Structural Change and Competition In the U.S. Dairy … · Structural Change and Competition In the U.S. Dairy Industry ... Dec. 2008 CFTC Sanctioning of DFA ... 9 4,212 2.7 2 12,200

Structural Change and CompetitionStructural Change and CompetitionIn the U.S. Dairy IndustryIn the U.S. Dairy Industry

Brian W. GouldBrian W. GouldAssociate ProfessorAssociate Professor

Department of Agricultural and Applied EconomicsDepartment of Agricultural and Applied EconomicsUniversity of WisconsinUniversity of Wisconsin--MadisonMadison

Economic Research ServiceEconomic Research ServiceDecember 7, 2009December 7, 2009

Presentation OutlinePresentation Outline

Industry structure at the farm levelIndustry structure at the farm levelFarm size and locationFarm size and location

Classified pricing of farm milk in the U.S.Classified pricing of farm milk in the U.S.Pricing practices of dairy manufacturersPricing practices of dairy manufacturersImplications of a thin marketImplications of a thin market

Industry structure in the marketing of farm milkIndustry structure in the marketing of farm milkEmergence of regional/supraEmergence of regional/supra--regional cooperativesregional cooperatives

Industry structure in milk processing/distributionIndustry structure in milk processing/distributionSuizaSuiza →→ Dean FoodsDean Foods

22

Dairy Farm StructureDairy Farm Structure

5,6965,696WA5,2365,236NM4,2334,233IAIA2,9422,942WA3,0123,012MOMO7,7637,763MIMI5,5935,593WA4,3924,392WA3,6253,625TX3,0653,065TX7,8657,865NM5,7055,705MIMI4,6674,667OHOH3,9943,994IAIA4,4204,420OHOH8,4168,416TX5,7435,743TX5,2345,234MIMI4,3104,310OHOH4,6024,602MIMI8,7828,782MNMN7,2237,223ID5,5395,539TX4,9704,970MIMI4,6704,670IAIA

10,57510,575PAPA9,4939,493MNMN10,01410,014PAPA8,4968,496PAPA7,1247,124PAPA12,31512,315ID11,15611,156PAPA10,03010,030MNMN9,5359,535MNMN9,4579,457CA12,43212,432NYNY11,92111,921NYNY11,06711,067NYNY10,97410,974NYNY9,6369,636MNMN24,47224,472WIWI23,25923,259WIWI20,94720,947CA13,57713,577CA10,34110,341NYNY41,20341,203CA32,245 32,245 CA24,187 24,187 WIWI22,38022,380WIWI18,435 18,435 WI WI ProdProdStateStateProdProdStateStateProdProdStateStateProdProdStateStateProdProdStateState

2008200820002000199019901980198019701970Milk production has shifted westwardMilk production has shifted westward

Note: Top ten states. Production is in terms of millions of lNote: Top ten states. Production is in terms of millions of lbsbs 33

Distribution of milk production by herd size, 2007Distribution of milk production by herd size, 2007

0%

10%

20%

30%

40%

50%

60%

1-49 Head 50-99 Head 100-199 Head 200-499 Head 500+ Head

Wisconsin New YorkPennsylvania MinnesotaMichigan United States


Farms Avg SizeWI 14,200 88NY 5,700 110PA 8,300 66MN 5,100 90MI 2,700 124US 69,995 131

Distribution of milk production by herd size, 2007Distribution of milk production by herd size, 2007

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1-49 Head 50-99 Head 100-199 Head 200-499 Head 500+ Head

California IdahoTexas New MexicoWashington


Farms Avg SizeCA 2,200 824ID 810 633TX 1,300 268NM 270 1,267WA 820 290

A majority of the milk produced in the U.S. takes place A majority of the milk produced in the U.S. takes place under Federal and State marketing ordersunder Federal and State marketing orders

CA and Federal Milk Marketing Order (FMMO) CA and Federal Milk Marketing Order (FMMO) system account for 83% of U.S. milk in 2008system account for 83% of U.S. milk in 2008

Formulas used to set Formulas used to set minimumminimum milk pricesmilk pricesPrices determined by use of milk (i.e., milk class)Prices determined by use of milk (i.e., milk class)Wholesale commodity Wholesale commodity pricesprices→→milkmilk component component valuevalue

Milk Class minimum price = sum of component Milk Class minimum price = sum of component values at standard milk compositionvalues at standard milk composition

Classified Pricing of Farm MilkClassified Pricing of Farm Milk

66

How can market structure either at the milk How can market structure either at the milk procurement or processing stages impact farm procurement or processing stages impact farm milk prices given above system?milk prices given above system?

