"My dad was the type of person who always said, 'I'll have a better year next year,'" says dairy producer Mark Anderson. "But I'm not willing to wait for next year. I choose to manage it now," says the 150-cow producer from Waupaca, Wis.
To Anderson, "managing it now" means taking control of his business and using the tools available to set his own milk price. However, the futures market is not something you can just jump into. You need to learn the basics and develop a plan to guide your business.
Learning for Anderson was two-fold. He attended a few seminars and joined a marketing club.
"Why should I run my business any different from say, Kmart?" he asks. They know the price they'll receive ahead of time, and by using the futures market, dairy producers can, too.
Just like Kmart, dairy producers need a marketing plan. Use the following five steps to develop one for your dairy.
Determine your goals
Deciding what price to aim for can be difficult if you haven't set goals.
Your first step toward goal-setting should be to examine your business, says Bob Cropp, extension agricultural economist at the University of Wisconsin. Ask yourself: Do you plan to expand? When do you plan to retire? Answering these questions will help you define goals. If, in order to expand your dairy, you must receive $12 for your milk, using the market to lock in that price floor becomes very important for the business' survival.
Examine your family goals, too. Sit down with family members and discuss the questions for the business. In addition, you'll need to consider: What level of family living do you want to achieve or maintain? Do you need to save money for college? For retirement?
Using what you've decided so far, now you'll need to look at the price required to meet those goals. This will help you decide if your goals are realistic.
One last point to consider is your cash flow, says Phil Plourd, commodity broker with Roger Blimling and Associates in Cottage Grove, Wis. If you decide to hedge in the futures market, do you have the cash flow to cover margin calls, or do you need to set up a separate line of credit at the bank? (For more information, see "How to handle margin calls" in the December 1998 issue of Dairy Herd Management.)
Determine your basis
The Basic Formula Price is the base used to set prices in the federal milk marketing orders. Hauling, pooling and other milk marketing order functions then come into play to determine your mailbox price. No matter where you live, even in California, the difference between the BFP and your mailbox price is your basis.
When using the futures market to set a price objective, basis affects the final price you receive. Say, for instance, you want to lock in a $13 price and you have a 90-cent basis. The futures market is trading at $12.10. By locking in at $12.10 and adding your 90-cent basis, you have a final price of $13. However, if you live in an area, such as New Mexico, which sometimes has a negative basis, you must subtract your basis from the contract price to find your final price. In addition, if your actual basis for the month varies from your average basis, your final pay price will differ a little also.
Use basis to help determine which marketing tool - hedging, options, forward-contracting - offers the best opportunity for your business at any given time.
Most experts recommend that you need three years of historical data on your dairy's basis. That will give you a good idea of the average basis for each month of the year, explains Cropp. In order to get a feeling of what your basis will look like and how it changes over the year, you can look at the average basis by federal order on the Dairy Herd Management homepage in the Markets section. The Internet address is: www.dairyherd.com.
For those who don't have Internet access, you can request a copy of "Average Monthly Basis, 1995-1998" from the Chicago Mercantile Exchange (CME). But remember, your dairy's basis will vary from the average for the federal order, says Cropp. It's very important to calculate your own basis to eliminate any surprises.
Determine your cost of production
If you don't know your cost of production you won't know your level of profit, let alone how you're doing at accomplishing your goals, says Plourd. You don't have to know your cost to the penny, but you do need to know approximately how much you spend to produce milk on your farm.
There is no single right way to calculate the cost of production. Your local extension office may have worksheets or even computer programs to help you calculate this.
At a minimum, cost of production should include the cost of land, labor, animals, feed and debt service. Once totaled, divide it by the milk production to obtain a cost per hundredweight.
Learn about the markets
Now that you have a good understanding of your goals, basis and cost of production, you can start learning about the markets. Areas of interest include: market trends, demand, production, outlook and historical performance.
Here are four approaches you can use to learn more:
- Join a marketing club. This can be a great way to learn about the markets in a small group environment, explains Bob Wepner, dairy producer and investment broker with A.G. Edwards and Sons in Appleton, Wis. Contact your local extension agent to see if such a club exists in your area. Or, consider starting your own.
- Talk to neighbors who use the futures market. Ask what sources of information they use to stay informed.
- Find a broker who is willing to work with and educate you on the markets. Ask him if he has experience with dairy commodities. The CME and the New York Board of Trade both maintain directories of brokers who work with dairy commodities.
- Market information is readily available on the Internet, and in a variety of market reports which you can subscribe to, as well as in the dairy magazines you receive. An Internet markets resource information desk is available through the Dairy Herd Management homepage. You can access it at www.dairyherd.com and then click on Markets.
Set profitability targets
In step one, you defined price and profit objectives to meet business and personal goals. Now, with your knowledge of the markets and the tools available, you can write a plan.
For example, say your cost of production is $11 per hundredweight and you need to make an average profit of $2 per hundredweight to meet your goals. You have several choices to make based on market conditions.
When the market trends upward, you may decide to use options because they set a price floor, carry a minimal cost and still allow you to benefit from any market rallies. When market trends indicate a decline, you may want to use futures contracts to place a hedge and lock in a milk price. And, when the market is uncertain, you may want to evaluate whether the futures market or forward-contracting through your co-op gives you the best opportunity.
If you prefer, your profitability targets can be more specific, explains Plourd. Some producers prefer to set signposts which guide them on how much milk to hedge when the market hits a certain price target. For example, they might decide to lock in 25 percent of their production for each time the futures market makes an incremental 25-cent increase above $13.
The key, says Plourd, is developing a plan that you are comfortable with and then exercising it when the opportunity arises.
- "Average monthly basis 1995-1998"
On the internet at: www.dairyherd.com.
For a paper copy, call: CME (800) 331-3332
- Cost of production worksheet.
On the internet at: http://www.wisc.edu/dairy-profit/pubs.html
- Marketing club information.
On the internet at: http://aae.wisc.edu/futures/
- Directory of brokers who work in dairy.
NYBT (800) 433-4348 or CME (800) 331-3332