United States

Department of

Agriculture

Rural Business–

Cooperative

Service

RBS Research

Report 188

Cost of Balancing Milk

Supplies: Northeast

Regional Market
Abstract The seasonal nature of milk production and fluid consumption necessitates maintaining seasonal and operating reserves to ensure fluid demand is satisfied. Operating

reserves are maintained at a certain percentage of fluid milk needs to satisfy day-today fluctuation in demand. Seasonal reserves vary month to month depending on production and consumption level. Manufacturing plants incur higher costs because of the

fluctuating reserve milk volume. The costs of balancing reserve milk supplies are estimated using two scenarios. One assumes the volume of operating reserves is 10 percent of fluid demand, and the other, 20 percent.

Keywords: Milk, operating reserves, seasonal reserves, reserve-balancing cost.

Cost of Balancing Milk Supplies:Northeast Regional Market 

K. Charles Ling

Rural Business-Cooperative Service

United States Department of Agriculture

RBS Research Report 188

October 2001
Preface This is an update of A Reserve-Balancing Pool for Services by Dairy Cooperatives,

ACS Research Report 51, published in August 1985 (1) .This report clarifies the

methodology and uses actual milk volumes and utilizations of the Northeast market to

estimate the costs incurred by manufacturing plants in balancing reserve milk supplies.

This update was requested by the Association of Dairy Cooperatives in the Northeast,

which consists of Agri-Mark, Inc., Dairy Farmers of America, Inc., Dairylea

Cooperative, Inc., Land O’Lakes, Inc., Maryland & Virginia Milk Producers Cooperative

Association, Inc., St. Albans Cooperative Creamery, Inc. and Upstate Farms

Cooperative, Inc.

i
Contents Highlights ............................................................i

Seasonal Nature of Milk .................................................1

Reserves To Satisfy Fluid Demand ........................................2

Operating reserves ................................................2

Seasonal reserves ................................................2

Necessary reserves ...............................................2

Total reserves ....................................................2

Necessary Reserve Balancing Costs ......................................4

Fixed and overhead costs ...........................................5

Plant manufacturing costs ..........................................6

Total balancing costs ..............................................6

Doubling Operating Reserves ............................................6

Satisfying fluid demand .............................................6

Total balancing costs ..............................................8

Conclusions ..........................................................9

References ..........................................................9

i
Highlights Based on 1995-99 Northeast market information, monthly milk deliveries are higher

than the annual average during January through June and peak in May. Milk deliveries

decline sharply from June to July and stay relatively low throughout summer and fall,

and bottom out in November. The seasonality index indicates that May deliveries are

11 percentage points higher than November.

The seasonal pattern of fluid demand is quite different. It peaks in September and

maintains a higher than average level through fall and winter until March. The lowest

fluid consumption month is June. The seasonality index shows that fluid demand in

June is 11 percentage points lower than it is in September. Beside this annual cycle of

fluid uses, processing plants have a weekly cycle of fluid demand.

Two categories of milk reserves, operating and seasonal, are required to meet fluctuating fluid needs. Operating reserves satisfy fluid demand of the peak day and week,

while seasonal reserves are necessary because of the nature of milk production and

fluid milk demand. If producers supplying the market raise a sufficient number of cows

to produce enough milk in the lowest milk producing months in the fall to fully satisfy

the highest fluid demand and operating reserves in that same season, then more milk

will be produced than is needed in other seasons. The extra volume produced in these

other seasons constitutes seasonal reserves.

The sum of operating and seasonal reserves represents the necessary reserves--the

minimum standby milk volume needed to satisfy fluid demand year-round. Assuming

that the operating reserve is 10 percent of fluid demand, then the volume of necessary

reserves ranges from 2.9 million pounds per day in October to 8.6 million pounds in

June. Necessary reserves in June are equivalent to 33 percent of the fluid demand for

that month. In September and October, those reserves are 10 percent of fluid demand,

representing the required operating reserves only.