Lets examine the valuation of FMMO Class III milkLets examine the valuation of FMMO Class III milk76.4% of Upper Midwest milk in 200876.4% of Upper Midwest milk in 200836.0% of U.S. milk36.0% of U.S. milk3.1% of Florida milk3.1% of Florida milk

77

Classified Pricing of Farm MilkClassified Pricing of Farm Milk

NASS Grade AButter Price

($/lb)

Butterfat Value($/lb)

Class III Price

($/cwt)

OtherSolids Value

($/lb)

Class III Skim Price

($/cwt)

x 3.5

x 0.965

x 5.9

NASS CheddarPrice ($/lb)

Protein Value($/lb)

x 3.1

88

Mailbox Price

($/cwt)

NASS DryWhey Price

($/lb)

98% of WI mailbox pricevariabilitydetermined byClass III

FMMO Pricing of Class III MilkFMMO Pricing of Class III Milk

CME Butter Spot Price

CME Cheddar Spot Price

Lag

Lag

The Chicago Mercantile Exchange (CME) spot The Chicago Mercantile Exchange (CME) spot cheese marketcheese market

1997: Spot cheese market moved to CME after 1997: Spot cheese market moved to CME after allegations of price manipulation on the Green Bay allegations of price manipulation on the Green Bay National Cheese Exchange National Cheese Exchange

Cheese Pricing: A Study of the National Cheese Cheese Pricing: A Study of the National Cheese ExchangeExchange, Mueller, W.F., B.W. Marion, M. , Mueller, W.F., B.W. Marion, M. SialSial and and F.E. F.E. GiethmanGiethman, Dept. of Ag & Applied Economics, , Dept. of Ag & Applied Economics, Univ. of WIUniv. of WI--MadisonMadison

((www.aae.wisc.edu/fsrg/finalFolder/Allwww.aae.wisc.edu/fsrg/finalFolder/All Chapters Chapters File.pdfFile.pdf))Good review of NCE historyGood review of NCE history

Milk Pricing and Market StructureMilk Pricing and Market Structure

99

Cheese producers generally use the CME in setting sales Cheese producers generally use the CME in setting sales prices even though not part of FMMO systemprices even though not part of FMMO system

Carlson and Gould (1996) study of Wisconsin Cheese Carlson and Gould (1996) study of Wisconsin Cheese plant managersplant managers

Typical statement: Typical statement: ““22¢¢ over the Fridayover the Friday’’s CMEs CME””Lag effect on NASS prices used in formulasLag effect on NASS prices used in formulas

Impacts all cheese varieties not just cheddarImpacts all cheese varieties not just cheddar2008: Cheddar was 31.7% of U.S. cheese prod.2008: Cheddar was 31.7% of U.S. cheese prod.

The Commodity Futures Trading Commission (CFTC) The Commodity Futures Trading Commission (CFTC) has regulatory oversighthas regulatory oversight


1010

Spot Cheese Market: Market Oversight Has Increased, Spot Cheese Market: Market Oversight Has Increased, but Concerns Remain About Potential Manipulationbut Concerns Remain About Potential Manipulation

GAOGAO--0707--707, July 2007707, July 2007A comparison of CME and NCEA comparison of CME and NCEGeneral findingsGeneral findings

Daily anonymous tradingDaily anonymous tradingSame products and participants as at the NCESame products and participants as at the NCE

Markets have characteristics associated with Markets have characteristics associated with manipulation potentialmanipulation potential

Low trading volumeLow trading volumeSmall number of traders undertake majority of Small number of traders undertake majority of tradestrades


1111

Spot Cheese Market: Market Oversight Has Increased, Spot Cheese Market: Market Oversight Has Increased, but Concerns Remain About Potential Manipulationbut Concerns Remain About Potential Manipulation

