a smaller sample collection. The farmer pays by far the most substantial part of hauling expenses but in some instances and areas, the cooperatives and processors may pay a considerable portion of that cost. To the degree that this occurs, the farm value of the milk will be understated since the whole hauling charge is deducted from the f.o.b. first plant price paid to the farmer.

Data for estimates of procurement and assembly, processing and wholesaling are usually directly acquired. The procurement and assembly functions are assigned on the basis of the above-mentioned survey and on the irregular and unpublished Federal Order market data. Approximately 82.8 percent of the hauling charge (or 59.7 percent of the total function) is an expense to the farmer. The rest of the hauling charge, as well as other assembly costs, are paid by the cooperatives.

Processing and wholesaling cost breakdowns are based on a sample of thirty firms. A cost survey was conducted by a private consulting firm which carried out accounting functions for those thirty processing firms. However, the sample includes only independent firms, it includes none of the large national processors such as Carnation, Borden, Hood, or Sealtest. To the extent, then, that costs and profits vary between large nationals and independents, the cost data used by ERS is unrepresentative of this industry. A more representative sample seems unlikely since the larger firms have simply refused to provide cost data. An even greater omission is that vertically integrated retail chains are not included in the sample.

Profit figures for processing and wholesaling functions are directly acquired; "other" costs are a residual. Between 1972 and 1973, profits in processing rose by 100 percent and wholesaling profits rose by 83 percent, combining to give an overall increase in profit of over 91 percent to the processor. USDA believes that this unusually large increase in profits was due to general price instability following the removal of price controls in the last quarter of 1973. Prices rose rapidly at each stage of the spread; however, processors were able to raise prices more rapidly and substantially than producers or retailers.

BLS does not report a wholesale milk price because the wholesaling and retailing functions often merge and overlap. The retail spread is the difference between the BLS retail price and the farm value plus procurement and assembly, processing and wholesaling spreads. USDA admits that many cost allocation decisions are "truly arbitrary" because of this overlap. In addition, increasingly substantial amounts of milk are being delivered directly by processors to retailers, bypassing the wholesale level entirely. To compensate for this, it may be that the wholesaling and retailing functions should be merged in the cost component charts, thereby providing a more realistic representation of what actually occurs. At present, however, a standard form is utilized on component charts for all commodities, regardless of appropriateness to a specific product.

The retail spread is broken out into cost components on the basis of the results of the 1972 Cost Component Task Force mentioned earlier in this report. Profit is not a "directly acquired" figure, but rather is "proportionally" allocated.

USDA personnel have recommended merging the wholesaling and utilizing functions in the cost component charts. This is seen as a more realistic representation of what actually occurs. However, standard form is required of component charts for all commodities, regardless of the most appropriate format to a specific product. Thus, USDA has refused to revise the format of the dairy charts.

CHAPTER 6

BUTTER

A. FARM Value

Farm-to-retail spreads and cost components for butter are based on 1-pound units sold directly to the consumer at retail prices for use in the home. These figures do not include butter purchased by institutions.

To determine the farm value of butterfat used in butter production (i.e., the price received by the farmer, less transportation charges, for that portion of milk used in the production of butter which he sells), four sources of data are employed:

(1) The price paid for milk which goes to butter plants. (This data is published by Federal Orders for individual markets. Some markets produce a high proportion of butter, while others produce very little. Therefore, the average derived from the Federal Order data is weighted by share of butter production per market.)

(2) The average price for non-Federal Order milk which goes into butter production. (A figure provided by the Statistical Research Service.) Non-Federal Order data is published as an aggregate, i.e., not providing an individual market breakdown. (This non-Federal Order figure is necessary since approximately half of all butter production is manufactured from milk not marketed under the Federal Order system.) An average derived from data sources (1) and (2) is a figure representing the price of almost all milk which goes into butter production.

(3) A value ratio is applied to the cost of milk to the processor. In order to determine the value of butterfat, wholesale prices are used. The amount of butter produced from a hundredweight of milk is fairly constant, only needing adjustment as the butterfat content of fluid milk goes down. USDA calculates the current butter production per hundredweight of milk at 4.48 pounds. That figure multiplied by the wholesale price of butter, determines the wholesale value of butterfat per hundredweight of milk. The wholesale value of non-solid contents is similarly determined. The relationship between these two wholesale figures establishes the required ratio.21

(4) The farm value of butterfat is the last data input. To arrive at this figure, it only remains to subtract the expense of transportation from production point to processing point. (This charge is determined from the survey conducted to determine hauling charges for fluid milk.) Specific data concerning butter was requested from both producers and processors. Milk used for butter production is generally transported shorter distances.

To illustrate: let us say that the wholesale value of the butter produced from a hundredweight of milk is 45 percent of the wholesale value of all commodities produced from that hundredweight. The 45 percent of the price paid, by the processor to the producer, for the milk is considered the price of butterfat.