To process the peak daily volume of necessary reserves of 8.6 million pounds of milk

requires three butter-powder plants, each with a daily capacity of 3 million pounds of

milk. A butter-powder plant with this capacity would cost an estimated $28 million. The

annual total capital cost of land, building, machinery and equipment, and the estimated

overhead of taxes, licenses, insurance and administrative cost, are estimated at $3

million a year, or $9 million for the three plants. Prorating the cost to the milk volume

represented by the unused capacity because of the fluctuating necessary reserves,

the allocated annual fixed and overhead cost for reserve balancing is $2,991,166.

Increased butter and powder manufacturing plant costs due to under-capacity use

caused by fluctuating necessary reserves are also calculated. They range from 4 cents

per hundredweight of milk manufactured in May to 83 cents per hundredweight in

October. Expanding these extra costs by the total volume of necessary reserves,

monthly total increase in the manufacturing costs due to reserve balancing is estimated to be zero in June and ranges from $94,755 in May to $836,460 in December.Total

extra manufacturing cost for balancing necessary reserves for the entire year is estimated at $6,745,641.

Fixed and overhead costs prorated to the milk volume of unused capacity and the

manufacturing cost increases on the actual processed volume due to under-used plant

capacity are combined to constitute total reserve-balancing costs. The three butterpowder plants would incur annual total costs of reserve balancing estimated at $9.7

million to maintain necessary fluid reserves.

iii
Highlights If operating reserve is 20 percent of fluid demand, the peak daily volume of necessary

reserves is estimated at 11.8 million pounds of milk or the equivalent of four butterpowder plants, each with a daily capacity of 3 million pounds of milk. The allocated

annual fixed and overhead cost for reserve balancing is $3 million per year.Total extra

manufacturing cost due to balancing necessary reserves for the entire year is estimated at slightly less than $8.6 million. The annual total costs of reserve balancing are

estimated at $11.6 million.

Given the seasonalities of milk production and fluid demand, the volume of operating

reserves needed to satisfy fluid milk demand is the key factor in deciding the volume of

seasonal and necessary reserves, and in turn, the total costs of balancing reserve milk

supplies.

iv
v
Cost of Balancing Milk Supplies:

Northeast Regional Market 

K. Charles Ling

RBS Agricultural Economist

Seasonal Nature of Milk

The seasonal nature of milk deliveries in the

Northeast market is best portrayed by the index of seasonality in table 1. The index is derived from the combined data from 1994-99 of the three Federal Milk

Market Orders in the Northeast that preceded the current order. The index expresses a particular month’s

milk deliveries as a percentage of the 12-month moving average centered on that month, subject to the

adjustment to make the annual average index to be

100.

The seasonality index of milk deliveries shows

that the first six months of the year reflect the period of

higher than average milk deliveries, with May being

the peak. The index of 106 indicates that May is 6 percent higher than annual average daily deliveries (average index=100). Milk deliveries decline sharply fro m

June to July and stay relatively low throughout summer and fall. Deliveries are usually lowest in

November. With an index of 95, November is 5 percent

below annual average daily deliveries. Deliveries

recover in December and increase steadily through

winter and spring until peaking again in May. The

drop from May to November is 11 percentage points,

based on average daily deliveries. On an actual daily

delivery basis, the discrepancy between the peak and

trough would have been even greater.

The seasonality index of fluid demand is calculated in the same manner as the index of deliveries.

However, the seasonal pattern of fluid demand is quite

different (table 1). Fluid demand peaks in September

and maintains a higher than average, although declining, level through fall and winter until March. The

peak (seasonal index=105) is 5 percent above annual

average daily consumption (average index=100). The

lowest fluid consumption month is June. The index of

94 is 6 percent below the annual daily average. The

June low is 11 percentage points below the September

peak.

Besides the annual cycle of fluid uses, processing

plants have a weekly cycle of fluid demand. Typically,

fluid processing plants operate fewer than 7 days a

week and their operating schedules are geared to meet

consumers’ weekly shopping patterns. They receive

milk for fluid processing to fit their weekly operating

schedules. Fluid demand fluctuations pose problems

for the supply-balancing plants, particularly for their

required manufacturing capacity and plant operations.

