Pricing Milk in 2019: A Marketing Coach on Doing Something or Nothing

Lee Gross, FYP Consulting

Robin Schmahl, Marketing Coach at FYP Consulting

What’s your plan for pricing milk in the New Year?  Will you use the new Dairy-RP program?  Do some hedging?  Forward price with your processor?  Or stay on the sidelines and take what’s offered?  Robin Schmahl ([email protected]) is our marketing coach at FYP Consulting and helps producers with marketing decisions every day of the week.  I had a conversation with Robin about the pros and cons of milk pricing choices, including doing nothing.  We also talked about what’s needed to have confidence in a marketing plan (spoiler alert: an honest and accurate cost of production!).

A lightly edited transcript of our conversation follows.

Lee Gross

What’s your advice to dairy producers for 2019?

Robin Schmahl

Be a price maker - not taker - and stay in business.

Lee Gross

What do you mean “price maker”?  Don’t dairy producers take what’s offered?

Robin Schmahl

That’s part of the problem.  We’re accustomed to taking what’s offered.  Marketing tools enable us to secure profitable prices as well as capture higher prices if the market moves up.  And remember that marketing tools are just as useful to a small dairy as a large one.

Lee Gross

And “staying in business” - that seems obvious but be more specific.

Robin Schmahl

Staying in business means covering all costs - fixed costs like depreciation, insurance, property taxes, loan payments, and salaries paid, as well as cash costs like wages, feed, repairs, vet, and consultant fees.  Staying in business also means taking sufficient owner family living draws to maintain the desired standard of living.

Lee Gross

That means that a producer needs to know their total cost of production, right?

Robin Schmahl

Yes.

Lee Gross

So how does a producer get an honest and accurate cost of production, one they have confidence in?

Robin Schmahl

Confidence is the key word.  Marketing milk without knowing cost of production is (or should be) scary.  Is the price offered high enough to cover all cost of production?  Producers need to treat their dairy as a business and do the same things that other successful businesses do.  That includes knowing exactly what producing milk costs.

Obtaining an accurate cost of production requires help from the dairy’s accountant, nutritionist, and the management team/owner.  Each has specific information to contribute to calculating cost of production.

Lee Gross

I’m a fan of calculating three costs of production:  1. Just enough to stay in business with a bare-bones family living draw.  2. The items in “A.” plus funds to keep machinery and equipment updated, and have a year-to-year satisfactory family living draw.  3. The items in “A.” and “B.” plus profit to expand or retire debt at a faster pace, a family living draw sufficient to put kids through college, fund retirement accounts, and support personal hobbies and interests.  Having three costs of production in hand shows what’s possible as milk prices move up and down.

Let’s shift to milk marketing.  Marketing tools have been available for many years yet many producers don’t use them and stay in the cash market.  Why is that?

Robin Schmahl

There is apprehension about taking a position or committing to a price then missing the upside if prices move higher.  There is also the element of unfamiliarity with marketing tools and strategies.  Plus it takes time for producers or someone on the dairy to learn marketing and monitor market changes.  Also, some producers have had a past bad experience which limited the upside or felt they didn’t “make money” marketing.

Lee Gross

Well, isn’t making money the point?  Or is the point to stay in business like you said earlier?  Or both?

Robin Schmahl

There is an element of both. You need to make money in order to remain in business and you need to remain in business in order to make money. The focus of a good marketing strategy is to capture high prices AND limit downside losses.  There’s no point in losing money month after month waiting for the milk price to go up.

Lee Gross

What’s the best thing that can happen if a good marketing plan is implemented?

Robin Schmahl

Three things:  1. Peace of mind knowing there’s a floor under milk prices and a limit to monthly losses when prices are low.  2. Peace of mind knowing that higher milk prices will be captured if the markets move up.  3. Confidence knowing all costs are covered, all bills will get paid, loan payments made, and satisfactory family living draws made available.

Lee Gross

What’s the worst thing that can happen if a marketing plan is implemented?  Is there a downside?

Robin Schmahl

Producers may feel they give up profit by missing the highest prices of the year.  But those concerns are offset by the upside we already talked about - knowing they are selling for a price that will cover all costs and return a profit, keeping them in business another year.

