Monday, October 12, 2009

Why has the Make Allowance Changed so Much?

Many factors point to a recovering dairy market, however, full recovery is still in the future. Through 2007 and the early part of 2008 milk prices were very high. During that time, the cheese makers were able to get significant increases in the make allowance in the Federal Milk Marketing Order milk pricing formulas.

In the April 7 post to this blog, the formulas were reduced to the simplest form to illustrate the importance of cheese prices in the formulas. To arrive at the standard Class III milk price, one can multiply the cheese prices times 9.6, the dry whey price by 5.9 and the butter price times just .4.

Then one needs to subtract the make allowances (the cost to convert the milk to cheese, whey, and butter). For the current formulas that is $3.17/cwt of milk.

Class III Milk Price = + 9.6 x Cheese Price + 5.9 x Dry Whey Price + 0.4 x Butter Price - $3.17

Over the course of 2007 and 2008, the make allowances were increased by a significant 23%. This amounts to $.60/cwt re-allocated from the dairy producer to the cheese producers.

If the pricing formula changes were evaluated at September 2009 Class III component prices, it would make a significant change in what the dairyman receives.

(Due to rounding, the actual Class III price differs slightly from the simplified calculation.)

  1. The increases in make allowances were made during a period when milk prices were high - see the chart below. The red arrows mark the dates when the make allowance changes were effective. There was no decrease in the make allowance when milk prices deteriorated. The reallocation of funds from the milk producer to the cheese producer stayed in place in spite of high losses to producers. The $.60 change is obviously a much bigger percentage to the milk producer when milk prices are low.

  2. Cheese manufacturing has reached significant economies of scale, and new cheese plants are being built with a high degree of automation and the capability to very precisely blend ingredients. While automation is expensive, it is never used unless there is a significant return on investment through cost reduction for the expenditure. The cost to make cheese should be going down, not up.

If the U.S. is to remain a major supplier to the global cheese markets, all factors in the chain must be extremely efficient. If there is no pressure to improve, there will be no improvements. A reasonable and comfortable make allowance does not create pressure to improve.

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