1

Table 1—Indices of seasonality of producer milk

deliveries and fluid demand, Northeast Orders 1

Month Producer milk deliveries Fluid demand

Percent

January 100.1 101.9

February 101.8 100.6

March 103.7 100.9

April 105.4 98.2

May 106.0 98.1

June 103.4 94.0

July 97.8 94.2

August 97.0 98.1

September 96.3 105.2

October 95.4 104.6

November 95.0 102.8

December 98.1 101.4

——— ———

Simple average 100.0 100.0

1 Based on pool statistics 1994-1999, calculated using 12-month

moving average method.
Reserves To Satisfy Fluid Demand

Two categories of milk reserves, operating and

seasonal, arerequired to meet fluctuating fluid needs.

Operating reserves satisfy fluid demand of the peak

day and week, while seasonal reserves are necessary

because of the nature of milk production and fluid

milk demand (table 2).

Operating reserves—These include reserves that

ensure a sufficient supply for the daily fluctuating

fluid demand encountered by processing plants. The

reserves also cover shrinkage and returns of packaged

products ordinarily experienced by processing plants.

The analysis in this section assumes the operating

reserves required by the market are 10 percent of fluid

demand. (Later, the same analysis assuming 20 percent operating reserves is also presented.)

In table 2, operating reserves are set at 10 percent

of fluid demand every month. Both follow the same

seasonal pattern. In June, operating reserves drop to

2.6 million pounds per day and peak at almost 3 million pounds in September. The annual average is 2.8

million pounds a day.

Seasonal reserves—Milk deliveries are high in

spring and low in the fall, but just the opposite of fluid

demand in spring and fall. If producers supplying the

market raise sufficient number of cows to produce

enough milk in the lowest milk producing months in

the fall to fully satisfy the highest fluid demand and

operating reserves in that same season, then more milk

will be produced than is needed in other seasons. The

extra volume produced in these other seasons constitutes seasonal reserves (table 2).

To calculate the seasonal reserves, October is the

base month when milk deliveries exactly supply the

needs of fluid demand (29.3 million pounds per day)

and operating reserves (2.93 million pounds a day).

The production base needed in October will create an

extra volume in the other months—determined by the

ratio of the other months’ seasonality indexes for milk

deliveries to October. The difference between the

resulting volumes and the other months’ fluid

demands and operating reserves represents the seasonal reserves for the other months.

For example, the ratio of January’s seasonality

index for milk deliveries to October is 1.0493

(100.1/95.4). So, the production base used to meet the

October fluid demand and operating reserves of 32.227

million pounds per day (29.297+2.93) would produce

33.815 million pounds of milk (1.0493 x 32.227) in

January. January requires 31.35 million pounds of milk

per day for fluid demand and operating reserve

(28.5+2.85). Thus, the seasonal reserves for January are

2.464 million pounds per day (33.815 – 31.350). The

seasonal reserves for other months can be calculated in

the same way, using October as the base.

There is a wide range of seasonal reserves. The

volume peaks at 6 million pounds per day in June and

drops to 0.1 million pounds a day in September. There

are no seasonal reserves for October. (November is seasonally the lowest month for milk deliveries. But, if

November production matched fluid demand and

operating reserve for that month, a situation would

occur where there would not be enough milk to cover

relatively higher fluid demand and operating reserves

for October—a negative seasonal reserve. Therefore,

October, the next lowest milk production month, is

used as the benchmark for calculating seasonal

reserves.)

Necessary reserves—The sum of operating and seasonal reserves represents the necessary reserves--the

minimum standby milk volume needed to ensure sufficient supply for satisfying year-round fluid demand.

The volume of necessary reserves ranges from 2.9 million pounds per day in October to 8.6 million pounds

in June and averages 5.7 million pounds (table 2). On a

daily average basis, necessary reserves are 21 percent

of fluid demand. In other words, for every 100 pounds

of fluid demand, an average minimum of 21 pounds of

milk reserves are needed to satisfy year-round

demand. Necessary reserves in June are equivalent to

33 percent of the fluid demand for that month. In

September and October, necessary reserves are 10 percent of fluid demand, respectively,representing the

required operating reserves but without seasonal

reserves because these are the two seasonally lowest

milk delivery months.

