3. CLASS I PRICING STRUCTURE

 This decision adopts a Class I pricing structure that

provides incentives for greater structural efficiencies in the

assembly and shipment of milk and dairy products. In conjunction

with other reforms discussed in this decision, the adopted Class I

price structure provides the necessary changes needed to improve

milk pricing in the consolidated markets. The adopted Class I

pricing structure results from additional quantitative and

qualitative analyses of Option 1A and Option 1B that were

presented in the proposed rule issued January 21, 1998 (the PR),

consideration of public comments received to these options, and

the legislative requirements of the AMAA. The adopted Class I

pricing structure utilizes USDSS model results adjusted for all

known plant locations and establishes differential levels that

will generate sufficient revenue to assure an adequate supply of

milk while maintaining equity among handlers in the minimum prices

they pay for milk bought from dairy farmers. 

Background

Although not required by the 1996 Farm Bill, the legislation

provided authorization for the Secretary to review the Class I

price structure as part of the consolidation of the orders

including the consideration of utilization rates and multiple

basing points for developing a pricing system. In any event, the

consolidation of orders requires the review of the pricing system

because historically, Class I pricing provisions, as well as other

Federal order provisions, have been reviewed primarily on an

individual market basis. The reform effort provides the

opportunity to consider and establish a nationally coordinated

Class I pricing surface that uses location adjustments to the

differential levels to price milk for fluid use in every county in

the United States. 

The PR provided an extensive review of 7 options that were

developed and considered. After qualitative and/or quantitative

analysis, all but Option 1A and Option 1B were preliminarily

eliminated for various stated reasons. Nonetheless, the PR

invited comments on any of the seven pricing options or any other

pricing ideas. Also, the Department indicated a preference for

Option 1B for a number of reasons. Nearly all of the public

comments received in response to the PR on Class I price structure

focused on the relative merits of Option 1A and Option 1B. No

persuasive comments were received to cause the Department to

further consider the other five options.

The USDSS Model

Option 1A and Option 1B were based to a significant degree on

the U.S. Dairy Sector Simulator Model (USDSS). The USDSS was used

to evaluate the geographic or “spatial” value of milk and milk

components across the U.S. Using 240 supply locations, 334
consumption locations, 622 dairy processing plant locations, 5

product groups, 2 milk components (fat and solids-not-fat) and

transportation and distribution costs among all locations, USDSS

determines economic efficient location values for milk and milk

components. The model initially used data from May and October

1995, and for this decision used updated data from May and October

1997.

The supply and consumption of milk used by the model are

aggregated to geographic points -— consumption points and supply

points —- to simplify a very complex problem. The production of

milk and the consumption of dairy products are fixed at the

various supply and consumption points used by the model. Plant

locations were restricted to those presently processing products

but plant processing locations were not constrained with respect

to the volume processed. Processing costs were assumed to be

uniform between locations and across plant volumes (no economies

of scale). Therefore, the model allowed processing to move among

available locations to find the least cost solution in terms of

assembly from supply points through distribution to consumption

points.

Transportation costs in the model include costs of raw milk

assembly, interplant bulk shipment, and the cost of hauling

finished products. Transportation costs among regions reflected

not only distance traveled, but also differences in wage rates and

State highway weight limit restrictions. While assembly costs and

interplant bulk shipments were calculated using a linear cost

function, the finished product functions were non-linear. In

fact, finished product hauling costs (e.g., packaged milk) fell

below raw milk assembly and hauling costs on an equivalent unit

basis in many cases at distances more than 900 miles. Previous

spatial modeling had assumed constantly higher finished product

transportation costs versus raw milk assembly and shipping costs

for all distances. The updated model results were based on

transportation cost analyses, particularly the reduction in

distribution costs for finished products resulting in distribution

costs for these products on par with bulk milk assembly and

hauling costs. 

The output from the USDSS model provided information as to

optimal processing locations and volumes at those locations, milk

assembly, and intermediate and finished product distribution

flows. It represented a least cost, or “most efficient”

organization of the industry. Importantly for the research, the

model provided the marginal values (i.e., the value of one more

unit) of milk at each location. These values, technically known

as shadow prices, are indicative of values that are consistent

with the optimized solution. A shadow price on one unit of milk

at any processing location can be interpreted as follows: If the
1 Any references to the "current" system of Class I prices or the

"current" price structure are to be interpreted as those established in

or after the final decision based on the 1990 national hearing issued

March 5, 1993 (58 FR 12634).

processor at a particular location had one more unit of milk, the

entire pattern of milk assembly, and product transportation could

be reorganized in such a way that marketing costs, equal to the

shadow price, could be saved. This notion of marginal value is

consistent with economic theory on how prices are determined in a

competitive market.

