A report by consultant McKinsey and Co. projects that the California dairy sector must continue to grow or dairy producers will face some difficult financial challenges over the next 20 years.

Already fraught with a persistent glut of milk, enormous environmental challenges and lack of new processing capacity, the California dairy sector will need to continue its growth or face declining profits and harder times ahead, according to a report commissioned by the California Milk Advisory Board.

"These three challenges end up amounting to a problem where the industry will face a sustained period of tougher profits and tougher economic times for dairymen," said David Palecek, a consultant with McKinsey and Co., which conducted the study.

Stimulating debate among California dairy producers and processors on how they can grow profitably in the next 20 years, the study outlined several policy options that could buoy the industry's competitive edge and increase profitability for producers.

California is now a major exporter of dairy products nationally and globally. Producers enjoyed have several decades of success and two of their most profitable years in 2004 and 2005. But they are also at a crossroads because the very strategies that have worked so well to drive their success in the past are now threatening the dairy sector's viability, the report said.

Ray Souza, a dairy producer from StanislausCounty and president of Western United Dairymen, which conducted a forum this month to facilitate discussion of the study, said the McKinsey report lays down a road map for producers to look at where they want to go in the future.

"And it comes at a critical time because we're on the heels of developing a new Farm Bill, so we're looking at milk pricing and our dairy industry both in a national and statewide level," said Souza.

More than 300 dairy producers and others attended the forum in Modesto to debate how their industry should move forward.

Many producers agree that one of the biggest problems they face is the abundant milk surplus that remains unstoppable, even in difficult years such as last summer when a record heat wave killed thousands of cows and squelched milk production.

Ideal weather, large farm scale, impressive herd productivity and other factors have all contributed to the oversupply of milk. And without policy changes that offer producers an incentive to control supply, producers will likely see major price downturns in coming years that are more severe and linger longer than they have ever experienced, the report said.

Historically, the state's milk production has been growing at rates of between 2 percent and 4 percent a year and is expected to continue at this pace through 2020. But demand for California milk is expected to grow by only 15 million pounds annually, or 2.3 percent.

To increase demand, U.S. dairy consumption would have to increase by 30 percent per capita and the state would need to boost its market share where possible and take advantage of expanding international trade.

 

Future of quota debated

The report proposed several "groundwork steps" as potential solutions to some the industry's current problems. One is to minimize the costs of environmental mitigation. Another is to continue promoting and marketing its products. The report also urged producers to invest more in production efficiency and product innovation, as well as help make laws and regulations more efficient.

But perhaps one of the most debated issues covered in the report is the future of quota, which entitles certain dairy producers to an extra payment on top of the standard pool price paid to non-quota holders.

"There are those that feel that quotas have outlived their usefulness but at the same time there are a number of people who adamantly support it," said Souza.

Palecek said that eliminating quotas would unlock around $1.7 billion in value for the dairy sector and remove incentives that contribute to the oversupply of milk.

Don Giacomazzi, who operates a thousand-cow dairy in KingsCounty, said he relies on his quotas to survive during tough times when milk prices fall way short of his production costs.

"We have a lot of money in it," he said of quotas. "There was a huge need for quota when it was put in and it worked well. But now these big dairies come in and they have no quota or very little to speak of, so as a result, they want to get rid of it. They want everybody to be the same."

Giacomazzi said he agrees with the report that larger dairies with the most efficiencies will be survivors, while weaker ones will likely leave the dairy business. But he laments that with current land values, he cannot afford to buy more land to add to his dairy and make it bigger and more profitable.

Alternative policy options

The McKinsey study offered other alternative policy options for producers to consider. The first involves reforming the regulatory system by changing the pooling and pricing system to two classes of milk — fluid and manufactured; issuing a production quota to restrain supplies of milk; and buying out the current quota and using the money to fund industry-wide investments.

The second option is to create a controlled market in which the government would cease to set milk prices and there would be no mandated supply constraints.

"A lot of dairymen fear this outcome because they fear it would be a throwback to the days prior to pooling," said Palecek.

A third alternative is for producers to form a federated marketing co-op to market all pooled milk in the state and bring all pricing, supply and investment decisions in-house.

Yet another option is not to do anything and keep things the way they are, Palecek said.

"That should be an explicit choice and a period of discourse should and needs to happen as part of industry deciding which way it needs to move forward," he added.

Whether it is necessary for the state's dairy sector to grow is a question that producers and processors need to answer, said StanislausCounty dairy producer Ray Prock Jr., but at the same time, they should be prepared to market any future growth.

Domenic Carinalli, a dairy producer in SonomaCounty, said he fears some producers will react too quickly to the McKinsey findings and make judgments and decisions without knowing all the answers and ramifications.

"We think it's important that the dairy industry embark on a pathway where they debate the pros and cons of the different alternatives and figure out how exactly they want to adopt them and then move forward over the next several months or year and adopt one of the solutions that they choose would best fit the industry," said Palecek.

"The devil will be in the details on these things and a lot more work will have to go into this to flesh out the various options," he said.

CaliforniaFarm Bureau Federation