Between Jan. 1, 1999 Between Jan. 1, 1999 –– Feb 2, 2007 closing price Feb 2, 2007 closing price determined by unfilled bids and uncovered offers:determined by unfilled bids and uncovered offers:

Blocks: 17% of trading daysBlocks: 17% of trading daysBarrels: 28% of trading days Barrels: 28% of trading days

% of Trades: Jan 1, 1999 % of Trades: Jan 1, 1999 –– Feb 2, 2007Feb 2, 2007


1212

Largest 2 Sellers: 68%Largest 2 Sellers: 68%Largest 3 Sellers: 67%Largest 3 Sellers: 67%

Largest 4 Buyers: 56%Largest 4 Buyers: 56%Largest 2 Buyers: 74%Largest 2 Buyers: 74%BarrelsBarrelsBlocksBlocks


Ratio of Monthly CME Spot Sales and U.S. Cheddar Production

0.00

0.75

1.50

2.25

3.00

3.75

4.50

5.25

6.00

6.75

Jan-00

Jul-00

Jan-01

Jul-01

Jan-02

Jul-02

Jan-03

Jul-03

Jan-04

Jul-04

Jan-05

Jul-05

Jan-06

Jul-06

Jan-07

Jul-07

Jan-08

Jul-08

Jan-09

Average %

Relationship between weekly average CME Spot Relationship between weekly average CME Spot and NASS Cheddar Block pricesand NASS Cheddar Block prices


1 .00

1 .25

1 .50

1 .75

2 .00

2 .25

1/15/009/15/005/15/011/15/029/15/025/15/031/15/049/15/045/15/051/15/069/15/065/15/071/15/089/15/085/15/09

C M E 2-W eek LagN ass

$/lb

( ) ( )2

0.006 0.004

NASS Cheddar Block Price =0.017 0.982CME Spot Price(-2) R 0.990+ =

1414

Class III futures and spot prices linked viaClass III futures and spot prices linked viaFMMO pricing rulesFMMO pricing rulesClass III futures cash settle to Announced Class IIIClass III futures cash settle to Announced Class III

Dec. 2008 CFTC Sanctioning of DFADec. 2008 CFTC Sanctioning of DFAMay 21May 21-- June 23, 2004 cheese spot market activityJune 23, 2004 cheese spot market activityDFA attempted to manipulate June, July and Aug. DFA attempted to manipulate June, July and Aug. 2004 Class III futures2004 Class III futures

Long in Class III futuresLong in Class III futuresFutures started to declineFutures started to decline


1515

“…“…attempted to manipulate Class III milk futures contract attempted to manipulate Class III milk futures contract prices through purchases of cheddar cheese blocks on the CME prices through purchases of cheddar cheese blocks on the CME Cheese Spot Call market in an effort to minimize potential Cheese Spot Call market in an effort to minimize potential losses from losses from DFADFA’’ss speculative long Class III milk futures speculative long Class III milk futures positionspositions…”…” (CFTC, 2008)(CFTC, 2008)

HanmanHanman (CEO) and (CEO) and BosBos (CFO) found guilty(CFO) found guiltyFined $12,000,000Fined $12,000,000Cannot trade for 5 yearsCannot trade for 5 years

http://future.aae.wisc.edu/pubs/pubs/show/408http://future.aae.wisc.edu/pubs/pubs/show/408

Similar relationship found between NASS and CME Similar relationship found between NASS and CME butter spot pricebutter spot price


1616

In marketing of farm milk dairy cooperatives have In marketing of farm milk dairy cooperatives have played a major role and has increased over timeplayed a major role and has increased over time

Coop Member Milk as % of U.S. Production

50

55

60

65

70

75

80

85

1957 1964 1973 1980 1987 1992 1997 2002 2007

Source: Ling, Marketing Operations of Dairy Cooperatives, variSource: Ling, Marketing Operations of Dairy Cooperatives, various issuesous issues

Concentration in the Marketing of Farm MilkConcentration in the Marketing of Farm Milk

1717

Source: Ling, Marketing Operations of Dairy Cooperatives, variSource: Ling, Marketing Operations of Dairy Cooperatives, various issuesous issues


1818

Dairy cooperative unification efforts in 1960Dairy cooperative unification efforts in 1960’’s s –– 19701970’’s s resulted in regional cooperativesresulted in regional cooperatives

