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Case Study: Dairy Industry: Price Forecasting and Optimization

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Dairy Industry: Price Forecasting and Optimization

An interview with Kevin Christensen

The Company

U.S. dairy farmers (both cooperative members and independents, located in 12 states).

The Challenge

The dairy farmers wanted to know if they were receiving fair market value pricing for their milk and if structural factors within the regions and the cooperatives could be changed to improve the farmers’ economic standing going forward.

In much of the United States, the price that farmers receive for their raw milk is regulated. The “federal minimum” guarantees that farmers receive a minimum price for the milk sold to processing plants. In some regions, however, the federal minimum is not a binding price floor, and the market price is (or should be) above the federal minimum. The difference between the federal minimum price and the market price is commonly referred to as the over-order premium. Whether dairy farmers are eligible for an over-order premium depends on factors including:

  • Number and production capabilities of dairy cows physically located in the region
  • Dairy processing capacity and capacity utilization
  • Weather conditions
  • Ability to profitably import raw milk from outside the region
  • Federal minimum price formulae
  • Fluctuations in the market price for finished dairy products

The Solution

A statistical model was developed, leveraging historical “milk check” data and other controls for the variables previously stated. Historical data from the farmer milk checks were analyzed to determine how the price received changed relative to the federal minimum and the over-order premiums negotiated and announced by local cooperatives. In addition, fees charged to cooperative members were analyzed to determine if they were reasonable based on concurrent economic factors. The quantitative analysis was accompanied by a separate but related qualitative analysis. That analysis involved a review of contemporaneous documents and USDA hearings to add greater context and understanding of what factors may exist that unnecessarily constrain the price of raw milk.

The Results

The results of the analysis showed that a higher price for milk could be achieved than had been compensated for, given the supply and demand conditions. The qualitative analysis identified areas where structural changes could help facilitate higher raw milk prices in the future. Ultimately, this analysis was used to increase compensation paid to farmers for their milk and implement changes that may prevent suboptimal pricing going forward.