Not all milk-to-feed ratios are created equal

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Editor's note: The following article was published by Michigan State University Extension and is part one of a series related to the milk-to-feed ratio.

Every month the USDA’s National Agricultural Statistics Service (NASS) publishes a report called Agricultural Prices. This valuable publication contains a wealth of economic data about all aspects of agriculture. One bit of data of particular interest to the dairy industry is the milk-to-feed ratio. The milk-to-feed ratio is a proxy measure for dairy profitability. It is promoted as representing how profitable, or unprofitable, it is for dairy producers to produce milk given current milk and feed prices. This ratio often receives a lot of attention in popular agricultural publications and websites.

To properly evaluate the milk-to-feed ratio one must first understand what data goes into it and how it is calculated. First, the milk-to-feed ratio requires knowledge of four numbers, the: 1) all-milk price ($/cwt), 2) corn price ($/bu), 3) soybean price ($/bu) and alfalfa hay price ($/ton). These prices are collected by the USDA’s Agricultural Marketing Service (AMS) and represent national averages.

Second, the milk-to-feed ratio is calculated as the ratio of the all-milk price in relation to a hypothetical 100 pounds of 16 percent protein-mixed dairy feed composed of a mixture of these three feeds (i.e., corn, soybeans and alfalfa hay). The 16 percent protein-mixed dairy feed consists of 51 pounds of corn, 8 pounds of soybeans and 41 pounds of alfalfa hay. Here is how the milk-to-feed ratio is calculated.

Step #1: Use the corn, soybean and alfalfa hay prices to calculate the price of the 16 percent protein-mixed dairy feed.

16 percent protein-mixed dairy feed value = (51/56 X Cornprice) + (8/60 X Soybeanprice) +(41/2000 X Alfalfa Hayprice)

For example: let’s use the actual commodity prices reported by the USDA in calculating the August 2012 milk-to-feed ratio: corn price, $7.35/bu; soybean price, $16.30/bu and the alfalfa hay price, $205/ton.

16 percent protein-mixed dairy feed value = (51/56 X $7.35) + (8/60 X $16.30) + (41/2000 X $205)

16 percent protein-mixed dairy feed value = $6.69 + $2.17 +$4.20

16 percent protein-mixed dairy feed value = $13.07 (per cwt of feed)

It is important to remember that the 16 percent protein-mixed dairy feed value is expressed in terms of 100 pounds of feed and not per 100 pounds of milk produced.

Step #2: Use the 16 percent protein-mixed dairy feed value and the all-milk price to calculate the milk-to-feed ratio. The August 2012 all-milk price was $19.10/cwt, therefore, the milk-to-feed ratio becomes:

milk-to-feed ratio = all-milk price / price of 100 pounds of 16 percent protein-mixed dairy feed

milk-to-feed ratio = $19.10 / $13.07

milk-to-feed ratio = 1.46

The milk-to-feed ratio represents how many pounds of the 16 percent protein-mixed dairy feed could be purchased with the gross revenue from one pound of milk at the stated all-milk price. So in our example a milk-to-feed ratio of 1.46 means the hypothetical dairy producer could purchase 1.46 pounds of feed when the USDA all-milk price was $19.10/cwt and the USDA 16 percent protein-mixed dairy feed was valued at $13.07/cwt of feed.

The logic behind the milk-to-feed ratio is that as the ratio goes higher the hypothetical dairy producer would be able to purchase more feed. Since feed typically accounts for 50-60 percent of the cost of producing milk a higher milk-to-feed ratio also suggests higher profits for dairy producers. Conventional wisdom says when the milk-to-feed ratio is greater than 3.0, milk production is more profitable and dairy producers, as an industry, will tend to expand production by adding more cows, decreased culling and increased milk per cow by feeding more concentrates. When the milk-to-feed ratio drops below 2.0 conventional wisdom says milk production is less profitable and dairy producers, as an industry, will contract by some producers going out of business, increased culling and/or decreased milk per cow by feeding less concentrates.

However, one must be very careful in interpreting the milk-to-feed ratio, because, as stated in this article’s title, not all milk-to-feed ratios are created equal. For example, let’s look at two very similar milk-to-feed ratios. In May of 2009 the milk-to-feed ratio was 1.49, while in March 2012 the milk-to-feed ratio was nearly identical at 1.48. By simply comparing the two ratios many would conclude the potential profitability for dairy producers in those two months were almost identical. Furthermore, based on conventional wisdom, most would conclude the dairy industry in general was likely to be in a contraction phase in both periods with perhaps some producers liquidating herds, others increasing culling, feeding less concentrates, etc.