Continued unification resulted in creation of multiContinued unification resulted in creation of multi--regional cooperativesregional cooperatives

Account for a significant percentage of U.S. milkAccount for a significant percentage of U.S. milkExample of Dairy Farmers of America (DFA) and Example of Dairy Farmers of America (DFA) and Land OLand O’’Lakes (LOL)Lakes (LOL)


1919


11.211.217,19317,19311MidMid--America Dairymen, IncAmerica Dairymen, Inc2.02.03,0893,0891313Western Dairymen, IncWestern Dairymen, Inc

3.13.11,4101,41044MidMid--America Dairymen, IncAmerica Dairymen, Inc0.20.21021029696Western Dairymen, IncWestern Dairymen, Inc

19961996Cooperatives Forming Cooperatives Forming DFADFA % of Top % of Top

100100Processing Processing

Sales ($ Mil)Sales ($ Mil)Processing Processing

RankRank

Milk Marketing Inc.Milk Marketing Inc.

AMPIAMPI--Southern Region*Southern Region*

Milk Marketing Inc.Milk Marketing Inc.

AMPIAMPI--Southern RegionSouthern Region

U.S. Prod. U.S. Prod. % %

Milk Milk MarketingsMarketings(Mil. Lbs)(Mil. Lbs)

Milk Milk Marketing Marketing Coop RankCoop Rank

4.54.57,0007,00033

3.43.45,2365,23677

0.80.8

0.80.8

353353

386386

3737

3535

Note: *Estimated. AMPI marketed 11,800 mil. lbs of farm milk aNote: *Estimated. AMPI marketed 11,800 mil. lbs of farm milk and was the 2nd was the 2ndnd

largest cooperative. The Southern Unit accounted for 32% of dailargest cooperative. The Southern Unit accounted for 32% of dairy processing sales.ry processing sales.


Dairy Farmers of America after formation, 1997:Dairy Farmers of America after formation, 1997:

25.225.2% of Coop Marketed Milk% of Coop Marketed Milk

26.226.2% of Coop Farms% of Coop Farms15.015.0% of U.S. Farms% of U.S. Farms

18,54318,543Number of FarmsNumber of Farms

20.220.2% of U.S. Production% of U.S. Production31,50031,500Milk Marketed (Mil. lb)Milk Marketed (Mil. lb)

2121


19971997Land OLand O’’Lakes and Lakes and

DairymenDairymen’’s Cooperatives Cooperative % of Top % of Top 100100

Processing Processing Sales ($ Mil)Sales ($ Mil)

Processing Processing RankRank

DairymenDairymen’’s Cooperative s Cooperative Creamery AssociationCreamery Association

Land OLand O’’ Lakes Lakes

DairymenDairymen’’s Cooperative s Cooperative Creamery AssociationCreamery Association

Land OLand O’’ Lakes Lakes

U.S. U.S. Prod. % Prod. %

Milk Milk MarketingsMarketings(Mil. Lbs)(Mil. Lbs)

Milk Milk Marketing Marketing

RankRank

2.72.74,2124,21299

7.87.812,20012,20022

1.11.1

3.83.8

499.4499.4

1,800.01,800.0

3030

55

Merger effective July 1, 1998Merger effective July 1, 1998

2222

Source: Ling, Marketing Operations of Dairy Cooperatives, VariSource: Ling, Marketing Operations of Dairy Cooperatives, Various Issuesous IssuesHoardHoard’’s Dairymen, Various Issuess Dairymen, Various Issues

Coop CR Values of U.S. Milk Marketed

15

25

35

45

55

65

75

1980 1987 1992 1997 2002 2007 2008

CR2 CR4 CR8CR10 CR20


2323

Source: Ling, Marketing Operations of Dairy Cooperatives, VariSource: Ling, Marketing Operations of Dairy Cooperatives, Various Issuesous IssuesHoardHoard’’s Dairymen, Various Issuess Dairymen, Various Issues

CR Values of Coop Milk Marketed

15

25

35

45

55

65

75

85

1980 1987 1992 1997 2002 2007 2008

CR2 CR4 CR8CR10 CR20


2424


Concentration in the marketing of farm milk: 2008Concentration in the marketing of farm milk: 2008

2.42.458.5958.5979794,6294,629Select Milk ProducersSelect Milk Producers1010

% of U.S. % of U.S. Prod.Prod.

