What would happen if Federal Milk Marketing Orders’ minimum price provisions were eliminated? Would it increase returns to dairy farmers? And even if it did, would it wreak too much havoc in the industry to be worth trying?
Ted, T3 and Anna dive into what might be The Milk Check’s most controversial conversation yet.
Anna: Welcome to The Milk Check, a podcast from T.C. Jacoby & Co., where we share market analysis and insights with dairy farmers in mind. The topic of Federal Order Reform is never far from our minds. Whether it’s a conversation on The Milk Check or a chat around the office, we talk about it all the time.
Do minimum price provisions still make sense? What would happen if we got rid of them? Would conditions on dairy farms change for the better? Or is Federal Order reform of this sort not worth the chaos it would likely cause?
Ted: What’s the objective of Federal Order Reform? From the dairy farmer standpoint and from the industry standpoint, from my perspective, the objective is to increase the price to the dairyman. The objective…
T3: We’re not talking about what the objective was 90 years ago when it was started.
Ted: Well, be it…
T3: But what it would be to change what we have now into something else.
Ted: Ninety years ago, it was started to monitor the veracity involved in weights and tests in butterfat and protein—well, we didn’t even have protein. We had butterfat and skim. And the perception in the ’20s and early ’30s was that everybody was cheating the dairy farmer on butterfat tests. And so they requested a Federal Order that monitored the tests. Eight or ten years later, it morphed into a price mechanism. And over the years, we’ve had classified pricing. So now we have basically two regulatory systems. And you have the Capper-Volstead Act, which allows dairymen to band together, similar to a labor union and bargain collectively. And then you have a regulatory system, which allows cooperatives to pay less than the mandated price, or the minimum price under the Federal Order into a pool plant. You have two regulatory issues involved here. You have collective bargaining, and the second issue is the classified pricing system, which prices fluid milk at one price, and yogurt and cottage cheese, and whips and dips at another, ice cream. And then you have the cheese at one price and you have butter / powder at another price. In order to participate in the classified pricing system, you have to participate in the regulatory system.
T3: But there’s not a rule that says you have to.
Ted: You can go unregulated if you want, unless you’re a bottling plant. If you distribute milk, quote-unquote, in the marketing area, in the defined marketing area, by law, you are going to be a pool plant. There are certain percentages involved that by law, you have no choice, you’re gonna be a pool plant. And anyone who sells milk into that pool plant is gonna be qualified. And it’s against the law to sell milk into that pool plant at less than the minimum price under the order.
T3: And the pool plant would basically be a plant that’s bottling milk that is sold as fluid milk at a store, gallon of milk, or a quart of milk, or whatever.
Ted: No, that’s the distributing plant.
Ted: A pool plant can be anything, it can be a silo down at the end of the string of silos, it can be a whole plant, it can be anything that you wanna make it. It depends on how you pipe it and how it’s approved by the regulatory system. The distributing plant is a bottling plant that distributes milk in the marketing area.
T3: And a pool plant can really be any plant that is also participating in the federal order.
Ted: Right, you could have a bank of silos that’s a half a mile long, and one silo down at the end and that’s a pool plant and the rest of it is unregulated.
T3: And there’s a lot of cheese plants and powder plants that are essentially set up that way.
Ted: Essentially yes, because the minimum price requirements are very seldom enforced for manufacturing plants. But most of them are set up just in case they have a pool facility at some point in their operation that’s piped correctly. Nothing wrong with it. I mean, it’s just the way it is and technically at least, even if the milk goes into that facility, the minimum price is defined at the regulated price at that location minus the freight and that is the regulated price of the dairyman. So if a proprietary handler carries his own milk supply, he has to pay his suppliers, his dairymen who sell him milk, the minimum price under the order where the dairyman pays the freight to get into the plant.
Now, in distributing plants, let’s call them distributing plants, you can call them bottling plants, the two are the same, you have a high volatility of production, you have sales, you bite off contracts, you have weather phenomena, a hurricane moving into the Southeast, for example, will cause a surge in requirements for milk. And then the minute the hurricane leaves, all of a sudden, nobody wants nothing. And you got to get rid of all that milk. So proprietaries are at a severe disadvantage in handling their own milk supply with their own producers, because they have to pay that minimum price. Which means basically, if they do their own balancing, they gotta pick up the tab. It’s always been expensive. But lately, it’s really gotten expensive, because the hauling costs have gone through the roof. And so balancing is a big, big issue. And for the last two or three years, particularly, we have seen that as milk have moved from one area to another area at huge discounts with the supplier paying the hauling for the privilege of getting it there.
