Fluid Milk: Farm and Retail Prices and the Factors That Influence
Them (14-MAY-01, GAO-01-730T).					 
								 
This testimony discusses fluid milk prices and the factors that  
influence them. GAO's work shows that while the farm price of	 
milk has some influence on the retail price, other factors may	 
ultimately have a greater influence on the retail price. Given	 
that farm prices account only for about 40 percent of the retail 
price, there is adequate opportunity for other factors, such as  
wholesale processing costs and retail pricing strategies, to	 
significantly influence the other 60 percent of the retail price.
This testimony summarized the October 1998 report, RCED-99-4.	 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-01-730T					        
    ACCNO:   A00994						        
  TITLE:     Fluid Milk: Farm and Retail Prices and the Factors That  
             Influence Them                                                   
     DATE:   05/14/2001 
  SUBJECT:   Dairy industry					 
	     Prices and pricing 				 
	     Dairy products					 

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GAO-01-730T
     
Subcommittee on Agriculture, Rural Development, and Related Agencies,
Committee on Appropriations, U. S. Senate

United States General Accounting Office

GAO For Release on Delivery Expected at 8: 30 a. m., Monday, May 14, 2001
FLUID MILK

Farm and Retail Prices and the Factors That Influence Them

Statement of Robert A. Robinson, Managing Director, Natural Resources and
Environment

GAO- 01- 730T

Page 1 GAO- 01- 730T Farm and Retail Milk Prices

Mr. Chairman and Members of the Subcommittee: Thank you for the opportunity
to discuss our work on fluid milk prices. Our statement today is based
primarily on our October 8, 1998, report entitled Dairy Industry:
Information on Prices for Fluid Milk and the Factors That Influence Them
(GAO/ RCED- 99- 4). 1 As you know, the process by which milk prices are set
is a very complex one. This is because milk prices are influenced by a
variety of federal and state programs that regulate the production and sale
of milk and because several entities are involved in the process of moving
milk from the farm to the consumer. Each of these entities- dairy farmers,
cooperatives, wholesale milk processors, and retailers- perform distinct
functions relating to the processing and marketing of milk, and each
receives a portion of the price of milk. At your request, our comments today
will focus on the relationship between farm- level and retail- level milk
prices and the factors that influence the price of milk as it moves from the
farm to the consumer.

In summary, for the period January 1996 through February 1998, we found the
following:

 On average, farmers received about 42 percent of the retail price of a
gallon of 2- percent milk (the most frequently purchased milk), and
retailers received about 17 percent; the spread between farm and retail
prices increased in most of the markets we reviewed.

 Changes in fluid milk prices at the farm level generally did not mirror
similar price changes at the retail level in most markets. This is because
as milk passes through various processing, packaging, and distribution
stages after it leaves the farm, a variety of other factors begin to
influence its price. For example, at the wholesale level, the costs of
pasteurization, packaging, and transportation, have a major influence on
milk prices, and for some retailers the pricing strategies used by other
retailers may have a significant influence on the prices that consumers pay
for milk at the retail level. Consequently, as milk moves farther from the
farm, farm prices may have less of an impact on prices than these other
factors.

1 We are currently updating the information included in the October 1998
report, at the request of Senators Feingold and Leahy, and expect to issue
our updated report in June 2001.

Page 2 GAO- 01- 730T Farm and Retail Milk Prices

U. S. dairy farmers produce about 20 billion gallons of raw milk every year.
The top four milk- producing states in the United States are California,
Wisconsin, New York, and Pennsylvania. About 7 billion gallons of the
nation?s milk is used to produce fluid milk products such as the four kinds
of milk- whole, 2- percent, 1- percent, and skim milk- as well as buttermilk
and flavored milk, yielding about $22 billion in retail sales annually.
Sales of 2- percent milk sold in gallon containers account for the largest
volume of retail fluid milk sales in the United States.

Fluid milk reaches the consumer by a variety of pathways. Dairy farmers who
produce the raw milk used in fluid products can (1) market it through dairy
cooperatives, (2) sell it directly to wholesale milk processors, or (3)
process it into fluid milk for direct sale to consumers. Most milk produced
by dairy farmers in the United States is marketed through dairy
cooperatives. Dairy cooperatives, in turn, can either sell, or arrange the
sale of, raw milk purchased from farmers to wholesale milk processors, or
they can process it into fluid milk and distribute the fluid milk to retail
outlets themselves. Wholesale milk processors process and package the raw
milk into fluid milk, which they then distribute to retail outlets.
Wholesale milk processors include independent bottling plants or retail food
chains that own bottling plants. Retail outlets purchase fluid milk from
processors for direct sale to consumers.

