The Price of Milk Is Decided by a Formula Nobody Can Explain
Dairy farmers are paid under federal marketing orders that classify milk by what it is turned into and pool the proceeds. The system was built for a perishable product with no bargaining power and has become extraordinarily complex.
The Problem With a Product That Cannot Wait
Raw milk is produced continuously, cannot be stored, and must be collected and processed within a couple of days. A dairy farmer with a full tank has no ability to hold out for a better price, because the alternative to accepting whatever is offered is pouring it away.
That is the weakest bargaining position in agriculture, and it produced predictable results in the early twentieth century: processors paying whatever they chose, farmers unable to refuse, and periodic collapses in farm income followed by supply disruption.
Federal milk marketing orders, established in the 1930s, were the regulatory response. They set minimum prices processors must pay farmers, administered by region.
Classified Pricing Is the Core Idea
The system does something unusual: it prices the same raw milk differently depending on what the processor makes from it.
| Class | Use | Relative Price |
|---|---|---|
| Class I | Beverage milk | Highest |
| Class II | Soft products, yogurt, ice cream | Middle |
| Class III | Cheese | Lower |
| Class IV | Butter and dry milk powder | Lower |
The rationale is demand elasticity. Beverage milk has no substitute and relatively inelastic demand, so it can bear a higher price. Cheese and powder compete in national and international markets against other suppliers, so pricing them high would simply move production elsewhere.
This is textbook price discrimination applied by regulation rather than by a firm, and the objective is to raise total revenue to farmers without pricing manufactured products out of their markets.
A farmer does not know what their milk will become when it leaves the tank. Charging different prices by end use only works if the resulting revenue is pooled and shared, which is why classified pricing and pooling are inseparable halves of one mechanism.
Pooling Redistributes the Difference
Because a processor buying milk for cheese pays less than one buying for bottling, and because farmers cannot control which they supply, the order pools the revenue.
All the money paid by all processors in a region is combined, and each farmer receives a blend price reflecting the average across uses, adjusted for milk components and location. A farmer whose milk went to a cheese plant and one whose milk went to a bottler receive approximately the same price.
Two structures exist. Most orders operate producer settlement funds that equalise across all participants. Some states, notably California historically and certain others, have operated under different arrangements, and several large producing regions sit outside the federal orders entirely, which creates competitive asymmetries that generate persistent argument.
The Component Pricing Layer
Modern orders do not price milk by volume. They price it by components, principally butterfat, protein, and other solids, because those determine the yield of the products made from it.
Component values are derived from published wholesale prices for cheese, butter, powder, and whey, run through formulas that subtract a make allowance, meaning an estimate of the processor cost of converting raw milk into the product.
The make allowance is a permanently contested number. Set too low and processors lose money on conversion; set too high and farmers subsidise processor inefficiency. It is adjusted through formal hearings, and the arguments are conducted between organised producer groups and processor associations with the department as arbiter.
The Class I Mover Change
An illustration of how consequential a formula detail can be arrived in 2019. The method for calculating the beverage milk price was changed from taking the higher of the Class III and Class IV prices to using an average of the two plus a fixed adjustment.
The change was intended to make the price hedgeable, since a higher of formula cannot be replicated with futures contracts, and was supported by parts of the industry for that reason.
Then the pandemic produced an extreme divergence between cheese and butter prices, and the new formula produced a beverage milk price far below what the old one would have. The resulting revenue loss to producers was measured in the hundreds of millions of dollars, and the episode became the central example in subsequent hearings about formula design.
It is a clean demonstration that in a system where the price is a formula, changing the formula is the entire policy.
What the System Does and Does Not Do
The orders set minimum prices, so a processor may pay more, and many do through premiums for quality, volume, or organic certification. The minimum is a floor rather than the market.
Critically, the system does not manage supply. It prices whatever is produced, which means it cannot prevent the recurring cycle in which high prices encourage expansion, expansion produces surplus, and prices collapse. Supply management exists in Canada through production quotas and has been repeatedly proposed and rejected in the United States.
The result is that American dairy has both a complex minimum pricing system and a persistent tendency toward oversupply, which is not a contradiction but is frequently mistaken for one.
The Bottom Line
Federal milk marketing orders exist because a perishable product produced daily by thousands of small operators gives the seller no bargaining power at all. They work by charging more for milk that becomes a drink than for milk that becomes cheese, and pooling the difference so individual farmers are not penalised for where their tanker went. The mechanism is coherent, the arithmetic has become nearly unreadable, and the 2019 formula change demonstrated that a technical adjustment in a pricing equation can move farm income across an entire country.