Totalreserves—These are defined as the milk volume in excess of Class I and Class II uses and, in fact,

are the manufacturing milk volume currently classified

as Class III and Class IV (table 2, column 9). Necessary

reserves are a part of total reserves. The other part in

excess of necessary reserves is the extra standby milk

volume to satisfy fluid demand. This volume may be

called excess reserves.

The relationship between milk deliveries, fluid

demand, and reserves is depicted in figure 1. In summary

Operating reserves = A fixed percentage of fluid

demand such as 10 percent

or 20 percent.

2
3

Table 2—Necessary reserves to satisfy fluid demand assuming 10 percent operating reserves, and total reserves, Northeast Orders

Seasonality index Necessary reserves 2 Total reserves 3

———————————– ————————————— ———————————

Producer Producer Percent Percent

Month milk Fluid milk Fluis Operating Seasonal fluid Mlk milk

deliveries demand deliveries 1 demand 1 recerves reserves Milk volume demand volume deliveries

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)

Percent ———————————Million pounds per day——————————— Mil.lb/day

January 100.1 101.9 64.735 28.500 2.850 2.464 5.314 19 26.321 41 

February 101.8 100.6 65.920 28.156 2.816 3.417 6.233 22 27.523 42 March 103.7 100.9 67.206 28.237 2.824 3.970 6.793 24 27.979 42 April 105.4 98.2 68.317 27.493 2.749 5.362 8.112 30 29.575 43 

May 106.0 98.1 68.774 27.471 2.747 5.589 8.336 30 29.772 43 June 103.4 94.0 67.176 26.343 2.634 5.952 8.586 33 28.559 43 July 97.8 94.2 63.643 26.582 2.658 3.797 6.455 24 24.896 39 August 97.0 98.1 63.035 27.572 2.757 2.438 5.195 19 22.882 36 September 96.3 105.2 62.476 29.476 2.948 0.107 3.055 10 21.230 34 October 95.4 104.6 62.163 29.297 2.930 0 2.930 10 21.758 35 November 95.0 102.8 61.866 28.793 2.879 0.419 3.299 11 22.570 36 December 98.1 101.4 64.303 28.605 2.861 1.673 4.534 16 25.757 40 

——— ——— ———— ———— ———— ——— ——— — — ———— — —

Simple average 100.0 100.0 64.968 28.044 2.804 2.932 5.737 21 25.735 40 

1 Five-year average, 1995-99.2 Necessary reserves are the sum of operating and seasonal reserves3 Total reserves are the sum of Class III and Class IV milk, or the sum of necessary and excess reserves.
Seasonal reserves = Reserve volume due to seasonality of milk production

if fluid demand and operating reserves are to be satisfied year-round.

Necessary reserves = Operating plus seasonal

reserves.

Total reserves = Milk deliveries in excess of

Class I and Class II uses.

Excess reserves = The difference between

total and necessary

reserves.

Necessary Reserve Balancing Costs

To process the peak daily volume of necessary

reserves of 8.6 million pounds of milk, three butterpowder plants, each with a daily capacity of about 3

million pounds of milk, arerequired. (The plants could

be cheese-whey plants of the same capacity, which

may entail a different set of cost estimates.) This

capacity allows the plants to operate 7 days a week (3

shifts, 20 machine-hours a day) and exhaust the available milk in June. The 8.6-million-pounds-per-day volume in June is the highest necessary reserves among

the 12 months (table 2, column 7). For this study, milk

4

Figure 1—The relationship between milk deliveries, fluid demand, and reserves, Northeast Orders

Milk deliveries

Class II

Excess reserves

Sasonal reserves

O perating reserves

Fluid demand

Million pounds per day

January

February

March

April

May

June

July

August

September

October

November

December

80-

70-

60-

50-

40-

30-

20-

10-

0-
volume is split equally between the three plants every

day of the year. Each plant experiences the same seasonal fluctuation in reserve milk volume.

The monthly variation of necessary reserves has a

major impact on the capacity use of a manufacturing

plant. The January necessary reserves are 3.3 million

pounds lower than the June peak reserves of 8.6 million pounds a day. The shortfall translates into a 38-

percent under-use of the plant capacity (table 3,

columns 1 and 2). The February shortfall is 2.4 million

pounds a day, a 27-percent under-use of plant capacity.

