The dairy producer feels like they’re between a rock and a hard place as premiums remain low while feed and shipping costs keep going up.
“So, what do we do about it,” T2 asks on this edition of The Milk Check, a two-part deep dive into what the industry can do to get more money on milk checks.
In part one, we discuss how the fierce competition for labor in rural areas has reduced hauling and processing capabilities, decreasing the demand for milk while the cost of feeding the nation’s large herd remains high.
Can rich Class III prices make up for low premiums and high input costs?
The conversation continues in part two, where we discuss the effects exports have on competition for milk from the farm.
T3: Welcome, everybody to the July podcast. We thought this would be a good time to have a discussion about markets. But not about markets the way that we usually talk about where we’re talking about cheese prices, or we’re talking about Class III prices or butter prices or powder prices. This time, I think we’ll focus on the basis. How we’re finding this market right now in the dairy industry throughout the dairy industry, from feed prices to milk prices, to finished product prices like cheese and butter, we’re seeing major changes and big differences in the basis prices, the premiums for milk, the overages for cheese. It is just so different, especially in the spot market from what we’re used to because it bears discussing because I think that’s affecting how people’s milk checks look, and I think it would be an interesting thing to discuss. Where should we start? Anna, Dad, do you guys want to start at the milk or should we start maybe with feed costs?
T2: Well, if you want to look back at it historically, we’re taking the bull by the horns here, six or eight years ago when we delivered milk to a buyer’s plant, we delivered it at class price, using Class II as the most obvious example plus a premium. And usually, the premium covered the freight, sometimes covered the freight and then even more in certain times of the year is that they’ll be from the dairy or the farm, and the buyer paid the freight. Today, we’re not doing that. And I guess the question is, why? Why are we delivering milk at prices considerably under-class? Does that mean that the people who are buying the milk are taking us for a ride and they’re making all the money?
Well, I do think that the people who are buying the milk and taking it from the processing plant to the converter to the grocery store shelf, I think that’s where the margin is. And we’re not getting a piece of that margin right now. So, why not? First of all, is the margin really there? In some cases, it is. If we look at 18-month-old cheddar in Costco, $6 a pound, especially cheeses in Whole Foods that I look at, some of them exceed $20 a pound. Now, that doesn’t necessarily tell the story in the cheeses that I see often, since we know who makes them, I bet you they are not running more than 100,000 pounds of milk a day, that’s 2 truckloads of milk a day into a certain kind of cheese, and maybe they only run that certain kind of cheese once or twice a month.
So just saying that there’s a big sale price on the cutting rack doesn’t necessarily tell the full story. But it would seem to me today that the margin for the industry is in the marketing side. And we’ll describe, for the purpose of this conversation, the marketing has been from the plant to the grocery store shelf. If you look at that, the dairyman is lucky to get 20% or 25% of the value on the grocery store shelf. The processor, manufacturer, if you will, he may get another 20% or 25%. It’s hard to say to be so categorical depending on whatever product that you’re looking at, and what the class price might be for that product. But the marketer may be getting 50% or more of the actual price that shows up on the shelf.
T3: Well, let me clarify that, and I can speak to cheese to help with that a little bit. The typical margin for cheese in the dairy case at a supermarket is approximately 25%. The typical margin for cheese in the deli case, your high-end specialty cheeses, is actually close to 50%. So it’s a lot higher, but the turn on that SKU is a lot slower.
T2: Twenty-five or 50% of what?
T3: So if you go to the store and you buy an 8-ounce package of shreds for $2. The supermarket delivered to that store, if they’re selling it for $4, they would have paid $3. So 25% of that price that the store sold it for, was the supermarket’s markup. And they always do it backwards. They don’t buy it for $3 and then add 25%, they sell it for $4 and back out the 25% so that they bought it for $3. That’s how their math works. And if it’s the deli case, it’s closer to 50%. So the margins in the deli case they’re a lot higher, but they turn those SKUs a lot slower and there’s a lot more of a personal involvement because in the deli case you usually have someone sitting there really cutting the cheese for you and wrapping it up for you and things like that.
