Challenges at the Dairy

This spring, dairy farmers were surprised when Dean foods cancelled their contracts to purchase milk.  When one follows the money, the trail leads back to Walmart.  For decades, Dean has bottled milk under the Great Value name and they continue to do so.  But in areas where these contracts have been lost, like Pennsylvania, Indiana, Kentucky, Tennessee, North Carolina, and Ohio, are areas where Walmart has built its own bottling plant. 

Dean does not place the blame on the new Walmart plants but they do state “the introduction of new plants at a time when there is an industry-wide surplus of fluid milk processing capacity” and losing milk volumes during a time of increased volume competition as reasons for ending dairy contracts.  Dean expects to continue to shrink production over the next two years in various phases, which could mean more cancelled contracts with dairies who supply to Dean. 

Walmart has just found a way to increase its margin in milk sales by eliminating the Dean processor.  It brings to mind the quote from Jeff Bezos, head of Amazon, “Your margin, is my opportunity.” 

But we cannot place the blame on Walmart for all the ills on the dairy farm.  The supply of dairy cattle in the U.S. dropped substantially from 2008-2010, ending at just over 9.1MM head.  Since that time, milk cows have risen to 9.4MM head.  At the same time, production by cow has risen by 12% over the past decade.  This has led to a larger glut of milk in the market. 

These two factors have shrunk the number of dairy operations from over 70,000 in 03 down to around 40,000 in 2017.  The average herd size has jumped from 129 in 2003 to 234 at the end of 2017. 

This is coupled with a drop in domestic demand for milk and milk products.  The average person in the U.S. drinks here gallons less of milk per year than they did in 2010.  Go to the grocery store and you will find a wide variety of nut and soy based milks.  In our house, milk was always in high supply.  Now with some of the kids emancipated and the remaining one with dairy intolerance, it is more common to find no or very little milk at the Love household. 

The other strong demand for dairy is international trade.  Mexico, Canada, and China combine to purchase $2.5 billion of U.S. dairy products.  These are the three largest buyers for U.S. dairy.  Concerns with trade may temper some of these numbers in the future. 

Overall, the world is awash in milk and the supply is increasing quicker than demand.  This is classic economics when we would expect prices to drop further until the supply/demand balances out.  Overall the problem cannot be blamed on Walmart. 

The dairy producer should review their milk contracts with legal counsel to see how easy it is for the buyer to exit the relationship and how much notice must be granted the producer.  A secondary market should be sought in case the first contract ends.  In other words, it never hurts to pack a backup parachute. 

Next, producers need to find some way to squeeze out some more margin from their dairy.  At this time, this could be the difference between living to milk another day and hanging it up.  We have seen some dairies invest capital in robots that milk and feed the cows.  Others are utilizing drones to watch over the herd or the condition of their crops they may be growing for silage.  The investments in technology may be huge, but the payoff can greatly increase margins as fewer workers are needed.  Also, human labor can be used to review the health of the herd instead of much of the traditional dairy labor.  This also allows the farmer to expand easier. 

These trends will tend to push out the smaller and less efficient dairy operator as those who can find ways to squeeze out another 5-10% profit from more efficiency.  Unfortunately, this will tend to put more milk in the market, which will have a downward pressure on prices.