The significance of the shadow value in terms of milk price

regulation may be stated: If the regulated price, or cost of milk,

is arbitrarily set higher than the shadow price at a particular

processing location, a lower cost solution could be found by

processing more milk at another location. This would imply higher

transportation costs for either raw milk assembly, finished

product distribution, or both. Such a result clearly leads to a

higher cost, less efficient system. It is also contrary to what

is generally thought of as the “orderly marketing” of milk which

is a fundamental reason for the existence and goal of Federal milk

marketing orders.

It should be stressed that the calculated shadow prices of

the model output provide information regarding the relationship of

the prices among geographic locations. They do not provide

guidance regarding the overall level of Class I prices or

differential values. That is, the model does not help us

understand whether the Class I differential should arrive at a

Class I price of $14 in Minneapolis and $15 in New York City, or

$15 in Minneapolis and $16 in New York City. However, it does

tell us that the resulting Class I price difference between the

two locations should be about one dollar.

A positive aspect of the USDSS model is the degree of detail

available in the output. This detail is achieved through the

careful assembly of spatially disaggregated data. However, it

should be remembered that by its construction, the USDSS is a

“model” and thus a simplification of a complex dairy industry. 

That notwithstanding, the USDSS model does provide an objective

and quantitative guidepost from which to compare current federal

order differentials and in considering possible alternatives.

Several factors were considered in selecting a replacement

for the current1 Class I price structure that served to form the 

criteria used to examine options. First, a Class I price

structure must be considered from a national, as well as a local

or regional, perspective. Many comments from industry addressed

Class I pricing issues from a local or regional perspective in the
development of options presented in the PR. These comments

provided valuable information about particular markets but

generally did not consider the feasibility or impact of a local or

regional issue on a national basis. While remaining mindful of

local and regional concerns, USDA has also evaluated alternative

Class I pricing structures from a national perspective, as should

be expected, given the national concerns expressed about milk

pricing.

Second, a Class I price structure must recognize the location

value of milk. Results from the USDSS model confirm that milk has

value at location. As described earlier, the model provided

shadow prices reflecting the relative values of milk and milk

components at geographic locations. While the model shadow prices

did not suggest Class I differentials for specific locations, they

do provide a means to evaluate price relationships among

locations.

Third, a Class I price structure must recognize all uses of

milk. The classified pricing system contained in the Federal milk

order program values milk for fluid use higher than milk used for

soft or hard manufactured products. The higher Class I price

encourages all milk to be used first to satisfy Class I needs. At

the point where the cost of moving milk from an alternate location

for Class I use is equal to the cost to supply milk for

manufactured products, demand for manufactured products influences

a market's ability to procure milk for Class I needs. Thus, all

uses of milk must be considered when evaluating a national Class I

pricing structure.

Finally, a Class I price structure must meet the requirements

of the AMAA. The broad tenet of the AMAA is to establish and

maintain orderly marketing conditions. For the Federal milk order

program, this is achieved primarily through classified pricing and

pooling. With regard to pricing, it is recognized that the

objective of the AMAA is to stabilize the marketplace with minimum

prices, not to set market prices. The pricing criterion of the

AMAA, § 608c(18), requires prices that are reflective of economic

conditions affecting supply and demand for milk and its products. 

In this regard, consideration was given to whether the proposed

prices would generate sufficient revenue for producers necessary

to maintain an adequate supply of milk. Equally important, the

prices need to provide equity to handlers with regard to raw

product costs as required by § 608c(5) of the AMAA. 

Evaluation Criteria

In evaluating the final Class I pricing options, nine

performance criteria, based upon regulatory objectives and

requirements of the AMAA, were again used as they were in the PR. 

The evaluation criteria are divided into two categories, objective

and administrative. The objective criteria are as follows:
1. Ensure an adequate supply of milk for fluid use. Class I

price levels need to provide a sufficient price signal to maintain

an adequate supply of milk for fluid use. This supply level can

be achieved through either the movement of milk to where it is

needed, increased production, or some combination of both.

2. Recognize quality (Grade A) value of milk. Grade A milk

is required for fluid use. Additional costs of obtaining and

maintaining Grade A status need to be reflected in Class I prices.

3. Provide appropriate market signals. A Class I price

should send timely signals to the market regarding supply/demand

conditions.

4. Recognize value of milk at location. Basic economic

theory, validated by actual market observations and Universitybased research, affirms that milk for Class I use has a different

value at different locations. This value needs to be reflected in

the Class I price in order for the system to recognize and

resemble the market rather than interfere with the market.

