Updating Make Allowances is Central to the Future of Federal Milk Marketing Orders

Key Points

• Make allowances – an estimate of dairy processors’ cost of converting milk into commodity dairy products and reflect the farmer’s basis to bring their product to market – are an important part of Federal Milk Marketing Orders’ pricing formulas.
• Established at fixed rates, make allowances for cheddar-type cheese, butter, dried whey, and nonfat dry milk were last updated in 2008, making this a central topic for FMMO reform in the 2023 Farm Bill.
• Costs for labor and utilities like electricity and natural gas typically account for at least a third to half of the total cost of production for dairy processors, or handlers, excluding cost of raw materials.
• From 2006 to 2021, labor costs in dairy product manufacturing climbed 48% per unit of production, according to the U.S. Bureau of Labor Statistics. From 2006 to 2022, the industrial rate prices for electricity rose 64%. Natural gas prices fell 11% but were more volatile. Breakeven costs can also vary widely from high-cost to low-cost dairy manufacturers.
• Outdated make allowances send inaccurate price signals to the marketplace, resulting in a misallocation of capital and resources that could cost farmers the market access they need to grow.

Why do make allowances need to be updated?

Federal Milk Marketing Orders (FMMOs) establish the minimum prices that regulated processors must pay for farm milk. FMMO formulas use wholesale prices of four dairy commodities – cheddar type cheese, dried whey powder, butter, and nonfat dry milk – to set minimum prices that reflect supply and demand conditions in dairy markets. These wholesale prices also help determine what processors can reasonably afford to pay for milk given the revenue they receive from selling those commodity products. That estimate of manufacturing costs is called the “make allowance.” Getting make allowances right is important to pricing because if the allowances for making these four products is set too high, the minimum prices for milk will be set too low, to the detriment of farmers. If the allowances are set too low, then the minimum prices are higher than what the processor can afford given their output prices.

Make allowances were last updated in 2008 and were based on data from as far back as 2006. With research showing that these 17-year-old estimates are no longer consistent with current costs, make allowances are among several important areas in FMMOs that dairy farmers and handlers widely agree should be addressed in the 2023 Farm Bill.

Not adequately updating make allowances in the pricing formulas for cheddar cheese, dry whey, butter, and nonfat dry milk, which are used to establish Class III and Class IV regulated milk prices, could negatively impact both handlers and farmers.

The first effect of increasing make allowances to reflect higher actual costs of manufacturing would be to lower all Class prices, and ultimately the minimum blend price that is paid to the farmer. However, asking processors to pay more than what they can reasonably afford carries longer-term negative consequences, including the risk of missing sales opportunities in a rising market and losing market access over time. Inadequate make allowances may lead to underinvestment in processing facilities or result in overinvestment in low-cost plants, thereby limiting market access and allowing international export competitors to meet rising global demand for high-value dairy products. However, make allowances are not meant to guarantee profit for handlers or represent their full cost of goods sold.

Dairy manufacturing costs are rising

Aside from milk and other milk components, which are the highest input cost for dairy product manufacturers, plants also spend money on depreciation, interest, labor, energy, packaging, transportation, administration, and other inputs to create finished products. Combined costs of labor and utilities like energy account for at least a third to half of the total production costs for dairy manufacturers, based on published research.

While current make allowances in FMMOs have remained constant since they were implemented in 2008, the industrial rate prices for electricity rose 64% from 2006 to 2022, according to U.S. Bureau of Labor Statistics (BLS). Natural gas prices fell 11% but were highly volatile. Labor costs in dairy product manufacturing climbed 48% per unit of production from 2006 to 2021, according to BLS.

Breakeven costs of production for dairy manufacturers also vary widely across the country, with high-cost manufacturers of commodity dairy products often having as much as twice the break-even cost of production compared to low-cost manufacturers.

Labor costs are particularly variable among handlers. Larger future plants will have greater automation and lower labor costs, while smaller or older plants will have higher costs. As new plants continue to benefit from labor-saving technologies and improved productivity that will help offset rising input costs, the difference in production costs between high-cost and low-cost manufacturers is expected to widen over time.

Cost structures among handlers will continue to change over time, requiring future adjustments in make allowances. While updating make allowances does not guarantee more investment in new processing assets with every handler, not updating them may result in lost growth opportunities for the dairy industry over the long term.

References

• Mark Stephenson, PhD., “Cost of Processing in Cheese, Whey, Butter and Nonfat Dry Milk Plants,” December, 2021
• Mark Stephenson, PhD., “Cost of Processing in Cheese, Whey, Butter and Nonfat Dry Milk Plants,” September 1, 2006
• Ken Bailey, PhD., “Marketing and Pricing of Milk and Dairy Products in the United States”
• International Dairy Foods Association, "Federal Milk Marketing Orders"
• International Dairy Foods Association, "Modernizing U.S. Milk Pricing"
• Congressional Research Service, "Federal Milk Marketing Orders"
• National Milk Producers Federation, "NMPF Unanimously Endorses Marketing Order"
• Wisconsin Cheese Makers Association, "WCMA Board of Directors Approves Reform Concepts for Federal Milk Orders"
• Edge Dairy Farmer Cooperative, "Milk Pricing Reform Priorities"