Virtually all animal agriculture faces hard times right now, but dairying is especially hard-pressed. Milk prices have fallen by half since last year, to their lowest level in 30 years — even without adjusting for inflation. Although feed prices have fallen from 2008’s record levels, dairy farming remains deeply unprofitable. A once-healthy export market for dairy products has dried up. And there is little relief in sight.
Indeed, the dramatic changes in the structure of Midwest dairying over the past decade or two will delay the industry’s return to profitability.
Adverse fluctuations in milk and input prices are not new to any farm sector, including dairying. Ups and downs in prices began millennia ago when subsistence peasants began selling some of their products to others. But the amplitude of dairy price swings over the past three years is extreme.
As with many farm products, both the demand for and supply of milk is “inelastic.” That means the quantities consumers are willing to buy or producers are willing to sell don’t vary greatly with price. In such situations, small shifts on other nonprice factors that influence buying or producing decisions cause large shifts in price. And structural changes in the dairy industry have made supply even more inelastic in the short and medium run than it used to be.
Until quite recently, U.S. dairying was dominated by farms small enough that only family labor was needed. In 1909, that typically meant 8 to 10 cows. Mechanized forage handling and milking machines boosted that to 30 to 45 by 1959 and perhaps 80 to 150 by 1989, at least east of the Rockies.
Southern California was an early exception. Favorable weather allowed dairying with minimal facilities. Federally subsidized irrigated alfalfa was a year-round forage source. Herds were much larger, more mechanized and used much more hired labor. As land prices rose in the Los Angeles area, this dairy model moved elsewhere in California and to places like Arizona and Idaho with similar arid climates and capacity for irrigated alfalfa. Such farms often milked as many as 1,000 cows and in some cases more than 2,500.
That model spread to the Midwest in the mid-1990s. When I grew up in Murray County, Minn., 50 years ago, a 100-head herd was enormous. Now, there is a 3,500-head operation a few miles to the west and a 7,000-head one just across the Iowa border.
The cost structure of these new, highly capital-intensive operations is different than traditional ones. Supply — a producer’s willingness to sell different quantities at different prices — depends on costs. A producer will produce another gallon only if the extra revenue he gets from selling it exceeds the extra cost of producing it. Reduce price, and you usually cannot justify producing quite as much.
But in today’s conditions, the adjustment is small.
In the old days, lower prices would motivate dairy farmers to cull their least productive cows, let a few stalls at the end of the barn sit empty and use the labor saved for some other more productive use.
Variable costs that fall as one cuts output, like feed, labor or electricity, were large relative to fixed costs like principal and interest on the barn and machinery.
Now, that is reversed, and the fixed cost of amortizing capital-intensive facilities is large compared to the variable costs. As long as the price of milk at least pays the variable costs, a rational manager will produce full out, trying to pay as much of the fixed-cost bill as possible.
Current milk prices are not high enough for such facilities to pay all their costs, and if prices don’t increase in the long run, these operations will go bankrupt. In the meantime, producing absolutely as much as can be justified by the milk-price vs. variable-cost tradeoff staves off the day of financial reckoning as long as possible.
In the traditional model, hundreds of thousands of individual producers, each with a string of 30 cows, would send two or three poor-producing cows to slaughter. This would cut milk production, and prices would recover. (Although hamburger prices would drop. )
In today’s highly capital-intensive model, production falls only when big operations go bankrupt. Even that helps less than one might think, because if someone else can scoop up the foreclosed-on facilities for cents on the dollar, it may make sense to put them back into use.
If low milk prices happen to coincide with high prices for beef, the adjustment is easier, because the value of a cull for meat is higher relative to the cow’s worth producing milk. But beef is in the doldrums, too, and the dairy culling going on will further suppress these prices.
Tight credit will make it harder for opportunists to scoop up foreclosed facilities and put them back into production. But the credit crunch and lenders’ own shaky financial status makes them unwilling or unable to exercise much forbearance toward existing financially stressed operations.
The prolonged low prices engendered by failing large-scale operations affect remaining traditional Midwest-style operations just as harshly.
It is a brutal situation out there, and it isn’t going to get better anytime soon.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.