Milk /Farm Milk /Farm (Mil Lbs)(Mil Lbs)

No. of No. of FarmsFarms

Milk Marketed Milk Marketed (Mil Lbs)(Mil Lbs)

82.382.33.47*3.47*43,448*43,448*156,399156,399All CooperativesAll Cooperatives

2.62.61.651.652,9452,9454,8574,857Manitowoc Milk Prod.Manitowoc Milk Prod.992.62.62.122.122,3562,3564,9904,990Foremost FarmsForemost Farms883.03.01.611.613,5633,5635,7515,751Family DairiesFamily Dairies773.13.11.661.663,5003,5005,8005,800AMPI (North Central)AMPI (North Central)663.13.12.612.612,2642,2645,9145,914DairyleaDairylea CooperativeCooperative554.24.214.8514.855325327,9007,900NW Dairy Assoc.NW Dairy Assoc.446.76.74.294.292,9652,96512,70612,706Land Land ‘‘O LakesO Lakes339.39.330.0530.0558958917,70017,700California DairiesCalifornia Dairies22

20.020.03.723.7210,17810,17837,90037,900DFADFA11

Note: * values for top 50 dairy cooperativesNote: * values for top 50 dairy cooperatives 2525

Source: 2001, GAOSource: 2001, GAO76.576.576.876.885.085.093.293.271.571.563.563.564.764.797.163.863.885.285.269.669.671.571.5

Dec '99Dec '99

74.774.772.472.411 11 MktMkt AverageAverage77.077.077.177.1Washington D.C.Washington D.C.84.284.284.884.8SeattleSeattle89.089.085.485.4Salt Lake CitySalt Lake City69.969.961.561.5New OrleansNew Orleans57.057.059.359.3MinneapolisMinneapolis62.762.763.163.1MilwaukeeMilwaukee98.296.596.5DallasDallas63.963.961.661.6CincinnatiCincinnati79.579.577.677.6CharlotteCharlotte70.470.468.568.5BostonBoston69.969.961.561.5AtlantaAtlanta

Dec '98Dec '98Dec '97Dec '97Market AreaMarket Area

Share of Milk Delivered by Four Largest Dairy CoopsShare of Milk Delivered by Four Largest Dairy Coops

U.S. CR41997: 35.82002: 40.22008: 40.1


2626

Dairy Industry: Information on Milk Prices and Dairy Industry: Information on Milk Prices and Changing Market StructureChanging Market Structure

GAOGAO--0101--561, June 2001561, June 2001

Dairy processing firms have become dominant Dairy processing firms have become dominant wholesale level playerswholesale level players

Similar to milk marketing business strategySimilar to milk marketing business strategyAcquire regional dairy processing plantsAcquire regional dairy processing plants

Concentration in Dairy ManufacturingConcentration in Dairy Manufacturing

2727

An argument has been made that another reason for An argument has been made that another reason for processing consolidation is the response to retail level processing consolidation is the response to retail level consolidationconsolidation

Dean Foods proposed 2009 purchase of 2 fluid Dean Foods proposed 2009 purchase of 2 fluid bottling plants from Foremost Farms in WIbottling plants from Foremost Farms in WI

““As food retailers consolidate to gain market share As food retailers consolidate to gain market share and operating efficiencies, Foremost Farms has been and operating efficiencies, Foremost Farms has been challenged to efficiently supply customers who have a challenged to efficiently supply customers who have a significant regional or national presence and prefer significant regional or national presence and prefer to have a sole supplierto have a sole supplier..””------ Dave Dave FuhrmannFuhrmann, , President, Foremost Farms, 4/7/2009President, Foremost Farms, 4/7/2009


2828

Dairy processing firms have become dominant Dairy processing firms have become dominant wholesale level playerswholesale level players

SuizaSuiza Foods and Dean Foods purchase more than 50 Foods and Dean Foods purchase more than 50 dairy processors over the 1997dairy processors over the 1997--2000 period2000 periodImportance of Dean Foods and Importance of Dean Foods and SuizaSuiza prior to mergerprior to merger


