Pricing and Policy Problems in the Northeast Fluid Milk Industry

Agricultural and Resource Economics Review,  Oct 2006  by Cotterill, Ronald W

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This article documents the need for reform of milk pricing in the Northeast. The New York price gouging law can be recast as a fair share law. This new milk policy "kills two birds with one stone." It corrects regional inequities in raw milk pricing by reforming the pricing of milk at retail by limiting and redistributing excessive retail margins to farmers and consumers. The fair share policy relieves allocative price inefficiency, improves the performance of the federal milk market order pool, and improves the general performance of the Northeast dairy farming and fluid milk industries.

Key Words: market power, bargaining, over-order premiums, fair share pricing

For dairy farming in any region of the United States, and especially the Northeast, the core of the sustainability issue is regional differences in cost of production and prices received for raw milk. Consumers are always going to drink milk and consume manufactured dairy products. A critical question is where will that milk be produced? This paper will not address regional cost of production differences.1 Rather it focuses on regional price differences, which have been ignored since the demise of the Northeast Dairy Compact in 2001. Moreover, the regional impacts of federal, regional, and state polices, and the performance of the Northeast fluid milk marketing channel, are critical determinants of the prices that Northeast farmers receive. I will critique the operation of federal milk market orders, document the demise of competition in fluid milk pricing among supermarket chains in the Northeast, and analyze two state-level fluid channel pricing policies that can improve price performance. The first is the New York price gouging law that primarily benefits consumers. The second is a new and as yet untried policy, a fair share approach that appropriates part of retailers' margins for payment back to farmers. This second policy can be fine-tuned to reduce retail milk prices as well. It also reinvigorates federal milk market classified pricing, which has been weakened by the increasing market power of supermarket chains in the Northeast.

Regional Farm Milk Price Differences

Let's start with the issue of farm-level milk prices in different parts of the United States. As part of the federal market order consolidation process that culminated with the establishment of eleven market orders in January of 2000, Cornell University researchers analyzed the location of milk production and milk processing plants for cheese, butter, cultured products, and fluid products throughout the United States (Pratt et al. 1998). Their basic result imitates work done by milk marketing economists on pricing in milk sheds before the advent of federal milk market orders (e.g., Cassels 1937). If there were no federal milk marketing policies and milk were allowed to move in an "open market" throughout the country, farmers would have different prices for raw milk throughout the United States.

This basic result comes from the fact that fluid milk, when compared to cream, butter, and cheese, is bulky, and therefore there is an economic advantage to producing it close to its consumption point. Working in 1934, Cassels explained the pricing and location of the production of milk for use as fluid, cream, or butter.

The cost of shipping a given quantity of milk in fluid form being greater than the cost of shipping its equivalent in the form of cream, it will naturally be shipped from points nearer to the market than those from which cream is shipped. Similarly, since the cost of shipping cream is greater than the cost of shipping its equivalent in the form of butter (or some other manufactured product), it will tend to come from a zone nearer the market than that from which the butter comes. Suppose that the cost per mile of shipping 100 pounds of milk is one cent and the cost of shipping its equivalent in the form of cream is 1/10 of a cent and its equivalent in the form of butter is 1/40 of a cent....If the prices for the three commodities (in this sense) f.o.b. city were the same, then at all points in the surrounding territory the farmers would obtain their best returns from milk used in the manufacture of butter and none would be available for shipment as either fluid milk or cream. In order that cream may be obtained, its city price must be higher than that being paid for butter, and in order that fluid milk may be obtained, its price must be higher than the price being paid for cream. The differences in the transportation rates will determine the distances from the market at which it will become more profitable to ship cream than milk and at which it will become more profitable to ship butter than cream [Cassels 1937, pp. 20-21].

Note that the technical properties of different dairy products and transportation cost differences dictate that fluid milk will be highest priced and produced closest to the consumption point. This result is not the product of federal milk market orders. What federal orders do is pool proceeds from the sale of all types of products and pay a blended price to farmers. The blend price paid to a particular farm depends on its distance from a consumption point, e.g., Boston. Orders ensure equitable treatment for farmers, i.e., their mailbox price does not depend on how their milk is used (fluid, cream, cheese, butter). Pooling removes the opportunity for milk assemblers/processors to chisel down higher value product prices by threatening to switch to farmers who sell at lower prices for cheese or butter.2