There is another 10% to 15% that goes into distribution, getting it from the cheese plant to the store. Now keep this in mind, when I say from the cheese plant, I’m talking about from the plant that packaged the cheese. If it’s a shred, I’m talking about the plant that shredded the cheese and put it in a plastic bag. So the margin for a lot of those converters is probably another 15% to 20%. And so if you kind of just start stacking it, you got 25% at the supermarket, 10% to 15% for distribution, another 20% for the converter, now add another probably 25% to make the cheese, you probably have a small sliver of a percentage to get it from the plant that made the cheese to the plant that converted the cheese. Somewhere in there, you probably had to pay for some marketing to get the product to actually move off the shelf. So you can kind of see how that all stacks up. So, yeah, it’s pretty easy to get to a place where the farmer themselves only makes about 25%.
T2: I think you just made my case. And if we’re going to get back to a premium structure that gives a premium to the dairyman who delivered the processor’s door, how are we going to do it? Milk is going to have to get very tight. And there’s got to be a lot of competition for that milk.
T3: Well, and I think that’s where the issue lies right now. It’s in the competition for that milk.
T2: Let me make that case, and I know I’ve made it before and I don’t want to be labored, but there’s two ways that the industry seems to think about this. The first is, since most of our milk is cooperative, and under the Capper-Volstead Act, collective bargaining is allowed to dairymen as members of co-ops. Collective bargaining, obviously, isn’t getting it done, not as far as getting the share of the marketing premium is concerned. And how can it if you’ve got 4% increase in production every year and only a 1% to 2% increase in disappearance?
But the other way to think about it is you’ve got to have demand for the milk and people competing for it, which means that there’s got to be a hell of a lot less milk around. And the industry has changed over the last 10 years where if the numbers for producing milk are profitable, it doesn’t take very long for people to be filled up the end of the barn with cows. And that’s what’s going on right now. So our class pricing is basically turning into benchmarks.
We’re measuring what the dairyman gets or doesn’t get based on classified pricing, or market pricing, or futures pricing, or whatever price indices you want to compare it to. But as long as we don’t have any competition for the milk, it’s pretty hard to see how this is ever going to change. And one of the things this obviously leads to is quotas, supply controls. And, you know, that had never worked when we tried it. But a lot of people are starting to think that well, maybe we ought to give it another try.
T3: So I’m going to push back on you a little bit on this one. Because I think what’s happening today is different than what we’ve been experiencing over the last 20 years. I think as we’ve come out of COVID, and the way the economy is working right now, there’s a couple of things going on that we really haven’t had to deal with as an industry, at least in my career, that’s causing some real convolutions in terms of overages and premiums for milk and even basis prices for feed costs like corn. And the issue is really labor. Most dairy plants, especially cheese plants, are in rural areas. And rural areas, pretty much throughout the country right now, have unemployment rates at 3%, they’re very low.
And the competition for labor right now is fierce. I know a number of cheese plants in the upper Midwest that have raised their wages as much as $4 an hour just to keep the people they have so they don’t lose them to the plant down the street. We have 50,000 fewer truckers on the road today than we did when the pandemic started over a year ago. For our company, I can tell you, our hauling costs have gone up, in some cases, 90% in less than 6 months. We used to be able to ship cheese 20 years ago from Idaho to Wisconsin and pay 6 cents. Three years ago, we shipped from Idaho to Wisconsin and we pay 10 cents, maybe 11 cents. Today, we’re paying as much as 18 cents.
The prices have really gone up. And so when you really think about labor costs have gone up, hauling costs have gone up, you were having inflation and because inflation seems to be happening very differently in rural America than in urban America, it’s not showing up in our overall economic statistics at the moment. But you can talk to just about any dairy farmer who’s trying to hire people for his farm, you can talk to just about any dairy plant, you can talk to just about any hauling company, they’re all going to tell you the same thing. They are turning down business because they can’t get the people.
