Fixing the Right Problem the Right Way

April 01,2015
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You don’t have to be a craftsman to understand the adage that when the only tool you have is a hammer, every problem looks like a nail. This type of reductionist thinking can affect many businesses, not just carpentry, but whenever such a thought process is applied, it distracts people from actually solving issues because their attention is focused on the wrong problem – and hence, the wrong solution.

A recent case in point is critical comments from some quarters regarding the venerable Federal Milk Marketing Order system. Clearly, the system isn’t perfect, and in fact, is in need of some change. However, we have to be very careful when evaluating any fixes that we don’t take a hammer to FMMOs when they are not the real source of the problem some want to repair.

One of the periodic concerns we’ve heard from dairy processors, particularly in the past year, is that the industry has experienced more price volatility in recent years. Markets at home and abroad have been seemingly moving more quickly, and less predictably, than ever before. In the case of 2014, farm-level milk prices reached levels never before seen. For dairy buyers, a $25 per hundredweight all-milk price last year was a tough pill to swallow. Of course, when prices are much lower, as they were in 2012 and are again in 2015, it’s the farmers who have reason to complain.

The truth is that last year’s high prices were not unique to the U.S., and certainly were not due to the federal milk order system. With over 15 percent of U.S. milk production now moving into world markets, we all recognize that our industry is more fully integrated with the world dairy trading system. The weather in New Zealand affects milk production there, and their problems can push up milk prices elsewhere around the world. Chinese demand has the same effect. Meanwhile, terrific weather last year in our Corn Belt affected global grain prices by pushing them down.

Any potential changes to Federal Orders are not going to magically wipe away the prospect of global and unpredictable price movements. Since dairy is by its nature a relatively price inelastic product, minor swings in production and consumption can create big swings in price. It is important to recognize that reality, because as we sell more into the world market, this will be the norm in the future.

The fact is that monthly-announced classified pricing actually sands off some of the rough edges of price volatility. While cash commodity markets, and the futures markets for Class III and IV prices, trade daily, the Federal Order price minimums change only monthly. That actually acts as a modifier of erratic, shorter-term price changes. While the monthly NASS-based price formulas woven into FMMOs have their own set of issues that need addressing, price volatility could actually accelerate in the absence of a monthly price formula calculation.

One of the ironies of all this discussion right now is that California’s dairy farmers are seeking to replace their state marketing system with the federal one. Dissatisfied with what many see as the state’s failure to update its program to address pricing imbalances, several farmer-owned cooperatives in California are now petitioning to create a Federal Order for their members. That’s a strong signal to me that Federal Orders are a relevant, and necessary, dairy policy mechanism in the 21st century.

The key issue with any policy is to continue monitoring and evolving it to keep up with changing conditions. We certainly see a need to reassess the issue of make allowances and end product price formulas, for example. They were included in the FMMO reform package in the late 1990s as a replacement for the old Minnesota-Wisconsin milk price, and haven’t been updated. And there are other changes also worth considering.

But let's be clear: at its core, the Federal Order system is designed to ensure orderly marketing and protect dairy farmers from predatory pricing practices. Some dairy companies believe that reform is about ending the system, not mending it, and in the process providing farmers a smaller share of the consumer’s dairy dollar – a share that has been shrinking over time. That's a non-starter for us. Our focus will be on reforms needed to strengthen – not weaken – Federal Orders so they continue to achieve their objective of benefiting producers and consumers by establishing and maintaining orderly marketing conditions.

Price volatility is a challenge for dairy farmers and processors alike. However, Federal Orders don’t create that volatility – market forces of supply and demand do. Thus, going after FMMOs with a hammer is not going to improve, or change in any meaningful way, the pricing pendulum. There are risk management tools available to help manage volatility. Let’s not use a hammer when the job at hand calls for a wrench.