T3: So let’s say you have a distributing plant in Atlanta, Georgia, they have to pay at least the minimum of price under the order for the milk. But maybe they’ll only buy the milk Monday through Thursday. But the cows give milk every day. And so Friday, Saturday and Sunday, now you have to get rid of that milk. Well, if the distributing plant got rid of that milk, they’d still have to pay for it into the minimum price into the order. And then they’d have to ship it to a non-distributing plant, let’s say a Class III plant, which would be shipping it all the way to Wisconsin, maybe they don’t need to go that far. But they need to ship it a long way which could cost them $3 or $4 a hundredweight.
Ted: I could ship it across the street. But if the guy doesn’t wanna pay the minimum price, he might wanna pay $5 under.
T3: So essentially the cost could be $3, $4, $5 a hundredweight…
Ted: Or more.
T3: Or more. As a result, that cost of balancing is become so cost prohibitive that distributing plants will always have contracts with a cooperative to buy only the milk they need when they need it. So that the cooperative has to handle the balancing. Because under the Capper-Volstead Act, the cooperative is allowed to sell that milk under the minimum price under the order.
Ted: The Capper-Volstead Act allows for collective bargaining. The Federal Order system provides for the minimum price under the order. And the cooperative can do what’s called check off. It can check off the balancing costs from the collection of producers that it has. It may have one small customer that it’s servicing that kicks its milk back on Saturday and Sunday, for example, or whenever. And then that is re-blended among the whole milk supply that that cooperative controls. The customers of that cooperative pick up the tab. And that’s an accepted phenomena under the current rules and regulation. And that’s the reason that 95% of the milk or thereabouts, 90-something percent of the milk of the United States is cooperative. Now, cooperatives perform a valuable service in this regard with regard to servicing the market. And then, of course, under the Capper-Volstead Act, they agencies in common, where they can set prices to multiple customers in the same marketing area. And then they, in effect, undertake the balancing responsibility for that marketing area.
T3: And that balancing responsibility can often mean losing $2, $3, $4 a hundredweight to move that milk elsewhere rather than into the distribution plant.
Ted: It could move that or even more. But the minimum price under the order supports the cooperative supplying the area and it supports the construction of marketing agencies in common. Let’s call them that. We also call them superpools, okay, where you sell in a designated area, cooperatives band together and set a price. Now, there’s a lot of practical reasons for that under the current rules. And the reason that that is practical is the minimum price provision under the order that keeps the proprietary customer from maintaining his own milk supply.
My contention is that given where we are right now, if you accept the premise that competition for the milk at the farm is what increases returns to the producer, then you need to put the fluid distributing plant in the game, and allow him to carry his own milk supply. It doesn’t mean he can’t negotiate with a co-op. But what it means is is he can carry his own milk supply and then he can afford to re-blend based on what the cost of his balancing issues are. And he can afford then to go out in the field and be competitive with other handlers in the field, including cooperatives. I would support that argument by saying that if you note who has the highest mailbox prices in the country, sometimes it’s Florida, because they have a very encapsulated system down there, which is generally just fluid and a little bit of Class II. But a lot of times it’s Wisconsin, why? Wisconsin has the lowest minimum price under the order. But they also have everybody competing for the milk.
So as a result, instead of, even under the surplus we’ve had for the last three or four years, all the handlers up in Wisconsin, all the plants who had their own milk supply paid a premium to their producers. They bought milk from out of the area and paid huge discounts, bought it at huge discounts. But they kept their own producers intact and paid those own producers a premium. If you eliminate the minimum price under the order, what in effect you would do is put bottling plants in competition with cheese plants and butter powder plants for premiums. If the bottling plant loses business, and he has to drop the price to his producers, the producers have the option of leaving that plant and going to someone else, perhaps a cheese plant or whatever. In my perspective, it does not mean that you change the qualification provisions. I can see where it might result in a reduction in PPDs under that scenario. But the PPDs in some areas have become superfluous anyway. The PPDs are through the roof, but then the check-offs are three and four times the PPD.