We know multiple cheese plants that have had to reduce shifts because they don’t have the people to run the plant. So instead of running three shifts a day, seven days a week, they’re running two shifts a day, six days a week. Well, what’s that really doing? That’s decreasing the demand for milk. And so by decreasing the demand for milk, now you got to find new places to go with the milk. Well, where are you going to go with the milk if every dairy plant is having part of the same problem? They can’t get the labor, so they can’t run at full capacity.
To me right now, I feel like we are stacking this problem on top of each other all the way from the feed supplier to the dairy farmer, all the way to the supermarket or the restaurant. The usual basis price for corn, depending on where you are in the country, is usually somewhere between 50 cents under a bushel, to 50 cents over a bushel. Currently, on average, I think most people would say it’s about 80 cents over a bushel. So not only is the price of corn high, but the basis price is high too. Now, it’s hard to say exactly why that basis price is high. But I’m going to argue some of it is the cost of hauling has gone up, which means moving in between different regions of the country has increased.
So you get the feed to the farm, it costs you more to get there already, now you got people in the milking parlor, you’re having trouble fully staffing the milking parlor. But the cows got to give milk, so the milk still comes out. You probably pay more to get that milk from the farm to the plant because those hauling costs have gone up. But you got a cheese plant that’s not running full because it can’t find the people. So now you’ve got co-ops that have to spot-sell that milk, at what, $2, $3, $4 under a hundred-weight because…
Anna: Sometimes only if you’re lucky.
T3: Yeah, exactly, you know. And so you’ve got premiums for milk that are going down, it’s easy to understand why the dairy farmer right now feels like they’re getting squeezed from both sides, their input costs have gone up, they can’t find the labor, and it feels like they’re getting a discount for the milk. But it doesn’t stop there. The cheese plant costs, they’re highly fixed costs because they have to build the plant, they got a big loan for that, they got to buy the equipment, they got a big loan for that. So, many cheese plants, especially your biggest ones, over 50% of the cost of running the plant is actually the debt service, you know, and they’re not running at full capacity because they can’t get the labor. So the cheese companies, a lot of them are hurting. Now you got to get the product from the cheese plant to the converter. The converters…and that’s even more labor intensive than the cheese plants. I know they’re having problems.
You’re kind of stalking this problem all the way to the supermarkets, your restaurants are having trouble getting staffed, it’s going all the way down through the system, and it’s causing some real big distortions on pricing. You know, you look at the futures board right now, and you look at Class III prices, and you look at cheese prices or even butter prices, your initial reaction is they’re not too bad. But if you’re at $17 a hundred-weight for a Class III price, $15 a hundred-weight for a Class IV price, let’s just round the blend and say the blend is somewhere around $16, but everybody’s getting $1 or $2 under, you’re at $14, and your hauling costs are higher, it’s easy to see why dairy farmers are really frustrated at the moment.
But it’s happening throughout the supply chain. And that, to me, is what’s really frustrating. We’re seeing it in our business, and we’ve got a lot of contracts where we promised people we’d be able to deliver at these prices, and we haven’t been able to because freight has been so difficult. We’ve got people cutting orders because they don’t have the people, they can’t run the cheese, they can’t convert the cheese. It’s a real mess at the moment. And I’m really concerned about it, and it’s causing some real distortions between what these market prices say the returns should be to the dairy farmer and what they actually are.
T2: So what are we going to do about it?
T3: Talk to your local congressman. I think first and foremost, let’s get the additional unemployment premiums lifted so that you get more people to work. I think that’s first and foremost.
T2: I agree that those things are impediments. And I also agree that getting people to work would increase the competition for the milk, which is a major price issue. So whatever it takes to get that done would be useful. We need to shorten the supply as opposed to the available markets. If exports are running at full tilt, and if we didn’t have the logistical problems or the labor problems, would we have a surplus right now? I expect we probably would.
T3: Yes, we would.
Anna: I agree.
T2: Anna, you agree with that?
Anna: Yes, I do. Do we have any idea when that will end? When does that get better? I know that many states actually terminated their additional unemployment benefits in June. And I know some places around here in Missouri are starting to see the benefit of that. But in terms of premium impact, do we have a timeline that we think that will improve on or what are you thinking?