333,2553,255115,3655,36520002000333,2003,200224,2374,23719991999223,0003,000332,8202,82019981998332,1002,100441,7201,72019971997221,6001,600323246946919961996551,4001,400404037937919951995

RankRankMil $Mil $RankRankMil $Mil $Dean FoodsDean FoodsSuizaSuiza

2929

April 2001, April 2001, SuizaSuiza acquires Dean Foodsacquires Dean FoodsCombined company processes 33% of U.S. fluid milkCombined company processes 33% of U.S. fluid milkCombined company keeps DeanCombined company keeps Dean’’s name and s name and headquartered in Dallasheadquartered in Dallas

Dean Foods recent major acquisitionsDean Foods recent major acquisitions

Horizon Organic Holding Co.Horizon Organic Holding Co.20042004White Wave, Inc.White Wave, Inc.20022002

Foremost Farms 2 Bottling PlantsForemost Farms 2 Bottling PlantsAlproAlpro division of division of VandemoorteleVandemoortele N.V.N.V.

20092009

Company AcquiredCompany AcquiredYearYear


3030

National concentration ratios in dairy processingNational concentration ratios in dairy processing

National values hide concentration within local areas and National values hide concentration within local areas and commoditiescommodities

55.055.036.936.921.821.814.614.619951995

46.146.146.546.544.944.9

CR10CR10

67.367.366.166.164.564.5

CR20CR20

28.228.218.918.92008200828.528.517.417.42001200126.826.815.915.919991999

CR4CR4CR2CR2YearYear


Source: Dairy Foods, Top 100, various issues.Source: Dairy Foods, Top 100, various issues.

3131

Source: 2001, GAOSource: 2001, GAO

54.554.543.743.745.745.7Wash. D.C.Wash. D.C.96.396.396.589.489.4MiamiMiami

66.966.979.479.481.981.973.973.988.188.152.452.4

Dec '99Dec '99

68.168.184.384.379.379.374.774.785.485.447.847.8

Dec '98Dec '98

69.369.385.085.066.866.864.464.466.266.238.5

Dec '97Dec '97

DenverDenver

DallasDallas

CincinnatiCincinnati

CharlotteCharlotte

BostonBoston

AtlantaAtlanta

AreaArea

75.675.6

63.363.392.592.597.452.452.483.483.475.975.9

Dec '99Dec '99

74.274.269.069.01414--Market Market AverageAverage

63.463.459.059.0SeattleSeattle

90.490.487.787.7S.L. CityS.L. City

87.687.690.390.3PhoenixPhoenix

47.847.838.5New OrleansNew Orleans

89.389.384.084.0Minneapolis.Minneapolis.

80.380.381.681.6MilwaukeeMilwaukee

Dec '98Dec '98Dec '97Dec '97AreaArea

Percentage of Fluid Milk Marketed by Four Largest ProcessorsPercentage of Fluid Milk Marketed by Four Largest Processors

3232


1999 U.S. CR4: 26.8

Antitrust suit filed against DFA, Dean FoodsAntitrust suit filed against DFA, Dean Foods ----Cheese Market News, October 9, 2009Cheese Market News, October 9, 2009

Private class action lawsuitPrivate class action lawsuitDean and Hood bottle 90% of fluid milk in the Dean and Hood bottle 90% of fluid milk in the NortheastNortheastSuite alleges unlawful agreements between Dean, Suite alleges unlawful agreements between Dean, DFA, Dairy Marketing Services and Hood to DFA, Dairy Marketing Services and Hood to reduce farm pricesreduce farm prices

DFA says recent allegations are without basisDFA says recent allegations are without basis ----Cheese Market News, October 16, 2009Cheese Market News, October 16, 2009

Background story can be found at:Background story can be found at:http://http://future.aae.wisc.edu/publications/dfa_suit.pdffuture.aae.wisc.edu/publications/dfa_suit.pdf


3333

Contact InformationContact Information

Univ. of Wisconsin Understanding Dairy MarketsWebsite: http://future.aae.wisc.edu

Brian W. Gould(608)[email protected]

Documents

Structural Change and Competition In the U.S. Dairy … · Structural Change and Competition In the U.S. Dairy Industry ... Dec. 2008 CFTC Sanctioning of DFA ... 9 4,212 2.7 2 12,200