The shortfalls for other months are calculated the same

way. The variation ranges from full-capacity operations in June to a shortfall of 5.7 million pounds a day

in October. This causes a 66-percent under-use of

plant capacity. The degree to which a manufacturing

plant is used at less than capacity increases the perunit cost of products actually made at the plant.

The fluctuating volume of necessary reserves

puts the reserve-balancing butter-powder plants at a

disadvantage compared with a plant built solely for

manufacturing. Milk volume going through the latter

type of plant can be maintained relatively constant at

full capacity to take advantage of least-cost operations.

Balancing necessary reserves, therefore, exacts a substantial cost on the three balancing plants.

Fixed and overhead costs–Based on available information, a butter-powder plant with a capacity of manufacturing 3 million pounds of milk a day is estimated

to cost $28 million. At a 9 percent interest rate, annual

total capital cost on land, building, machinery, and

equipment is $2.52 million. Add to this the estimated

overhead of taxes, licenses, insurance, and administration costs, and total annual fixed and overhead costs

are estimated at about $3 million. The fixed and overhead costs for the three plants are therefore estimated

at $9 million a year.Prorating the cost to the milk volume represented by the unused capacity, the allocated

annual fixed and overhead cost for reserve balancing is

nearly $3 million (table 3, column 3).

January’s unused capacity caused by fluctuation

in necessary reserves is 3.3 million pounds of milk per

day or about 38 percent of the peak necessary reserves

(combined capacity of three plants). The fixed and

overhead costs for the three plants are $9 million a

year or $24,658 a day.Prorating this cost to the 38 per5

Table 3—Estimated cost of balancing necessary reserves assuming 10 percent operating reserves, 

Northeast Orders

Plant cost increases on the actual processed volume 

caused by unused capacity 1

Unused Unused

capacity capacity Fixed and Converted

caused by percent of overhead to per Per daily Per monthly

Month fluctuation in peak costs of Per pound hundred- necessary necessary Total reserve

necessary necessary reserve of butter or weight reserve reserve balancing

reserves reserves balancing powder 1 milk 2 volume volume cost

(1) (2) (3) (4) (5) (6) (7) (8)=(3)+(7)

Million lbs/day $/month Cents/lb Cents/cwt $/day $/month $/month

January 3.3 38 291,266 3.8 48 25,536 791,606 1,082,873 

February 2.4 27 189,241 2.7 35 21,542 603,190 792,431 

March 1.8 21 159,588 2.1 26 17,885 554,446 714,035 

April 0.5 6 40,866 0.6 7 5,651 169,529 210,395 

May 0.2 3 22,226 0.3 4 3,057 94,755 116,981 

June 0 0 0 0 0 0 0 0

July 2.1 25 189,684 2.5 31 20,200 626,212 815,896 

August 3.4 39 301,878 3.9 50 25,872 802,045 1,103,923 

September 5.5 64 476,550 6.4 81 24,816 744,467 1,221,017 

October 5.7 66 503,565 6.6 83 24,338 754,474 1,258,039 

November 5.3 62 455,541 6.2 78 25,615 768,457 1,223,997 

December 4.1 47 360,761 4.7 60 26,983 836,460 1,197,221 ———— ————— —————

S u m 2,991,166 6,745,641 9,736,807 

1 Estimated to increase by 0.1 cent/lb of product per percentage point of unused plant capacity.

2 Assuming per cwt milk, 4.48 pounds of butter and 8.13 pounds of nonfat dry milk can be made
cent unused capacity results in $9,396 per day fixed

and overhead cost for reserve balancing, or $291,266

for January. Fixed and overhead costs for reserve balancing for other months are calculated the same way.

Plant manufacturing costs–These are directly associated with manufacturing operations of the plant

when milk is moved from the receiving deck through

the plant to the product delivery deck. They include

labor (direct labor, supervisory/indirect labor, and

fringe benefits), electricity, fuel, water and sewage,

plant and cleaning supplies, repair and maintenance,

depreciation, taxes and insurance, and miscellaneous

expenses. Except for depreciation, these items are generally called variable costs. They may be semi-variable

or semi-fixed.