So it becomes basically a dance that everybody does, they have this superpool price into the agency. It’s terrific, it looks great. But when it comes time to pay the dairymen, often they get checked off $3 or $4 a hundredweight at certain times of the year. So if the minimum price provision wasn’t there, you would have people competing to pool the milk and putting it in at an agreed price, obviously, it would be lower than an agency mandated price. But at the same time, you would have more competition for the milk out in the field, which would wind up with more money, in my view, in most areas, not all areas because some…the manufacturing plants in some areas have been driven out of business. But in a lot of areas where you have manufacturing, the premium for manufacturing will compete with the premium for a distributing plant. And the dairyman will be the beneficiary.
Anna: But if you’re reducing the price so that the Class I plant doesn’t have to pay that…
Ted: It does not. If you eliminate the minimum price under the order, you pay whatever you agree to.
T3: But at the same time, what it also means, this, I think, is where you’re going, is now the distributing plant has to handle their own balancing.
Ted: Doesn’t have to but they could.
T3: And they have options now that they wouldn’t have had before. For example, one thing that a distributing plant could do is in order to fill up some of the excess capacity in their plant, they could have a big sale for milk. And let’s say they discount the milk by $2 a hundredweight and pass that savings on to the supermarket, but it would have cost them $3 or $4 a hundredweight to ship that milk all the way to Wisconsin and wherever else they would have had to ship it to. And in today’s rules, they basically can’t do that.
Ted: Let me take it one step further. Suppose you’re selling to a chain store who are becoming bigger factors in the market these days. If the chain store is faced with the option of shipping the milk somewhere and getting it delivered at $5 under or discounting it and having a $0.99 sale over the weekend at his store. That’s an option that’s to the benefit of everybody because it puts milk on the grocery store shelf where customers can get it. Right now that’s a big problem. We’re losing market share. We’re losing market share because of our antiquated price provisions. We’re losing it to almond milk, for example, that has absolutely no nutritional value, we’re losing it to oat milk, which has only a little bit more than almond milk. And here the dairy industry is losing this market share. It doesn’t take a rocket science for someone who wants to market veggie milk to sit down and figure what the cost is gonna be under the current regulatory system. And what his product is gonna cost on the grocery store shelf to be competitive with it. It doesn’t take a rocket science to do that.
So you can throw a grenade in the room, if you will, by saying your grocery store, if he has his own producers and he’s not moving as much milk as he wants to take care of his own producer, he either moves the milk somewhere else or he has to drop producers. Or he has a sale at his store, which adds to the difficulty of the competition to compete with fluid milk. Plus, it puts more milk on the cereal in the morning when the price is cheaper for kids going to school and so on. It provides much more flexibility than the current system provides for. And my argument is that all these things will result in more money to the dairyman. More money to the dairyman as opposed to the current agency in common type system that we have.
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T3: So I can’t help but feel that the next question that needs to be asked is if we don’t have a minimum price on the order, why do we need an order at all?
Ted: Well, that’s a good question. I regard the classified pricing system as an advantage. An advantage on marketing, domestically and internationally. You have different returns that vary for your manufacturing alternatives. You have cheese markets on one side, you have butter powder markets on another side, you have yogurt markets, and ice cream markets on another side. And these markets change, you might have $2 or $3 a hundredweight difference between the butter powder market and the cheese market one way or the other. The dairyman or, pardon me, the manufacturer who’s sitting there running a manufacturing plant with his own producers. If he’s making cheese, and the butter powder return is $3 a hundredweight better at a given point in time, he’s gonna have a problem paying his producers a competitive price. You still have an effect, a market effect.
T3: But isn’t it better for the producer, if that milk would go to the butter powder plant where the value is $3 a hundredweight higher?
Ted: No, not if it’s pooled. If you keep the classified pricing system, it would be pooled. There might be an advantage because the markets change and the margins change with it. But by the same token, the classified pricing system, it doesn’t eliminate the difference, but it, let’s just say it ameliorates it a little bit. So that you wind up with a cushion between the various alternatives that allow manufacturers to invest only in cheese facilities and not having to invest in cheese facilities as well as butter powder facilities. So there’s hundreds of millions of dollars involved in that in terms of capitalization and in terms of the industry as a whole. If the industry had to go out and invest in butter powder facilities as an alternative, to protect themselves against the juxtaposition of varying prices, it would cost the industry billions, billions of dollars.