Also, some producers misinterpret how hedging accounts work.  They may see their hedging account increase in value, not realizing that this is the result of milk prices declining.  Let’s say 50% of milk is hedged at $16.00 and the market declines to $15.00.  The hedging account value grows, but overall income declines as the total value of milk is $15.50.  The reverse, seeing the hedging account decline in value, is better. If milk price moves to $17.00, the account loses value, but the value of milk hedged increases to $16.50. This example uses a forward contract or futures position.  By contrast options or option strategies allow more flexibility with higher prices captured.

Lee Gross

Let’s walk through the pros and cons (best and worst) of each of the marketing choices available in 2019.

Robin Schmahl

Cash/doing nothing - Pros: Getting the top prices offered.  Cons: Taking the lowest prices offered.

 

Tool Pros Cons
Cash – Do Nothing Getting the top prices offered Taking the lowest prices offered
Forward Contracting with Processor Protect the milk price from going lower and/or protecting profit Committing to a price below cost of production without tools in place to capture price increases, i.e. giving up upside opportunity
Futures Protecting a price that is profitable Margin calls that deplete cash and require a line of credit
Options Provides a milk price floor and leaves upside open Forfeiting premiums if prices rise
Dairy-RP Ability to choose types of coverage and government subsidizes for much of the premium, plus allows capture of higher prices Covers a quarter of the year instead of monthly like other tools so milk price swings within the quarter may result in no protection.  Also, small time window each day to obtain coverage (4 pm Central to 9 am Central) requiring close monitoring
Margin Protection Program (MPP) Good coverage at a reasonable cost (with new farm bill changes) May forfeit premium and not get paid.  Note: Can use MPP and Dairy-RP on same milk
Livestock Gross Margin (LGM) Protects IOFC (Income Over Feed Costs) if costs are known Protects margin only that can be a problem when milk and feed prices drop together - while dairy’s feed price may not be dropping.  Also, milk price is not protected.  Note: Cannot use LGM and Dairy-RP for same milk

 

Forward Contracting with processor - Pros: Protect the milk price from going lower and/or protecting profit.  Cons: Committing to a price below cost of production without tools in place to capture price increases, i.e. giving up upside opportunity.

Futures - Pros: Protecting a price that is profitable.  Cons: Margin calls that deplete cash and require a line of credit.

Options - Pros: Provides a milk price floor and leaves upside open.  Cons: Forfeiting premiums if prices rise.

Dairy-RP - Pros: Ability to choose types of coverage and government subsidizes for much of the premium plus allows capture of higher prices.  Cons:  Covers a quarter of the year instead of monthly like other tools so milk price swings within the quarter may result in no protection.  Also, there’s a small time window each day to obtain coverage (4 pm Central to 9 am Central) requiring close monitoring.

Margin Protection Program (MPP) - Pros: Good coverage at a reasonable cost (with new farm bill changes).  Cons: May forfeit premium and not get paid.  Note: Can use MPP and Dairy-RP on same milk.

Livestock Gross Margin (LGM) - Pros: Protects IOFC (Income Over Feed Costs) if costs are known.  Cons: Protects margin only that can be a problem when milk and feed prices drop together - while dairy’s feed price may not be dropping.  Also, milk price is not protected.  Note: Cannot use LGM and Dairy-RP for same milk.

Lee Gross

Milk marketing has a lot of moving parts.  Since FYP Consulting offers market planning services this next question is self-serving but needs to be asked:  Is it reasonable to expect a dairy producer to manage a marketing plan or should they be getting help like they already do with vet, nutrition, tax preparation, and legal work?

Robin Schmahl

Producers are focused on production and wear many hats.  Creating and executing a marketing plan requires commitment - either someone on the dairy with time and skill available or a hired consultant.  How much time does a producer have available to gather accurate cost of production information, write a marketing plan using the best tools for them, and monitor and execute that plan?  It can also be reassuring to have someone to talk to when the markets are gyrating.

Lee Gross

What are your closing words of wisdom for dairy producers going into 2019?

Robin Schmahl

Accept that milk marketing is as important to long-term success as everything else on a dairy. Marketing is not an option, it’s a necessity to capture profit, build equity, and limit losses.

First step for the New Year:  Commit to learning your cost of production.  Seek help if you don’t have the time or means to get that done.  Contact us at FYP Consulting if you’d like to discuss how to get started. The authors may be contacted at  www.fypconsulting.com

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