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How important is it in determining pay price?
By Ed Maltby, NODPA Executive Director
Added March 17, 2014. Producers continually struggle to have an equitable system for determining milk pay price that is easily explained to consumers; a price that both reflects the consumer’s willingness to pay extra for a high quality, environmentally-sound product, and that accurately reflects the costs of producing it. With non-organic milk there is an easy way to determine what share of the retail price goes back to farmers and many producers have suggested that there should be the same for organic milk. Many surveys suggest consumers believe that paying extra for organic milk means that producers are compensated for the higher cost of farming using environmentally sound practices without government subsidies, antibiotics, growth hormones and GMO’s. The reality is that producers are not compensated enough. If we are to use the share of the retail dollar as an argument to increase the organic pay price, we need to use the same independent criteria generated by the USDA Agricultural Marketing Service (AMS) that non-organic dairy uses in order to have an effective comparative measurement.
The non-organic producer’s farmgate pay price averages 50% of the retail price. This is determined through the data compiled by USDA AMS and the Federal Milk Marketing Order (FMMO). To determine the national average retail price for both organic and non-organic, the USDA AMS Dairy Market News surveys nearly100 retailers, comprising over 14,000 individual stores, with online weekly advertised features once every two weeks. With non-organic production there is constant monitoring of the farmgate pay price 1 so the calculation on the share of the retail dollar is very straightforward – take the average retail price and divide by the farmgate price, factor in an allowance for butterfat2. This is a very unsophisticated calculation for non-organic as it doesn’t take into account all the other uses of milk and milk by-products and the fact that under 50% of milk is sold as fluid products. Other products, more highly processed and refined with true added value, such as cheeses, yogurts, creams and even more differentiated products, represent where milk really obtains value. Applying the non-organic process in determining the producer share of the retail dollar to organic is more difficult and less accurate. In organic dairy we do not have the depth of independent data for fluid milk, nothing on the value of butterfat and no independent data on farmgate price/blend price/NASS all-milk price that can be used to determine what producers receive. On the positive side it is estimated that 75% of organic milk is sold as fluid, so the fluid retail price is more relevant, and more organic milk is sold as whole milk than non-organic (approximately 25% is sold as whole milk) so factoring in the price of butterfat is slightly less important. NODPA and The National Organic Coalition have campaigned for many years for more investment in data gathering for organic dairy, and over the last six years that has improved but recent budget cuts have resulted in a contraction of this service.
Using a retail price as an indication of true value to the consumer or it’s own value in the marketplace has a few challenges. Fluid milk, both organic and non-organic, is used as a loss leader to encourage consumers to shop at different stores, so the retail price does not necessarily reflect the standard margins that retailers use with other products or what the consumer is willing to pay. Organic dairy is also seen as an entry point for consumers who do not yet purchase organic products, so may be heavily discounted to attract new consumers and to compete with other specialty product stores, for example between Whole Foods and Trader Joe’s. Horizon Organic is now using the reputation of its branded milk product to sell other non-dairy organically-certified products. Ironically, processors have found that positioning other non-dairy beverages and juices like soy and almond milk in the organic dairy refrigeration case increases sales for those products, especially when the retail price gap between organic and non-organic dairy products is small.
Comparing the share of the dollar that organic producers are left with to the non-organic share is complicated by a different pricing structure. There is a greater range of prices for organic than in non-organic. On the lower end, there is the retail price of store brand product which can be as low as $2.50 per ½ gallon (two ½ gallons for $5). There are also in-store promotions for set periods of time to encourage sales in competitive markets where ½ gallons have been as low as $2.40 per ½ gallon. For the majority of stores, the retail price of branded product will be between $3.50 to $4.99 per ½ gallon, with the higher prices found in the Northeast and the lowest in the Northwest. The higher price for branded organic ½ gallons is approximately $4.99 which would be found in areas with a lower volume of sales of organic, poor distribution, or no competition.