5. Facilitate orderly marketing with coordinated system of

prices. A system of Class I prices needs to be coordinated on a

national level. Appropriate levels of prices will provide

alignment both within and among marketing areas. This

coordination is necessary for the efficient and orderly marketing

of milk.

6. Recognize handler equity with regard to raw product

costs. Appropriate levels of Class I prices provide known and

visible prices at all locations thereby ensuring that handlers are

able to compete for available milk supplies on an equitable basis.

Three administrative criteria are identified and described as

follows:

1. Minimize regulatory burden. The Class I price structure

should not significantly increase the burden on handlers,

particularly small businesses. This would include increased

reporting requirements and record keeping, as well as possible

increases in administrative assessments should Market

Administrators be required to manage a more complex regulatory

system.

2. Minimize impact on small businesses. The Class I price

should be set at a level that does not disadvantage small

businesses in competition with large businesses.

3. Provide long-term viability. The Class I price structure

should be expected to operate for an extended time period without

major modifications.

The nine evaluation criteria listed above are used to

qualitatively evaluate each of the options. Each option is

evaluated based on how the option performed compared to the

current system, either better than, worse than, or the same as,

for each performance criterion. The results of the qualitative
analysis provided a preliminary framework for quantitative

analysis using a multi-regional model developed by the Economic

Research Service (ERS) of the Department. 

As previously indicated, Option 2 - Relative Use

Differentials, Option 3A - Flat Differentials, Option 3B -

Modified Flat Differentials, Option 4 - Demand-Based

Differentials, and Option 5 - Decoupled Baseline Class I Prices

with Adjustors, were eliminated from further consideration. They

were eliminated for various reasons including failure to adhere to

AMAA requirements, the likelihood of creating disorderly marketing

conditions, and impacts on small businesses. A discussion of the

five eliminated options, including the evaluation against the

criteria and/or quantitative analysis were described in detail in

the PR.

The Final Options

Three options formed the basis for final consideration and

are described below. All options present national Class I pricing

structures developed utilizing the USDSS model. The options

continue to vary in their reliance and application of the USDSS

model but all remain based on economic principles contained within

the model. These options include Option 1A, a modified Option 1B,

and the adopted Class I pricing structure.

Option 1A: Location-Specific Differentials

Option 1A establishes a $1.60 per hundredweight fixed

differential for three surplus zones (Upper Midwest, West, and

Southwest) within a nine-zone national price surface, and for the

other six zones, an added component that reflects regional

differences in the value of fluid and manufacturing milk. This

option emphasized current supply and demand conditions with the

USDSS model output.

Some minor changes were made to the Option 1A differential

levels presented in the PR. The changes only involved adjusting

certain county specific differentials to provide for more

appropriate price alignment in several counties in the northeast,

seven counties in Florida, and one county in North Carolina. 

Other than these minor changes, Option 1A is the same as published

in the PR. 

Modified Option 1B: Relative Value-Specific Differentials

This option continues to establish Class I differentials

based on a relationship between prices and geographic location as

indicated by the USDSS model, but uses more current data. 

Modifications were made to Option 1B with respect to how adjusted

Class I differentials were established for each county in the

United States. This modified version of Option 1B continues to

establish differential levels by setting and equating the relative

value-specific differential of $1.20 per hundredweight in

Minneapolis, Minnesota. The Option 1B differentials in the PR
relied on an algorithm to set location adjusted differentials in

every county. The modified Option 1B price surface takes into

full account all known plant locations as was done in the

development of Option 1A. This approach ensures that all plants

similarly located would have similar prices.

The Adopted Class I Price Structure

The adopted Class I pricing structure establishes a price

surface that also utilizes USDSS model results adjusted for all

known plant locations and establishes differential levels that

will result in prices that generate sufficient revenue to assure

an adequate supply of milk. The differential levels will better

maintain equity by raising the level 40 cents per hundredweight

higher than the level proposed in Option 1B and in modified Option

1B. The higher differential level reduces the likelihood of

class-price inversions, where the Class I prices are below the

manufacturing milk prices for the month.

The USDA Multi-Regional Dairy Sector Model

 Option 1A, modified Option 1B and the adopted Class I

pricing structure were evaluated qualitatively against the

evaluation criteria and quantitatively utilizing the USDA multiregional dairy sector model. This model was developed to answer

some very specific questions about possible changes in the dairy

sector, particularly changes being considered in milk marketing

orders. The main focus of the model’s development and use was to

quantitatively examine the impacts of the changes under

consideration in the classified pricing of milk and dairy products

in the milk order system on an order-by-order and regional basis,

and for other areas of the country not currently a part of the

milk order system.

