DairyLine Broadcast: Insufficient Make Allowances Erode Processing Capacity

The make allowance is an integral part of how milk is priced by the U.S. Department of Agriculture (USDA).

The federal pricing system starts with the value of a commodity - butter, for instance. It assigns a fixed portion of that price to the manufacturer to cover costs of processing the butter, then sends the remainder to the farmer. By law, the only money the processor keeps to cover the costs associated with producing and marketing that butter is the make allowance. When prices rise for butter, the make allowances stay the same, and the additional money becomes the higher price paid back to the farmer. That's a problem if the fixed make allowance is not covering rising plant costs, and this currently is the case for many processors.

Let me share a story to illustrate this complex pricing regulation. Last year, when USDA was considering raising the make allowances to reflect higher processing costs, the sale of bull calves came up in testimony. One dairy producer at the hearing fully accepted the fact that rising costs of feed to grow out the steer meant the price of a bull calf sold into a beefing operation would drop.

However, the same farmer could not accept that milk processors - like beef producers - must be compensated when their costs rise. To him it was crystal clear: Raising make allowances lowers milk prices. There was no understanding that an insufficient margin - the fixed make allowance - erodes milk processing capacity.

In the completely unregulated market for bull calves, it was freely understood that there is a relationship between the value of the input and the costs associated with creating output. But in the highly regulated milk market, that same relationship is not accepted.

If feed lots can't make money raising steers, what happens to the market for bull calves? Likewise, if firms can't cover their costs of processing dairy products, what eventually will become of the market for farm milk?

DairyLine is heard on more than 90 radio stations, and Rutherford provides listeners with a processor perspective on industry issues during his broadcasts twice a month.

Posted April 21, 2008