Determining the share of the retail dollar
Since 2006, NODPA has been compiling data on retail pricing, but it was not until 2008 that organic retail prices were included in the USDA AMS Dairy Report. As the chart (below) shows, the average organic retail price from 2008 to 2014 is $3.65 per ½ gallon, with a high of $3.93 in July, 2012 and a low of $2.88 in March, 2012. The chart shows the downward trend in the retail price of a ½ gallon of organic milk. Over the last few years, there has been no difference in retail pricing for the different fat-types of milk from Whole Milk to Fat Free.
In the absence of any independent data on pay price NODPA has taken the various packages paid by the leading brands and calculated a year round price averaging the seasonal payments and deductions. (For more detail on pay price from 2006 to 2013, please go to the NODPA Home page and click on “Pay price Summary Chart 2006-2013.”) In 2006, the average year-round pay price per hundred pounds in the Northeast, including seasonal payments and MAP, but without components, was $26.50. In 2008, that price increased to $28, and in 2012, to $31. The chart and table below shows the share of the retail dollar graphically, with approximately $1.50 added for components on top of the calculated base, plus MAP prices to reflect more of an average farmgate price for the Northeast. With a lower pay price in the West, the percentage share of the retail dollar is less.
You will notice that as the retail price averages go down, the share of the retail dollar increases. The pay price does not change proportionately with the changes in retail price. Although the costs of organic inputs are at the highest level since organic records have been kept, the average retail price is dropping. If the pay price was tied to a percentage of the retail price, processors might lower the average retail price which would lower pay price to control their costs and by doing so maintain their margins.
Who sets the retail price?
The simple answer is that the retailer sets the retail price. Short of access to the confidential business information of stores, distributors, processors and marketers, the exact journey of money from that gallon of milk at the checkout to its ultimate recipients cannot be known. The processor sets the price they sell to the retailer or distributor and that price is set differently for branded product and store brand. The processor will have to factor in their costs but also what the market will stand. If your competitor is pricing low to increase sales, do you follow them down or maintain your price? Do you give the retailer other incentives, for example in-store promotions, volume discounts, shelving fees, advertising credits, direct supportive marketing, reductions in other products that make up your “basket” of products presented to the retailer, or refuse the contract? Competition in the store brand products is particularly sharp, plus in-store promotions will skew the data especially where the major brands are competing heavily as the retailer’s share is subsidized by the brand.
The retailer takes the price they pay and adds their margin. In the early days of organic milk, when organic dairy wasn’t a commodity, the retailer would normally be looking for a 30% share of the retail dollar. With the increase in store brand product, the retailer buys at a lower price than branded product and may also choose to lower its share to stimulate sales, and also attracts organic consumers to other products where the margins will be higher (loss leader). This practice results in pricing of $2.50 per ½ gallon, with more consumers gravitating toward the cheaper store brand product, especially new consumers, but with an increase in volume that benefits the retailer.
Is the organic producer’s share of the retail
dollar irrelevant in any discussion of pay price?
Organic pay price changes have come from shortage of supply (increase of $4 from 2003 to 2006); increased competition when HP Hood entered the market; and most recently increases in the Market Adjusted Premiums (MAP) when high feed costs threatened supply. Coincidently, those increases happened at the same time as the producer share of the retail dollar increased and the average retail price decreased. Using the existing data, we would need a $3 increase on base price to bring the share of the retail dollar up to the same level as non-organic, assuming the retail price does not drop. History shows that an increase in pay price has no direct effect on the average retail price.
When looking at calculating pay price, an easier place to start is with costs of production and a pay price that gives an adequate Return On Investment (ROI) to re-invest in the farm (an essential part of organics), a modest family income (in the $60,000/year), and an ability to service all debt so producers have at least 60% equity against liabilities. Available data and reports from producers suggest that non-organic dairy will be more profitable than organic dairy for 2013 and 2014 based on accepted financial comparisons like ROI and net income. How we use the limited existing data to determine an equitable organic pay price and how this might be tied in with the new margin insurance program in the Farm Bill could be a way to address a pay price that is falling behind costs of production. But that is another article...