The multi-regional model establishes a baseline consistent

with the USDA official baseline projections for the dairy sector. 

It assumes 36 regions. These include: 32 Federal Milk Marketing

Order areas (including Tennessee Valley that was terminated on

October 1, 1997) and four non-Federally regulated areas

(California, Other Unregulated Western Counties, Unregulated

Northern New York and New England and Other Unregulated Eastern

Counties) and projects baseline information through the year 2005. 

The demarcation between the unregulated Western and Eastern

counties follows a line extending north to south on the eastern

State borders of North Dakota, South Dakota, Nebraska, Kansas,

Oklahoma and Texas.

The model baseline also assumes that the Class III price

would be the Basic Formula Price (BFP), the Class II price would

be the BFP plus 30 cents, each region’s Class I price would be the

BFP plus the current Class I differential and the Class III-a

price would continue. All other changes to milk order provisions

together with the three price surface alternatives are presented
as changes from the baseline over the period of the years 2000

through 2005. Each of the alternatives include the impact of

consolidation into 11 regional markets and moving to wholesale

product price formulas in setting the class prices.

From its baseline, the model has the ability to quantify the

impacts of pricing changes in the consolidated regions and in

estimating how the end use of milk may be expected to change with

the changes in how the order program will price milk. The model

can generate long-term supply, demand, and price projections that

are consistent with the USDA official baseline projections. 

The model estimates regional milk production based estimates

of milk-per-cow and number-of-cows for the 36 defined areas. The

milk cow inventory and milk-per-cow estimates for each area is

based upon reported state data. Changes in the inventory of cow

numbers and output-per-cow for each region are related to regional

farm milk prices and feed costs, and past regional net returns to

dairy farmers (a measure of profitability). Milk marketings in

the region are in direct relationship to milk production in the

region.

Once the volume of regional milk marketings is determined,

marketings are distributed to seven uses: bottled whole milk,

bottled low-fat milk, soft manufactured dairy products, American

cheese, other cheese, butter, and nonfat dry milk. Each of the

seven uses has a retail demand equation. Generally, the demand

for the specific product is a function of per capita income, the

retail price or the Consumer Price Index (CPI) of the product, and

the price or CPI of a substitute product (e.g. margarine for

butter). 

Demands for raw milk for use in fluid milk products and soft

manufactured dairy products have priority in the model and such

demands are filled regionally from the region’s raw milk supply

before the national demands of the hard manufactured product

markets are met. The Class I and Class II uses of milk in each

region are based upon differences in prices and population by

region. A CPI for fluid milk and other dairy products are

estimated for each region based upon a margin mark-up equation and

the region’s Class I and Class II prices. These values are used

to estimate regional per capita use, and when multiplied by

projected population for each region, determine the amount of milk

allocated to Class I and Class II uses.

The sum of each region’s raw milk supply less the milk used

in Class I and Class II results in a measure of the national

manufacturing milk supply. The model solves for equilibrium in

supply and demand by solving for wholesale prices of cheese,

butter, and nonfat dry milk that equate the supply and demand in

the hard manufactured dairy product markets. The hard

manufactured product markets, the Class I markets, the Class II
markets, and the farm level raw milk supply are linked through

price equations that relate the changes in wholesale product

prices to changes in prices for milk used in Class I, Class II,

Class III, Class III-a (or Class IV) and the farm level all-milk

price.

A Class III and Class III-a (or Class IV) price is calculated

from the model’s estimates of wholesale cheese, butter, and nonfat

dry milk prices; and these Class III and Class III-a (or Class IV)

prices are used to predict Class I and Class II prices. Changes

in Class I and Class II prices affect demand for Class I and Class

II products and the amount of milk available nationally for

cheese, butter, and nonfat dry milk production. Likewise, the

amount of milk used in each class in each region and the regional

class prices affect the farm level all-milk price and the supply

of raw milk in the region and therefore the amount of milk

available nationally for cheese, butter, and nonfat dry milk

production. The model iterates until an equilibrium is achieved

for the year in the wholesale product markets and then advances to

the next year.

A brief summary of the quantitative impacts of each

alternative price surface is included with the qualitative

analysis presented below. A detailed description of the USDA

multi-regional dairy model, as well as a complete discussion of

the impacts of the pricing alternatives are contained in the Final

RIA.

Option 1A: Location-Specific Differentials

Option 1A would establish a nationally coordinated system of

location-specific Class I differentials reflecting the relative

economic value of milk by location. An important feature of the

option is the location adjustments that geographically align

minimum Class I milk prices paid by fluid milk processors

nationwide regardless of the defined milk marketing area

boundaries or order pooling provisions. A basic premise of Option

1A is that the value of milk varies according to location across

the United States. 