Most milk produced in the United States is regulated under either federal or
state programs. These programs ensure that farm prices do not fall below a
minimum level and provide a safety net for individual farmers who lack
market power compared with other entities, such as wholesale milk processors
and retailers. The primary federal programs include the milk marketing order
and dairy price support programs. Currently, about 70 percent of the milk
produced in the United States is regulated under the federal milk marketing
order program. The federal program sets minimum prices that can be paid to
farmers for unprocessed, fluid- grade milk in specified marketing order
areas. These prices vary by the class of product for which the milk is used,
and, for some classes, the minimum price also varies by location. 2 Some
areas, such as California, which are not under the federal milk marketing
order program, are covered by state programs. In these areas, dairy farmers
are paid the minimum milk prices that are

2 The four usage classes are Class I for fluid milk; Class II for soft
manufactured dairy products such as yogurt and ice cream; Class III for hard
cheese; and Class IV for butter and powdered milk. Background

Page 3 GAO- 01- 730T Farm and Retail Milk Prices

established by the state government. These minimum prices may be higher than
federal minimum prices. 3

Dairy farmers selling milk within a federal milk marketing order receive an
average price, or blend price, that is based on the weighted average of the
prices for the four usage classes for all the raw milk sold in that
marketing order. The average price of milk they receive depends, in part, on
the extent to which the total milk supply in a specific area is being used
for fluid or manufacturing purposes. Buyers of milk regulated by federal and
state programs are permitted to pay farmers prices in excess of the
established minimums- known as over order premiums. Any such excess payments
are determined by market forces.

In our 1998 report, we analyzed milk prices for the period January 1996
through February 1998, for 31 selected markets across the country, including
the Philadelphia, Pennsylvania, market. We found that on average, farmers
received 42 percent of the retail price for a gallon of 2- percent milk,
cooperatives received 10 percent, wholesale milk processors received 31
percent, and retailers received 17 percent. 4 However, the portion received
by those in various stages of the milk marketing chain varied substantially
among the markets. For example, the portion of the average retail price that
farmers received ranged from about 31 to 54 percent, and the portion that
retailers received varied between about 4 and 31 percent. 5 For the
Philadelphia market, we found that farmers, on average, received 42 percent
of the retail price of a gallon of 2- percent milk and retailers received 20
percent.

Furthermore, we found that retail prices for a gallon of 2- percent milk
remained constant or increased in 27 markets and decreased in 4 markets
during the review period. In contrast, farm prices decreased in 27 markets

3 In addition to federal and state regulatory programs that set minimum milk
prices, in 1996, the Congress approved the creation of the Northeast
Interstate Dairy Compact for six New England states. The Compact supplements
federal and state programs by setting the minimum price to be paid to
farmers for fluid milk marketed in the six- state area. The Compact is
scheduled to terminate, unless reauthorized, by September 30, 2001.

4 For the 1998 report, our detailed analysis focused on data for 2- percent
milk; consequently our results may not reflect pricing patterns and trends
for whole, 1- percent, and skim milk.

5 Except for one market where retailers received a negative return because
milk was being used as a loss leader. Analysis of Farm- toRetail

Prices

Page 4 GAO- 01- 730T Farm and Retail Milk Prices

and remained constant in 4 markets. As a result of these price changes, the
spread between farm and retail prices had increased in 27 of the 31 markets
over the 26- month period we reviewed. In the Philadelphia market, we found
that between January 1996 and February 1998 the farmlevel price had
decreased by about 13 cents while retail prices had remained constant. As a
result, the difference between farm and retail prices had increased by about
13 cents per gallon.

In addition, retail prices for the four kinds of milk- whole, 2- percent, 1-
percent, and skim- varied significantly in the 31 markets we reviewed. For
example, in some markets, 1- percent milk was the lowest- priced milk sold
at the retail level; in other markets, skim milk was the lowest- priced
milk; and in still other markets, the lowest- priced milk sold in retail
stores shifted among 2- percent, 1- percent, and skim milk. For the period
we reviewed, in the Philadelphia market, skim milk was the lowest- priced
milk sold, averaging about $2.31 per gallon and whole milk was the highest-
priced, averaging about $2.58 per gallon.

