Dick Groves, Publisher, Editor, Cheese Reporter
May 18, 2001
Farm milk prices are on the rise, which
means that retail milk prices are also going
to increase and sales are going to go in the
tank. That’s just simple dairy economics at
Or is it? Recent evidence indicates that at
least part of that equation doesn’t always
work as expected. And that evidence, in
turn, could have some effect on future
dairy policy discussions.
One piece of that recent evidence is the
University of Connecticut’s study of the
Northeast Interstate Dairy Compact. As
reported a couple of weeks ago, that study
concluded that retail prices did in fact go
up when compact over-order prices went
into effect, but they actually increased
considerably more than did farm milk
prices. Retailers and processors basically
used the compact price to boost their profit
margins, the study found. Prior to compact
implementation, the study said, when farm
prices dramatically increased or decreased,
retail prices “hardly budged.”
Another piece of that evidence was
submitted on Monday of this week, at a
hearing in Philadelphia, when (as reported
on our front page) Robert Robinson of the
US General Accounting Office told a US
Senate subcommittee that while farm milk
prices have some influence on retail prices,
other factors may ultimately have a greater
influence on retail milk prices. As Robinson
pointed out, because farm milk prices
account for only about 40 percent of the
retail price, there is “adequate opportunity”
for other factors, such as wholesale
processing costs and retail pricing
strategies, to “significantly influence” the
other 60 percent of the retail price.
A couple of thoughts spring to mind here.
First, and frankly foremost, are those “retail
pricing strategies” Robinson referred to.
The Connecticut study of dairy compacts,
as well as previous studies of slotting
allowances by various federal agencies and
entities, leave us a bit leery of having milk
sales determined in part by “retail pricing
After all, recent evidence has also found
that fluid milk demand is more price-elastic
than previously believed. That is, increases
in prices lead to decreases in demand. So if
retailers decide, strategically, to boost milk
prices, demand will decline accordingly.
Why might retailers make such a decision?
First of all, because milk is a profitable item
already, one of the most profitable in the
entire store, as shown by previous dairy
industry-conducted studies. Second,
because they can, at least in some markets,
because according to the Connecticut
study they have quite a bit of market
Another point concerning retail and farm
price movements concerns dairy policy
discussions. Historically, one of the main
arguments against legislatively boosting
farm milk prices is because it would end up
That is, if farm milk prices are artificially
increased, retail prices will also move
higher, and demand will suffer.
The GAO’s Robinson would seem to at
least partially disagree with that argument.
His point that other factors may have a
greater influence on retail prices than do
farm prices would seem to mean that
policy-makers should pay more attention to
those “other factors” than they do to farm
prices if ensuring reasonable prices to
consumers is their main goal. Put another
way, arguments that legislated attempts to
boost farm prices will end up costing
consumers maybe shouldn’t carry as much
sway as they once did.
Or maybe they should be viewed in
conjunction with those “other factors.” In
the dairy industry, for example, fluid milk
and cheese are sold through different
channels, with retail being far more
important for fluid milk than for cheese.
And things are changing rapidly within the
retail sector. While retail consolidation is
certainly a concern, we seem to recall
seeing recent studies that indicate
supermarkets are becoming less important
as far as retail milk sales are concerned.
More and more milk is being sold through
retail channels that include wholesale clubs,
convenience stores and mass
And of course the array of milk moving
through those channels is changing as well.
What’s sold in the supermarket is different
than what’s sold at convenience stores.
And competitive pressures to sell those
Thus far, we’ve looked at the price issue
from a demand standpoint. But that ignores
the all-important supply side of the
equation, of which there is also recent
evidence of a more practical, as opposed
to academic or theoretical, nature.
That is, while farm price increases may not
make it all the way through the supply chain
to consumers and therefore may have
minimal effect on demand, they do appear
to have a fairly large impact on supply. And
that’s something policy-makers always
need to keep in mind.
The latter part of the 1990s illustrated the
effects of high prices on milk supplies. In
1998 and 1999 we saw some of the
strongest milk prices in history. The result
was a two-year expansion (1999 and 2000)
in milk production unlike any other in
history. That expansion, of course, then led
to a collapse in prices that lasted from late
1999 until early this year — and persisted
despite some of the strongest demand
increases in memory.
The collapsed farm prices in turn led to
legislative efforts to prop up milk prices
beyond what the market dictated. While
this is a politically tempting idea, it creates
at least some potential problems.
Yes, apparently it doesn’t necessary hurt
dairy demand, since farm price increases
don’t necessarily show up in retail prices.
But it does, potentially, lead to oversupply,
because producers expand when milk
prices are high (“high” being a relative
Our conclusion to all of this is that
legislatively propping up milk prices may
not harm demand as much as once thought,
but should still be viewed cautiously
because of what can happen to supply. •