Compared to the modified Option 1B and the adopted Class I

price structure, this option tends to most reflect the current

Class I pricing surface. Although extremely similar to the

current Class I price surface, there are distinct differences. 

Option 1A would establish a nationally coordinated price surface

that uses location adjustments to adjust the price of milk for

fluid use for every county of the United States.

Under Option 1A, Class I differentials are the lowest in

geographical areas evidencing the largest supplies of milk

relative to local/regional fluid milk needs. The differentials

become progressively higher as they move from these areas to

markets with less production relative to demand for fluid milk. 
Nine differential zones provide the basis for establishing the

price structure. These zones were established based on results of

the USDSS model, knowledge of current supply and demand

conditions, and recognition of other marketing conditions such as

fluid versus manufacturing markets, urban versus rural areas, and

surplus versus deficit markets. 

Class I differentials under this option range from a low of

$1.60 per hundredweight in the lowest valued zones of the Upper

Midwest, Southwest, and West, where there are abundant supplies of

milk in excess of fluid milk use, to a high of $4.30 per

hundredweight in Florida, where there are deficit supplies of milk

for fluid use.

Analysis Based on Evaluation Criteria. Option 1A performs

equal to or better than the current Class I system in each of the

evaluation criteria. This is largely explained by the

adjustments, improvements, and fine-tuning made to the current

system of Class I differentials

Option 1A was evaluated against the objective criteria as

follows:

1. Ensure an adequate supply of milk for fluid use. Option

1A performs essentially the same as the current price structure in

ensuring an adequate supply of milk for fluid use. Option 1A

changes current differential levels in some regions to more

accurately reflect current milk supply-demand conditions. Option

1A will have minimal impacts on farm level milk prices and should

ensure adequate supplies of milk for fluid use.

2. Recognize quality (Grade A) value of milk. Option 1A

recognizes the quality value (Grade A) of milk through the

addition of a differential that begins at $1.60 per hundredweight

in the base zone.

3. Provide appropriate market signals. Option 1A adjusts

and refines the existing Class I price structure to provide

appropriate market signals. In some geographical areas, Class I

differentials would be increased. These changes indicate that

current Class I differential levels are not high enough to attract

adequate supplies of milk to the applicable fluid milk markets. 

In certain other areas, Class I differentials would be lowered,

indicating that they exceed levels necessary to adequately supply

the associated markets with their fluid milk needs.

4. Recognize value of milk at location. The spatial values

of milk reflected in Option 1A recognize the value of milk at

location more accurately than the current system for two principal

considerations. First, in structuring the differentials in Option

1A, the effect of current Class I differential levels on milk

supplies, demand, and dairy farmer returns regionally during the

past decade were considered. Second, the relative values of milk

and milk components at geographic locations throughout the United

States from the USDSS model results were considered.

5. Facilitate orderly marketing with coordinated system of

prices. Option 1A provides a comprehensive national pricing

surface for Class I milk that establishes a value for Class I milk

in every county. Thus the price any processor would pay for milk

would be the same regardless of which order the processor is

regulated under. As such, Option 1A is an improvement over the
current price structure which evolved in a piecemeal fashion. 

Additionally, the Class I differentials and location adjustments

in Option 1A would facilitate more efficient and orderly marketing

of milk for fluid use through the nationwide coordination of

prices when compared to the current system.

6. Recognize handler equity with regard to raw product

costs. Class I differentials proposed under Option 1A are

consistent with the inherent economic value of milk at location. 

The coordination and alignment of prices, based upon cost

differences and current marketing conditions, better ensures

handlers of equity in competing for available milk supplies.

Option 1A was evaluated against the objective criteria as

follows:

1. Minimize regulatory burden. Option 1A would not change

the regulatory burden of the Federal order program. Option 1A

would not result in increased reporting, record keeping,

compliance, or administrative costs to handlers.

2. Minimize impact on small businesses. In regions where

more of the actual value of fluid milk would be reflected in the

differentials than is currently reflected, small businesses may

have a marginal improvement in their relative competitive

bargaining position vis-a-vis large businesses. This is based on

the concept that large businesses (producers, cooperatives or

handlers) are better able to negotiate premiums above minimum

order prices due to advantages attained from their size. Overall,

this option is not expected to materially impact small businesses

differently than the current price structure.

3. Provide long-term viability. To the extent the location

adjusted Class I differentials under Option 1A will correct

instances of price misalignment and more accurately reflect the

economic value of milk by location, the long-term viability of

Option 1A is expected to exceed that of the current price

structure. 