However, a more careful analysis of those two months would reveal an entirely different situation. A major drawback of the milk-to-feed ratio is in the fact that it is a ratio. A ratio does not take into account the size of the pie. For example, which would you rather have, a 20 percent slice of an eight inch apple pie or a 20 percent slice of a 16 inch apple pie? In both cases you receive the same ratio of the pie (i.e., 20 perecnt), but in the latter case you will receive a much larger slice in an absolute sense. The same is true when it comes to the milk-to-feed ratio.

So to properly evaluate a specific ratio we need to take into account the size of the pie. A measure that does this is to calculate income over feed costs (IOFC) for each specific milk-to-feed ratio, thus, taking into account the absolute value of the milk price and feed costs (i.e., the size of the pie). IOFC is calculated:

IOFC ($/cow/day) = [Milk Price ($/cwt) X (Daily Average Milk Production (pounds/cow/day) / 100)] – Daily Feed Costs ($/cow/day)]

Where

Daily Feed Costs ($/cow/day) = [Daily Feed Per Cow (pounds feed/cow/day) / 100] X (Price of 16 percent protein-mixed dairy feed)

Returning to our two example months of May 2009 and March 2012; let’s look at the raw data the USDA used to calculate those nearly identical milk-to-feed ratios (Table One).

Table One USDA data for the May 2009 and March 2012 milk-to-feed ratios.

Item

May 2009

March 2012

All-milk price ($/cwt)

$11.60

$17.20

Corn price ($/bu)

$3.96

$6.35

Soybean price ($/bu)

$10.70

$13.00

Alfalfa hay price ($/ton)

$137

$201

16% protein-mixed dairy   feed ($/cwt1)

$7.84

$11.64

Milk-to-feed ratio

1.49

1.48

1$ per hundredweight of 16 percent protein-mixed dairy feed

Now let’s first calculate the daily feed costs for each month. In order to do so we make an assumption that daily feed per cow is 56 pounds of the 16 percent protein-mixed dairy feed.

May 2009:

Daily Feed Costs ($/cow/day) = (56 pounds/cow/day / 100) X ($7.84/cwt of feed)

Daily Feed Costs ($/cow/day) = $4.39

March 2012:

Daily Feed Costs ($/cow/day) = (56 pounds/cow/day / 100) X ($11.64/cwt of feed)

Daily Feed Costs ($/cow/day) = $6.52

Now let’s calculate IOFC for each month. In order to do so we make an assumption that daily average milk production per cow is 80 pounds.

May 2009:

IOFC ($/cow/day) = [$11.60/cwt) X (80 pounds/cow/day / 100)] – $4.39/cow/day

IOFC ($/cow/day) = $9.28/cow/day - $4.39/cow/day

IOFC ($/cow/day) = $4.89

March 2012:

IOFC ($/cow/day) = [$17.20/cwt) X (80 pounds/cow/day / 100)] – $6.52/cow/day

IOFC ($/cow/day) = $13.76/cow/day - $6.52/cow/day

IOFC ($/cow/day) = $7.24

In both months, for all practical purposes, the milk-to-feed ratios are virtually identical. However, the size of the pie is larger in March 2012. Therefore, the nearly identical milk-to-feed ratio in March 2012 produces a much larger IOFC than in May 2009 by almost 50 percent. The average cow in March 2012 is able to contribute $2.35 more to non-feed expenses than the average cow in May 2009 despite nearly equal milk-to-feed ratios and significantly higher daily feed costs. If non-feed expenses were equal in the two months, it becomes obvious that despite almost identical ratios the hypothetical dairy producer had more profit potential in March 2012 as compared with May 2009.

This example points out probably the largest drawback in using the milk-to-feed ratio as a proxy for dairy farm profitability. Therefore, be extremely careful when comparing milk-to-feed ratios. The measure more highly correlated with dairy profitability is IOFC and not the milk-to-feed ratio. The May 2009 as compared with March 2012 example proves the truth of that conclusion.

Michigan State University Extension will be releasing a second article about the milk-to-feed ratio. The article will be examining whether conventional wisdom is correct in predicting the effect of the milk-to-feed ratio on U.S. dairy producer behavior, so keep an eye out for that.


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