Assume that there is no shipment of intermediate

product, cream or skim, into or out of the butter-powder plants. A 1-percent decrease in milk volume going

through a butter-powder plant will correspondingly

decrease plant capacity use. The fluctuating volume of

necessary reserves affects under-use of the butter and

powder plants by the same percentage. Under-capacity

percentages reported in table 3 apply equally to both

butter and powder production.

Increases in the costs of manufacturing butter

and powder due to under-capacity use caused by fluctuating necessary reserves can be calculated. Based on

data available to RBS Cooperative Services, it has been

estimated that for every 1-percent decrease in the plant

capacity use, product cost will increase one-tenth of a

cent per pound (2).

Table 3 lists increases in the in-plant costs of manufacturing butter and powder caused by the fluctuating volume of necessary reserves for the 12 months.

June is operated at full capacity and the manufacturing

costs are the lowest. When the plant is operating at less

than capacity, manufacturing costs increase by 3.8

cents per pound of butter or powder in January, by 2.7

cents in February,etc.

By using standard yield factors of 4.48 pounds of

butter and 8.13 pounds of powder per hundredweight

of milk at 3.67 percent butterfat test, the above increases in manufacturing costs can be converted to a perhundredweight-of-milk basis. Column 5 of table 3

shows that increases in manufacturing costs due to

under-capacity plant use caused by necessary reserves

range from 4 cents per hundredweight of milk manufactured in May to 83 cents in October. Expanding

these extra costs by the total volume of necessary

reserves (table 2, column 7), monthly total increase in

the manufacturing costs due to reserve balancing is

zero in June and ranges from $94,755 in May to

$836,460 in December (table 3, column 7). Total extra

manufacturing cost for balancing necessary reserves

for the entire year is estimated to exceed $6.7 million.

Total balancing costs–This combines fixed and

overhead costs prorated to the milk volume of unused

capacity and the manufacturing cost increases on the

actual processed volume due to under-used plant

capacity (table 3, column 8). For maintaining milk

reserves necessary for the fluid market, the three butter-powder plants incur a total reserve-balancing cost

of more than $1 million in January, $792,431 in

February, etc. June has no reserve-balancing cost

because the plants operate at full capacity during that

month. Annual total costs of reserve balancing areestimated at more than $9.7 million.

Doubling Operating Reserves

The calculation in this section is the same as the

previous one, except that operating reserves are doubled or 20 percent above fluid demand. This entails a

different set of reserve milk volumes and the associated costs of reserve balancing.

Satisfying fluid demand--Operating reserves areset

in table 4 at 20 percent of fluid demand every month

and follow the same seasonal pattern. The operating

reserves range from the low of 5.3 million pounds per

day in June to the high of 5.9 million pounds in

September. The annual average is 5.6 million pounds a

day.

The volume of seasonal reserves is zero in

October when milk deliveries exactly supply the need

of fluid demand and operating reserves. That volume

peaks at 6.5 million pounds per day in June and drops

to a low of 0.1 million pounds a day in September.

(October is used as the benchmark for calculating seasonal reserves to ensure sufficient minimum volume of

milk to cover fluid demand and operating reserves

year-round.) While the volume of operating reserves

is doubled, the volume of seasonal reserves is only

slightly higher than when operating reserves are 10

percent of fluid demand.

Necessary reserves, the sum of operating reserves

and seasonal reserves, range from 5.9 million pounds

per day in October to 11.8 million pounds in June, with

8.8 million pounds being the daily average (table 4).