Because the USDSS model only determines the relative value

differences for fluid milk between location, it could not be used

for determining an appropriate differential level. Option 1A

utilizes $1.60 per hundredweight as the minimum differential

level. A complete explanation of the factors that developed and

explain this differential level was set forth in the PR. In

summary of those reasons, the $1.60 per hundredweight differential

level is used in Option 1A because it would ensure a sufficient

supply of milk for fluid uses in the most surplus regions.

Option 1A will have little impact on small businesses, either

producers and processors. In certain situations, it may improve a

small business’ competitive marketing position as compared to

current levels. Because the $1.60 base zone differential includes

a competitive factor as discussed previously, more of the actual

value of fluid milk will be reflected in the minimum Federal order

price. This may decrease the level of the over-order value that

must be negotiated between processors and producers. Doing this

would provide small businesses with a more equitable competitive

position.

Quantitative analysis of Option 1A using the USDA multiregional model evaluated the various impacts of this pricing

option. Overall, the magnitude of price and income changes under

Option 1A is relatively small when compared to the baseline. 

Option 1A results in an 8-cent increase in the average Class I
price for all current Federal orders. Further details of the

impact of these Class I price changes, and others, that are based

on the USDA model results are available in the final Regulatory

Impact Analysis (RIA). 

Modified Option 1B--Relative Value-Specific Differentials. 

Modified Option 1B would also establish a nationally coordinated

system of Class I differentials and adjustments that recognizes

several low pricing areas. Modified Option 1B more directly

applies the USDSS model’s optimal solution in developing the Class

I price structure.

The modified Option 1B differentials differ from those

published in the PR. The differences are explained largely by a

more complete consideration of all known plant locations. The

Option 1B differential values published in the PR relied on an

algorithm to establish differential levels for those counties that

were not part of the optimal solution. However, all plant

locations need to be considered for setting prices at these

locations and prices must be aligned between locations. This has

been done in modified Option 1B and results in a “zoned” structure

of relative price differences that are aligned. 

Modified 1B Differential Level:

As pointed out in the Option 1A discussion, the USDSS model

only provided information regarding relative differences in prices

between geographic locations and offers no information for

determining the level of Class I differentials used in setting

Class I prices. The same is true for modified Option 1B. 

Modified Option 1B relies much more directly on the geographic

price relationship results of the USDSS model in defining the

structure and relative differences represented in its differential

schedule for all locations.

While modified Option 1A establishes a $1.70 Class I

differential at Minneapolis, adjusted from a minimum level of

$1.60 (the lowest differential level at any location in Option

1A), modified Option 1B sets a Class I differential at Minneapolis

at the current level of $1.20 per hundredweight. It is important

to note that any modified Option 1B zone could be discussed as the

“starting” point differential. This decision only refers to and

references Minneapolis at the $1.20 level for illustrative

purposes since it provides a degree of continuity in how Option 1B

was presented and discussed in the PR.

Because Option 1B was expected to result in a significant

change to the industry in both the pricing surface and the level

of Class I differentials, it was proposed in the PR in conjunction

with three alternative transitional phase-in programs. However,

none of the phase-in programs received public support.

The final RIA statement provides the full measure of the USDA

multi-regional model analysis of this option. In short, modified

Option 1B is rejected because the differential levels it would set

would result in minimum prices that would not generate sufficient

revenue to assure an adequate milk supply. Additionally, for

markets with lower differential levels, there is a greater

potential for class-price inversions that would increase the

likelihood of disorderly marketing conditions.

The Adopted Class I Price Structure 

The adopted Class I pricing structure results from additional

quantitative and qualitative analyses of Option 1A and Option 1B,

consideration of public comments received to these options, and
the legislative requirements of the AMAA. The adopted Class I

pricing structure utilizes USDSS model results adjusted for all

known plant locations and establishes differential levels that

will generate sufficient revenue to assure an adequate supply of

milk and better maintain equity among handlers by raising the

level 40 cents per hundredweight higher than the level used in

modified Option 1B.

The Class I differential level was set by determining the

differential level that results in prices which will generate

sufficient revenue to bring forth an adequate supply of milk

throughout the Federal order system. As in both Option 1A and

modified Option 1B, the adopted Class I pricing structure adds a

differential value to the basic formula price in setting Class I

milk prices. Additionally, it is set at a level that minimizes

the likelihood of class-price inversions, discussed in the BFP

section of this decision. The $1.60 Class I differential level

(at Minneapolis) achieves these objectives for a nationally

coordinated Class I pricing structure.