In 1998, we reported that for the period January 1996 through February 1998,
changes in prices at any given stage in the milk marketing chain were most
often reflected in changes in prices at the next stage. For example, in most
of the markets we analyzed, there was a strong correlation between changes
in farm prices and changes in cooperative prices- the next stage in the milk
distribution process. Similarly, changes in wholesale prices generally
correlated with changes in retail prices. In contrast, changes in prices
received by farmers less frequently correlated with changes in retail
prices. This is because as milk moves from the dairy farm to the consumer it
passes through various processing, packaging, and distribution stages, and
many factors other than the farm- level price begin to influence fluid milk
prices at each subsequent stage. In particular, we found that supply and
demand forces influence milk prices at all stages of the milk marketing
process; however, the following factors influence milk prices at each
particular stage:

 Federal and state dairy programs have a major influence on farm- level
prices for raw milk used in fluid products. These programs provide farmers
with the assurance that milk prices will not fall below the government- set
minimums and therefore may play a significant role in the production
decisions of dairy farmers.

 The price that cooperatives charge wholesale milk processors for fluid
milk is influenced not only by the minimum price established by federal
Relationship Between

Farm and Retail Milk Prices

Page 5 GAO- 01- 730T Farm and Retail Milk Prices

and state milk marketing order programs but also by the services that the
cooperatives provide to the wholesale milk processors. Cooperatives
generally sell raw milk that will be used for fluid purposes to wholesale
milk processors at prices above the federal or state minimums. This higher
price, in part, compensates cooperatives for the services they provide to
wholesalers. These services include (1) transporting milk from different
milk- producing areas, (2) scheduling milk deliveries to coincide with
demand, and (3) standardizing the component content of milk deliveries. In
addition, cooperatives may be able to sell milk to wholesale milk processors
for a price higher than the government- set minimum price because they have
greater market power compared with the wholesalers. One of the primary
reasons dairy farmers become members of cooperatives is to benefit from the
cooperative?s greater bargaining power.

 Processing, packaging, and distributing costs have a significant influence
on the wholesale price of fluid milk, in addition to the wholesaler?s need
to earn a normal return on investment. Processing services provided by
wholesale milk processors include pasteurization, homogenization, and the
standardization of butterfat and nonfat solids in flavored milks,
buttermilk, whole, 2- percent, 1- percent, and skim milk. Wholesalers also
incur costs for packaging these products into a variety of types and sizes
of containers and arranging for their distribution to retail outlets for
sale to consumers. Costs of distribution may be significantly higher in
rural markets compared with urban markets because smaller quantities of milk
have to be transported over longer distances. Some wholesalers also provide
different levels of in- store service in addition to shipping the products
to retailers- such as unloading the milk at the store dock, restocking the
dairy case, and removing outdated and/ or leaking containers. Differences in
any or all of these factors will be reflected in differences in wholesale-
level prices.

 Retail prices for fluid milk are influenced not only by certain factors
that generally apply to all retailers but also by specific considerations at
individual retail outlets. The retail- level factors that generally
influence price include the wholesale cost of the product; retailers?
operating costs, such as labor, rent, and utilities; and their need to earn
a normal return on investment. In addition, the size, age, tastes, and
income levels of the population in the marketing area and the prices of
substitutes will influence how retailers set prices for milk. For individual
retail outlets, other considerations may influence the manner in which
retail prices for milk are set. To meet their stores? goals, such as profit
maximization and increased market share, individual retailers may use a
number of strategies for pricing fluid milk. In developing these pricing
strategies,

Page 6 GAO- 01- 730T Farm and Retail Milk Prices

retailers consider a variety of factors beyond their operating costs, such
as the prices charged by their competitors, the role that milk prices play
in attracting customers to their stores, the convenience offered by their
store compared with other stores, and their desire to build an image of
quality or low prices for their stores. Those retail pricing strategies that
are primarily based on a retailer?s operating costs are generally referred
to as vertical pricing strategies, whereas those strategies that are based
on responding to prices charged by competitors are referred to as horizontal
pricing strategies. Retailers generally use a combination of horizontal and
vertical pricing strategies when setting prices for fluid milk.

In conclusion, Mr. Chairman, our work shows that while the farm price of
milk has some influence on the retail price, other factors may ultimately
have a greater influence on the retail price. Given that farm prices account
only for about 40 percent of the retail price, there is adequate opportunity
for other factors, such as wholesale processing costs and retail pricing
strategies, to significantly influence the other 60 percent of the retail
price.

That concludes our prepared statement. If you or other Members of the
Subcommittee have any questions we will be pleased to respond to them.

For future contacts regarding this testimony, please contact Lawrence J.
Dyckman or Anu Mittal on (202) 512- 5138. Individuals making key
contributions to this testimony and/ or the report on which it was based
include Jay Cherlow, James Dishmon, and Jay Scott. Contacts and

Acknowledgment

(360089)
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