On a daily average basis, necessary reserves are 32 percent of fluid demand. For every 100 pounds of fluid

demand, it is necessary to carry an average minimum

of 32 pounds of milk reserves to make sure that fluid

demand will be satisfied year-round. Necessary

6
7

Table 4—Necessary reserves to satisfy fluid demand assuming 20 percent operating reserves, and total reserves, Northeast Orders

Seasonality index Necessary reserves 2 Total reserves 3

———————————– ————————————— ———————————

Producer Producer Percent Percent

Month milk Fluid milk Fluid Operating Seasonal fluid Mlk milk

deliveries demand deliveries 1 demand 1 recerves reserves Milk volume demand volume deliveries

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)

Percent ———————————Million pounds per day——————————— Mil.lb/day

January 100.1 101.9 64.735 28.500 5.700 2.688 8.388 29 26.321 41 

February 101.8 100.6 65.920 28.156 5.631 3.728 9.359 33 27.523 42 March 103.7 100.9 67.206 28.237 5.647 4.331 9.978 35 27.979 42 April 105.4 98.2 68.317 27.493 5.499 5.850 11.349 41 29.575 43 May 106.0 98.1 68.774 27.471 5.494 6.097 11.592 42 29.772 43 June 103.4 94.0 67.176 26.343 5.269 6.493 11.762 45 28.559 43 July 97.8 94.2 63.643 26.582 5.316 4.142 9.459 36 24.896 39 August 97.0 98.1 63.035 27.572 5.514 2.660 8.174 30 22.882 36 September 96.3 105.2 62.476 29.476 5.895 0.117 6.012 20 21.230 34 October 95.4 104.6 62.163 29.297 5.859 0 5.859 20 21.758 35 November 95.0 102.8 61.866 28.793 5.759 0.457 6.216 22 22.570 36 December 98.1 101.4 64.303 28.605 5.721 1.825 7.546 26 25.757 40 

——— ——— ———— ———— ——— ——— ——— — — ———— — —

Simple average 100.0 100.0 64.968 28.044 5.609 3.199 8.808 32 25.735 40 

1 Five-year average, 1995-99.2 Necessary reserves are the sum of operating and seasonal reserves3 Total reserves are the sum of Class III and Class IV milk, or the sum of necessary and excess reserves.
reserves in June are equivalent to 45 percent of the

fluid demand for that month. In September and

October, necessary reserves are 20 percent of fluid

demand, representing the required operating reserves

but without seasonal reserves because these are the

two seasonally lowest milk delivery months.

Total reserves (the milk volume in excess of Class

I and Class II uses and classified as Class III and Class

IV) remain the same fixed volume as in the previous

section. Because of the higher necessary reserves in

this section, excess reserves are lower.

Total balancing costs—To process the peak daily

volume of necessary reserves of 11.8 million pounds of

milk, four butter-powder plants, each with a daily

capacity of about 3 million pounds of milk, are

required.

The monthly variation of necessary reserves has a

major impact on the under-capacity use of a manufacturing plant. January necessary reserves are 3.4 million

pounds lower than the June peak reserves of 11.8 million pounds a day. The shortfall translates into a 29-

percent under-use of the plant's capacity (table 5,

columns 1 and 2). February shortfall was 2.4 million

pounds a day, a 20-percent under-use of plant capacity.

The shortfalls for other months are calculated the same

way. The variation ranges from full-capacity operations in June to a shortfall of 5.9 million pounds a day

in October, or a 50-percent under-use. Note that

monthly under-capacity volumes caused by fluctuating necessary reserves are almost the same when operating reserves are 20 percent of fluid demand as when

operating reserves are 10 percent of fluid demand (column 1 of both tables 3 and 5).

Following the same calculations in the previous

section, the fixed and overhead costs for the four

plants are estimated at $12 million a year. By prorating

the cost to the milk volume of unused capacity,the

allocated annual fixed and overhead cost for reserve

balancing is more than $3 million (table 5, column 3).

Increased plant costs of manufacturing butter and

powder caused by the fluctuating volume of necessary

reserves for the 12 months are listed in table 5, column

4. June is operated at full capacity and the manufacturing costs are the lowest. When the plant is operating

8

Table 5—Estimated cost of balancing necessary reserves assuming 20 percent operating reserves, 

Northeast Orders

Plant cost increases on the actual processed volume 

caused by unused capacity 1

Unused Unused

capacity capacity Fixed and Converted

caused by percent of overhead to per Per daily Per monthly

Month fluctuation in peak costs of Per pound hundred- necessary necessary Total reserve

necessary necessary reserve of butter or weight reserve reserve balancing

reserves reserves balancing powder 1 milk 2 volume volume cost

(1) (2) (3) (4) (5) (6) (7) (8)=(3)+(7)