T3: Oh, boy, that’s a loaded question.
T2: You would think our politicians could come up with a guest worker program that would work, and yet they’ve been struggling with it now for how many years?
T3: No offense, Dad, I don’t have a lot of faith in our politicians’ ability to get along in Washington and therefore accomplish much these days.
T2: Obviously, that’s the case but something as simple as a guest worker program ought to be doable. I had dinner with a very knowledgeable dairyT30 years ago, and he was of the same opinion, and yet here we are. I guess these days immigration is a major political football and makes it impossible to solve this particular problem. On the other hand, here we are giving away food stamps and subsidies in the city for unemployment purposes, and we can’t get help out in the countryside. Maybe just a Greyhound bus to go from the city to the countryside every morning and night would be the answer to the problem. But somehow, I don’t think that’s going to work very well, either.
T3: Anna, I think to more directly answer your question, my gut feeling is that it’s going to take a couple of years for this to really feed fully through the system. And I say that because the answer is a combination of getting more people back to work and better technology to create better efficiencies, whether it’s at the hauling level, things like driverless trucks, whether it’s at the plant level, more automation to decrease the number of workers needed per pound of cheese, let’s say, to be made. I think there’s a lot of investments like that that need to be made in order to resolve this problem. I don’t think it’s going to go away quickly because you’re dealing with…in many rural counties throughout the country, you’re dealing with unemployment rates as low as 2.9%, you’re not going to just suddenly invent workers. So it’s going to take a while.
Anna: I agree. That’s why I was kind of curious. Even if we terminate all these extra benefits, I don’t know that that helps where we need it to help.
T3: It was interesting, just yesterday I was looking at unemployment rates state by state, and in certain states, county by county, I was curious. It was very interesting. So the unemployment rate, for example, right now in Wisconsin is 3.9%. In Illinois, just across, you know, the border to the south is 7.1%. California, it’s, I think, also 7.1%. And Idaho, I think it’s like 4%, or 3.9%. But if you actually go and look, even in California, at rural counties that are big dairy counties, almost every unemployment rate I see is below 4%. And so throughout the dairy industry, that’s a big issue.
I’m not sure how you’re going to solve it, even if you really open up the borders, and a lot of guest workers come in and whatnot, it’s just going to take a long time for all of that to stabilize. You know, one thing to keep in mind is I think most dairy farmers would agree, if we ended up with high Class III milk prices, they don’t have a problem with the premiums being lower. And so some of this, I think, is a tradeoff. I think inflation, I think the shortage of labor, I think a lot of these things that are kind of adding a lot of costs to the system at the moment are also creating an inflationary environment that are driving higher milk prices.
So if the answer is, hey, you’re going to have to get used to $18 milk, but you’re only going to get a 25 cent premium for your milk, or even if you’re 25 cents to $1 under for your milk, I think most dairy farmers probably would take that. And when you’re talking about inflationary pressures, a lot of times that’s what happens. And so these issues that we’re dealing with, as frustrating as they are, if the milk prices stay high enough, there’s survivable issues. So I do think there’s a lot of hope for the industry.
T2: I think you have a little bit of an optimistic view of how the dairy farmer’s gonna react. Anything negative on his milk jack, if it’s a check-off, or hauling costs, or whatever is going to be ill-received, even if he’s getting $30 a hundred-weight. The only way the dairyman is going to be happy is if it’s $30 a hundred-weight plus, and no negatives, nothing coming out of it. And I know they’ll all laugh up the sleeve with that, but they’ll all admit it’s true.
They’re going to have to get rid of the check-offs and the expenses for this or that or the hauling costs or whatever in order for it to be happy. I know we used to have a milk program that said “free hauling.” I used to say, you’d have to be an idiot to think that there’s going to be free hauling. It’s going to be paid for by the dairyman no matter what. But you know what, it’s the way the mind works. If you think it’s not on your check, it’s out of sight, out of mind. So there’s no such thing as free hauling, but theoretically, your thought would be correct. That’s not the way they’re going to want to look at it.