T3: So I can’t argue with that, the pooling in the federal order system helps reduce the total capital needs of the industry as a whole. But to me, it would still seem that it would benefit the dairy farmer best if there was always an incentive for the milk to go where it would receive the highest return. So for example, if the Class IV price was $3 above the Class III price, you would want every Class IV plant in the neighborhood to be maxed out instead of the Class III plants. And in the practical experience, I think we both know that that doesn’t always happen. In fact, at times the opposite happens.
Anna: Well, from our perspective, when we’re moving everything, the question is who has room for it on the days that I have it? Where’s the hauling the cheapest? When we’re picking a plant to send milk to, we don’t care what they’re making.
T3: Right. But if I’m the dairy farmer, and I’m looking at the utilization under that particular order, I would want, under the scenario I’m talking about, the most utilization possible in Class IV because that’s where the highest price is and Class IV is the class that month that would actually pull the blend price up, and therefore pull the minimum price for the order up.
Anna: I would say in general, that’s true. But depending on what your plants are, and who’s pooling it and everything else, if you can de-pool that, if that volume can get pulled off, it’s not gonna change the price. It doesn’t help. Especially if it’s II, you know…?
Ted: In the real world, the hot alternative, if it happens to be cheese or butter powder, the hot alternative will reach out for milk, because of the marginal profit possibilities that are associated with moving it into a hot market. So the marketplace does actually move the milk from the lower return to the higher return under the classified pricing system. But remember, you have contracts with producers, they’re not leaving and coming and going on a daily basis. They’re contracted, usually for a year with an anniversary date or something. And they’re obligated to go to a plan, which they like and which they have a relationship with and so on. So they don’t go jumping around from one day to another based on what’s the best return, butter powder or cheese. Which is another reason why the comfort of the classified pricing system is nice.
Now in Europe, they don’t have the regulatory system in the same way that we do. Most of the plants there are multipurpose plants, where they can react to different market possibilities, I view the minimum price into the order as the problem right now. It’s why we had the big surplus, why we have big check-offs in certain regions of the country, multi-dollar check-offs that wind up coming out of the dairyman’s pocket. Whereas if you get rid of those minimum price provisions, you put the distributing plants in a competitive environment with cheese plants and butter powder plants and so on. And competition for the milk will maximize the return to the dairyman based on whatever the markets are. If the markets are good, the dairyman will benefit, if the markets are bad, he’ll have same problem he has right now. When you have poor markets, you have poor markets.
Anna: The only way that argument makes sense to me is if the assumption that people will buy more milk if it’s cheaper is true. And I don’t think that that’s true.
Ted: Well, you sound like a cooperative, that philosophy has been there for 80 years. They think that milk is inelastic. I argue that milk is not inelastic. And then if you wanna be competitive with almond milk, or ersatz and veggie milks, and so on, you can’t tie your milk into a classified price that’s predictable for the next five years.
Anna: But I don’t think anyone’s buying almond milk because it’s cheaper.
Ted: I think they are.
Anna: I would disagree. I think most people that are buying that are buying it because they believe that it will be healthier for some reason or they’re lactose intolerant or, I mean, it’s not taste in my opinion.
T3: Well, I think there is a false belief out there with a substantial portion of the population that some of these ersatz milks are actually healthier for them than dairy milk. We are of the opinion, I think correctly, that that just isn’t true.
Anna: I think that’s part of it. I think part of it is just habits changing. You know, we’ve talked about this before, but I think, you know, grains being vilified, you know, cereals being vilified has more to do with the decrease then because almond’s cheaper, almond milk is cheaper.
Ted: The decrease in cereal consumption is a very real part of the problem, I agree with that.
Ted: But let’s face it, our marketing of dairy products, not only bottled milk, but across the board. Kraft Foods is no longer carrying the ball on marketing. They still market certain products that they have. And they, of course, do a good job on advertising nationally, even internationally and so on. But the dairy industry has got a lot of catching up to do on how they market their product. And consider the brand value of all those products on the grocery store shelf, 50% of the value of that product is the brand. And the dairyman winds up at 20%, 25% of the value. We’re gonna have to get their marketing squared away. And I think also minimum price provisions make it much more difficult to market.