Million lbs/day $/month Cents/lb Cents/cwt $/day $/month $/month

January 3.4 29 292,290 2.9 36 30,336 940,417 1,232,707 

February 2.4 20 188,046 2.0 26 24,108 675,020 863,066 

March 1.8 15 154,540 1.5 19 19,079 591,445 745,985 

April 0.4 4 34,629 0.4 4 5,024 150,732 185,360 

May 0.2 1 14,717 0.1 2 2,111 65,431 80,148 

June 0 0 0 0 0 0 0 0

July 2.3 20 199,534 2.0 25 23,352 723,906 923,440 

August 3.6 31 310,868 3.1 38 31,440 974,628 1,285,496 

September 5.7 49 482,139 4.9 62 37,060 1,111,789 1,593,928 

October 5.9 50 511,439 5.0 63 37,078 1,149,407 1,660,846 

November 5.5 47 465,038 4.7 59 36,958 1,108,729 1,573,767 

December 4.2 36 365,255 3.6 45 34,104 1,057,212 1,422,467 ———— ————— —————

S u m 3,018,495 8,548,716 11,567,210 

1 Estimated to increase by 0.1 cent/lb of product per percentage point of unused plant capacity.

2 Assuming per cwt milk, 4.48 pounds of butter and 8.13 pounds of nonfat dry milk can be made
below capacity, manufacturing costs increase by 2.9

cents per pound of butter or powder in January, by 2

cents in February,etc.

By using standard yield factors, increases in manufacturing costs are converted to a per- hundredweight-of-milk basis. Column 5 of table 5 shows that

increases in manufacturing costs due to below-capacity plant use caused by necessary reserves range from 2

cents per hundredweight of milk manufactured in

May to 63 cents per hundredweight in October.

Expanding these extra costs by the total volume of necessary reserves, monthly total increase in the manufacturing costs due to reserve balancing is zero in June

and ranges from $65,431 in May to over $1.1 million in

October (table 5, column 7). Total extra manufacturing

cost for balancing necessary reserves for the entire year

is estimated at $8.5 million.

Fixed and overhead costs prorated to the milk

volume of unused capacity and the manufacturing cost

increases on the actual processed volume due to

under-utilized plant capacity are combined to constitute total reserve-balancing costs (table 5, column 8).

For maintaining milk reserves necessary for the fluid

market, the four butter-powder plants incur a total

reserve-balancing cost of $1.2 million in January,

$863,000 in February, etc. June has no reserve-balancing cost because the plants operate at full capacity during that month. Annual total costs of reserve balancing

are estimated at $11.6 million.

Conclusions

Given the seasonalities of milk production and

fluid demand, the volume of operating reserves needed to satisfy fluid milk demand is the key factor in

deciding the volume of seasonal and necessary

reserves, and in turn, the total costs of balancing

reserve milk supplies. Therefore, knowing how much

operating reserves are needed is pivotal for the cost

estimation. This report uses 10 and 20 percent operating reserves above fluid demand for illustration. If

operating reserves are 10 percent of fluid demand, the

cost of reserve balancing is estimated at $9.7 million a

year. The annual cost is estimated at $11.6 million, if

operating reserves are 20 percent of fluid demand.

The estimation of the reserve-balancing costs

assumes all necessary reserves are balanced in the

hypothetical plants. In reallife,reserve balancing is

carried out among many manufacturing plants.

However, no manufacturing plant is known to have

kept separate records for calculating the reserve-balancing costs. The methodology used in this report

yields cost data that probably represent the best estimates.

References

1. Ling, K.C. A Reserve-Balancing Pool for Services by

Dairy Cooperatives, Research Report 51, United

States Department of Agriculture, Agricultural

Cooperative Service, Washington, DC, August

1985.

2. Ling, K.C. and Deborah Schwenk. Dairy Product

Manufacturing Costs at Cooperative Plants (1983-91):

Implications for Plant Operations. Unpublished technical assistance report, August 1993.

9
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