Increasing the differential level by 40 cents per

hundredweight at all locations does diminish the reliance on the

marketplace and over-order premiums in establishing market prices

inherent in modified Option 1B. However, the adopted Class I

pricing structure retains the more efficient pricing structure

that offers increased cost savings in the organization of the

nation’s milk supply and in the transportation of milk and dairy

products.

The adopted Class I pricing structure moves the dairy

industry into a better organized and aligned pricing system while

continuing to assure orderly marketing conditions for producers

and handlers. Restructuring the relative-value differential

relationships at the level specified will, among other things,

generate sufficient revenue in the national system of Federal

orders to bring forth an adequate supply of milk. The higher

level will also minimize instances of class-price inversions. The

location adjusted differentials established for each county are

set forth in the Class I Price Structure Maps, and in the General

Provisions § 1000.52. The following table sets forth the location

adjusted differentials at selected cities.

Comparative Class I Differentials at Selected Cities Under the

Adopted Class I Price Structure

City Current Adopted Difference

Dollars Per Hundredweight

New York City, NY 3.14 2.50 (0.64)

Charlotte, NC 3.08 2.55 (0.53)

Atlanta, GA 3.08 2.90 (0.18)

Tampa, FL 3.88 4.20 0.32

Cleveland, OH 2.00 2.00 0.00

Kansas City, MO 1.92 1.90 (0.02)

Minneapolis, MN 1.20 1.60 0.40

Chicago, IL 1.40 1.95 0.55
Dallas, TX 3.16 2.10 (1.06)

Salt Lake City, UT 1.90 1.50 (0.40)

Phoenix, AZ 2.52 1.55 (0.97)

Seattle, WA 1.90 1.45 (0.45)

The adopted Class I pricing structure was evaluated against

the objective criteria as follows:

1. Ensure an adequate supply of milk for fluid use. The

adopted Class I pricing structure establishes lower differentials

than current levels in many of the proposed markets. Because the

differential level is higher than under modified Option 1B, the

adopted Class I pricing structure relies less on the use of overorder premiums as the method to attract adequate milk supplies for

fluid purposes. While over-order premiums will remain useful for

allowing the market to find the final value of Class I milk, the

higher-level differentials of the adopted Class I pricing

structure will better serve to ensure that the minimum prices set

by the orders will attract an adequate supply of milk for fluid

use.

2. Recognize quality (Grade A) value of milk. As with

Option 1A and modified Option 1B, the adopted Class I pricing

structure similarly recognizes the quality (Grade A) value of milk

through the use of a differential added to the basic formula

price.

3. Provide appropriate market signals. The adopted Class I

pricing structure provides appropriate market signals in all

markets even though the adopted Class I pricing structure lowers

differentials in some markets. Over-order pricing will likely

function in most, if not all markets, even with the higher-level

differentials. However, the higher differential level better

ensures that the minimum prices established under the orders will

generate a sufficient supply of milk and better ensures equitable

minimum prices among regulated handlers than does modified Option

1B. Additionally, because class-price inversions are mitigated,

more appropriate price signals are provided to the marketplace.

4. Recognize value of milk at location. The adopted Class I

pricing structure appropriately recognizes the value of milk at

location. It is based on the location value of milk as determined

by the May 1997 results of the USDSS model. It also aligns the

relative-value differences while adhering to spatial-value

differences determined by the model giving full consideration to

all plant locations. Thus, in utilizing the model results that

determine the most efficient spatial value of milk for fluid use

to establish the price surface, the adopted Class I pricing
structure should perform better than the current system.

5. Facilitate orderly marketing with coordinated system of

prices. The adopted Class I pricing structure establishes a

coordinated system of differentials with appropriate location

adjustments. Like the other two options, a comprehensive national

pricing surface has been developed that establishes a value for

Class I milk in every county. As a result, a processor’s

regulated price will be the same regardless of the order

regulating it.

6. Recognize handler equity with regard to raw product

costs. With the 40-cent per hundredweight increase in the

differential level, processor equity is better maintained under

the adopted Class I pricing structure. With price increases or

decreases in some areas, the markets will need to adapt to the new

pricing structure. While it is not the intent of the Federal

order system to set market prices, the reflection of a larger

portion of the price under regulation provided by the adopted

Class I pricing structure, better assures handlers a reasonable

degree of equity with regard to raw product costs. 

The adopted Class I pricing structure was evaluated against

the administrative criteria as follows:

1. Minimize regulatory burden. The adopted Class I pricing

structure would not change the regulatory burden of the Federal

order program in terms of reporting, record keeping, compliance,

and administrative costs to handlers. 