Anna: I think if you didn’t have so many cooperatives, that might be more true because so much of it is cooperative milk. I don’t know how much that really inhibits anything.
Ted: Let’s think about that a minute. First of all, you have cooperatives who do an excellent job of marketing. But also there’s a lot of cooperatives that only bargain. And they’re just horrible at marketing, when they get a retail product, it shows up and it’s unattractive and it’s not marketed properly. They bargain with an ever shrinking group of customers that markets to the grocery store. I think changing the system in this regard would make a big difference. It would force the cooperatives to spend more time marketing their products and their retail products more aggressively. And it would also wind up, some of that 50% brand value in the cooperatives’ pocket, which then winds up in their dairyman’s pocket. Where right now it’s not. You know, you can’t be too categorical, because you do have some excellent marketing cooperatives. But as a general rule, the cooperatives are more interested in collective bargaining than they are marketing.
T3: You’re suggesting that getting rid of the minimum price that a bottling plant would pay for milk would actually, even though it’s counterintuitive, lead to a higher price that the farmer would see for their milk. Because the reality is today, even though there is a “minimum price,” there are costs that are outside that pricing mechanism that are passed down to the dairy farmer anyway. And so the reality is that even though there’s a minimum price under the order, the dairy farmer can be paid well under that minimum price. And so the minimum price is actually kind of pointless today. If you get rid of it, all you’ll really do is put more competitors into the marketplace for the dairy farmers’ milk. Most people on the surface would maybe argue that that’s not true that you’re actually lowering the price that a bottling plant would pay for the milk. But the flip side is also true that you’re also moving around where the costs are incurred. And so you put more costs in the form of balancing on the distributing plants’ and bottling plants’ plate. And so even though they may pay less for the milk, they bear more of the costs, and therefore less of those costs are passed down to the dairy farmer, ultimately.
Ted: They’ve got more options to get rid of the milk, if they had surplus. The cooperative can shuffle it down to the nearest butter powder plant or cheese plant to get rid of it. The distributing plant can run a sale. He can do a lot of things with regard to the balancing. He can vary his production schedule. If there’s an advantage, a cost advantage to jimmying that schedule and that’d be more convenient from the standpoint of disposing of the available milk supply, that can be done. So there’s a lot of options there that aren’t being taken advantage of today. And also, I would point out that Class I sales are declining at 1.5% to 2% per year.
T3: By the way, it was 4% the last quarter.
Ted: Yeah, well, let’s hope it winds up being 1.5%, 2% for the year instead of 4% for the year. And this is a big problem also. So locking yourself into a price under that kind of a scenario, you know, talk about counterintuitive.
T3: Yeah, you need the flexibility to truly compete with your competitors. And right now, we are losing that war.
Ted: We’re losing market share to veggie milks. But we’re also losing market share to the customer because we’re not doing a good job of marketing.
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T3: Anna, what are you thinking?
Anna: Well, he talked about check-offs. And the two biggest pieces of that are always hauling and premiums. When anybody has those things that come out of their check. And I can see how you arguing that if you have more milk that’s going, you know, on a shelf getting sold at 99 cents, if that reduces how much balancing is out there, how much moving it around and shipping it around that that would improve the price. But again, I only think that works if people actually buy more milk, if people actually drink more milk. And…
Ted: There’s been an argument for decades, multiple decades that milk pricing is inelastic and price doesn’t mean anything. I disagree with that. You know, and I’m sure if you go to a lot of dairy economists, they will disagree with me.
Anna: I think that it’s possible. But it does take, I mean, I’ve said for a long time it takes that marketing push, it really takes the advertising and everything else that has to come first, it won’t just be reducing that price and giving them a break on the minimum price. So if you did that, though, would you leave everything else intact, qualification and all that?
Ted: Yes, I would.
Anna: All that would stay the same?
Ted: I’d leave it there. And then depending on how much the PPD was, then the various handlers could decide whether or not they wanna ship a portion of their milk into distributing plants to maintain qualification standards.
Anna: So your pool distributing plant would still be responsible for their portion over the Class III price, the PPD, into the pool, they would still be responsible for that?
Ted: That’s the way I envision it, yes.
