Farm-to-Retail Spreads

Fluid milk prices lag those at the farm gate

Just as sure as the sun rises each morning, dairy farmers will complain that retail milk prices don’t reflect price changes at the farm gate.

The conventional wisdom is that retail prices immediately spike any time there is an increase in farm milk prices, and don’t retreat as fast or as far when farm prices fall.

There is some truth to that, says Andy Novakovic, a dairy economist at Cornell University. But retail prices do move up and down, and they never move by the same percentage
as farm prices because the cost structures are different.

The basic cost of fluid milk for retailers is the wholesale price, which is largely based on the Class I fluid milk price for their area. To that, add processing, handling, Federal Order and fluid milk promotion assessments. As a result, Novakovic says, "prices farther downstream are always going to be higher than upstream prices."

So applying a percentage increase or decrease to farm prices isn’t using the same base as retail prices. "When the Class I price hit its cyclical lows in 2002–03, 2006 and 2009, the observed retail price did not decline by the full amount of the Class I price drop," Novakovic says.

"However, the same tends to be true on the upside. Retail prices did not increase by the full amounts of the cyclical Class I price increases in 2001 and 2004," he says.

The only exception was 2007, when very large and sustained Class I price increases were fully matched by the change in retail prices. Class I prices averaged $21.28 per cwt. during the last six months of 2007, with retail prices shooting up to $4 per gallon or more.

Retail margins dipped to $5 per cwt. during that period (when they had been averaging $10). Burned by low margins, retailers pushed the retail/All-Milk margin to $15 per cwt. by early 2009. When milk prices crashed in 2009, retail prices came down, but retailers were able to maintain a $12 to $13 per cwt. margin.

"Retailers tend to not make price changes on signal, staple goods like milk. But when they do, they tend to make a bigger one and then stick with it," Novakovic says.

From his study of 12 years of milk price margins, Navokovic concludes:

• "Farmers get an average price, whether we think of it in terms of the All-Milk price or the Federal Order uniform [blend] price."
• "Processors pay class prices [plus premiums]. The cost of milk going into beverage products is the Class I price plus those premiums, not the farmer’s price."
• "Never compare milk prices along a supply chain using percentages. If the farm share of a retail price is 50% and a $1 per cwt. cut in the Class I price is fully reflected in a $1 per cwt. cut in the retail price, the farm price percentage change will be twice that of the fully impacted retail price. The Class I price fell 20%, but the retail price fell only 10%. That sounds suspicious, but the retail price fell fully by the absolute amount of the Class I price change."
   

Class I and retail fluid milk prices tend to move in tandem over time, though price changes have more short-term volatility at the farm level.