Anna: They just wouldn’t have to pay their own proprietary producers the minimum price.
Ted: Well, they could buy the milk whatever price they want for qualification. Let’s say we wanna qualify milk, where, right now, we have August through November qualification period. And let’s say it’s a long year, gee, I got to put that milk in there at 25 cents under to maintain qualification standards. We could do that, no minimum price. He could buy at whatever he can get away with.
Anna: You could do that. I think that actually would hurt the producers. I think your better option in that case would be to change the qualification provisions in each order. Because right now, I mean, even in Order 33, we’re working pretty extensively. Most of those plants don’t need, or haven’t needed for the past few years, the amount of milk that they would have to take in to get everyone in that order qualified and they’ve done it anyways. That’s a loser for everyone. The hauling’s expensive, everything about it is rough. I mean…
Ted: If it’s not cost effective, don’t do it.
Anna: Well, that’s why I’m saying. To me, changing the qualification provisions makes more sense than giving them the opportunity at a cheaper price.
T3: What if you got rid of the minimum price into the order, and at the same time actually tightened up the qualification provisions? I mean, what you’d actually do is force more farmers out of the order, but probably in a way that doesn’t necessarily hurt those dairy farmers.
Ted: I don’t think so. I think you’d have a negative effect. When you tighten the qualification provisions, basically, it adds a burden to the manufacturing facility.
T3: In what way?
Anna: That works against the entire point of the Federal Order system.
Ted: That’s how we got rid of all the manufacturing plants in the Southeast over the last 40, 50 years is because we tightened up the qualification to such an extent nobody could live with it. So as a result, you wound up with the cooperatives having all the milk, they could do the re-blending and doing the check-off for the producers and so on. The manufacturing facility couldn’t so there are no manufacturing facilities of note today in the Southeast. And there’s none with their own milk supply.
T3: But many would argue that the real reason there’s a lot less milk in the Southeast is because the weather of the Southeast is just not the right kind of weather.
Ted: Cost of production’s higher.
Ted: No doubt. No doubt, it is. However, certain products, depending on what kind of a premium they have to pay for their milk, certain products could be produced there. Fifty years ago, we had a vibrant manufacturing sector in the Southeast, vibrant. It was big time. Kentucky and Tennessee and the Western Carolinas, North Georgia and so on. Alabama, and Mississippi. All those plants had significant manufacturing. And it’s all gone today primarily because they tightened the qualification provisions up in order to eliminate the manufacturing plants and force the milk into the bottling plants. So no, I don’t agree that you ought to make the qualification provisions onerous. There probably needs to be some work done as to what’s the right level of difficulty. But I think depending on what the PPD is and so on, then you have to make a decision as to whether you wanna compete for qualification or not. And if you don’t, you don’t, you don’t have to. Keep in mind that a lot of milk up in Wisconsin, where the PPD is relatively low, people decide whether they wanna qualify or whether they don’t. And they put the pencil to it and decide based on pennies whether it’s useful to qualify an Order 30 or Order 32.
So they make that decision. I’ve come up with this thought because the other option is just get rid of the whole damn thing. And that’s sort of like Brexit, you know, where you got a cold shower of adjustment to the fact that you have these competing values, and you’ve got the responsibility to dairy farmers and so on. And we’ve had this qualification system for so many years that if you throw the whole thing out, you could wind up with a mess that would last for several years before it gets cleaned up.
Anna: I think it would be a big mess. But I think that one of the things that people keep trying to do is change it without figuring out what the motive is for changing it except for that they know it doesn’t work. Because…
Ted: Go back to your objective, what’s the objective?
Anna: Yeah, because the objective before was to make sure that you had manufacturing around for when the Class I plants didn’t need it. And to make sure that the producers had a place to go so they didn’t end up with no home and go out of business over the summer when school is out. That’s not the motive anymore.
Ted: That’s right. The objective has to be to improve the price of the dairyman.
Ted: There’s all sorts of platitudes that we hear. Orderly marketing conditions and so on, you know, as if this is some sort of a panacea that we’re all searching for, orderly marketing conditions. You know, I don’t believe in that and never have. I sort of like disorderly marketing conditions where basically markets are established. That’s what markets are for, is to move milk from disposition A to disposition B.
Ted: There is no such thing as orderly marketing conditions that are to the advantage of anybody.
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