2. Minimize impact on small businesses. Under the adopted

Class I pricing structure, a fuller measure of the Class I value

needed to attract adequate milk supplies will come from regulated

prices. Reliance on over-order payments negotiated outside the

Federal order system is diminished, but continues to be recognized

as in either the current system or in Option 1A. As a result, it

is likely that small handlers who might have been disadvantaged by

the original Option 1B will not be under this modified version. 

Federal order Class I prices are mandatory and affect

processors in a specific area equally as minimum enforced price

levels. Since more of the actual value of Class I milk is

represented in regulated prices, the potential for large handlers

to have an advantage over small handlers is mitigated in competing

for a supply of milk under the adopted Class I pricing structure. 

Large processors often have advantages related to economies of

scale and may be able to temporarily inflate over-order prices

they are willing to pay until they have forced smaller businesses

out of business who could not afford to pay higher prices. 

Additionally, with higher differentials and resulting higher

producer blend prices, the balance of market power between

producers and processors is better maintained. Producers will not

need to negotiate with processors to obtain a better price for
their milk to the extent that would have been expected under

modified Option 1B. Small dairy farmers have less production

volume, and typically have higher per hundredweight production

costs. Hence, small producers who are less able to negotiate for

prices that may be higher than the Federal order minimum price

will be better served under the adopted Class I pricing structure. 

When too much reliance is placed on the use of over-order premiums

(as in modified Option 1B), it is likely that dairy farmers

defined as small businesses would benefit less from the regulation

of milk marketing.

Small businesses may be impacted under the adopted Class I

pricing structure as adjustments are made in response to the new

pricing structure. However, to the extent that small producers

may not be able to bargain with processors for over-order premiums

to adequately cover their costs, the increased differential level

in the adopted Class I pricing structure minimizes this potential

outcome. The inability of small processors to compete with large

processors at price levels above Federal order minimums is

similarly eased.

3. Provide long-term viability. The adopted Class I pricing

structure provides for a more efficient pricing structure. This

option is an alternative from the current way the Federal order

program has approached Class I pricing. Historically the Class I

price established under Federal orders represented the minimum

value of Class I milk in the marketplace based on the cost of

maintaining Grade A milk and associated marketing costs together

with the cost of alternative milk supplies. The adopted Class I

pricing structure provides the opportunity for increased marketing

efficiencies by promoting a more optimal organization in the

assembly and distribution of milk products while establishing

prices that will assure an adequate milk supply. In this way, it

is expected to have long-term viability.

Quantitative analysis of the adopted Class I pricing

structure using the USDA multi-regional model evaluated the

various impacts of this pricing option. The evaluation assumed

the eleven market order consolidation, four classes of milk use,

and the BFP replacement presented earlier in this decision. Class

I differentials are reduced from current levels in about half of

the marketing orders. The reductions range from 4 cents per

hundredweight in the Ohio Valley order to as much as $1.18 per

hundredweight in the Eastern Colorado order. The Class I

differential for the Eastern Ohio-Western Pennsylvania order would

be unchanged. For the other markets, the Class I differential is

increased, ranging from 8 cents per hundredweight in the Greater

Kansas City order, to 57 cents in the Southeastern Florida order.

Under the adopted Class I pricing structure, six current milk

orders would have Class I differentials lower than the
differential established at Minneapolis. This gives explicit

recognition that these other areas have adequate milk supplies to

satisfy Class I demands at lower costs. For areas needing

supplemental supplies of milk for fluid use, the Class I

differentials are reflective of transportation costs from the

closest alternative supply area.

According to the USDA model analysis, the adopted Class I

pricing structure differential level would increase order

marketings over the six-year analytical period of the years 2000-

2005 when compared to the baseline. Raising the differential, in

conjunction with shortening the advance pricing notice of Class I

prices by 18 days as discussed in the BFP section of this

decision, minimizes class-price inversions. The rise in the allmilk price in the first year of implementation is expected to

stimulate additional milk production in the milk order system. 

This additional milk production results primarily from Class I

prices being established by using the expected higher Class IV

prices in the year 2000. Over the six-year analytical period, the

annual all-milk price is expected to drop by about two cents per

hundredweight, but the annual average of marketings in the entire

milk order system is expected to increase by about 8.3 million

pounds when compared to the baseline. This increase in marketings

is largely explained by the pooling of milk that was not pooled in

recent years because of class-price inversions.

The USDA analytical model suggests that annual cash receipts,

or revenue, for producers under the adopted Class I pricing

structure will increase in many markets when compared to the

baseline. The marketing areas expected to have the largest

average annual increases in producer revenue include the following

orders: Chicago Regional - $43.1 million, New York-New Jersey -

$18.7 million, Iowa - $17.5 million, Southern Michigan - $14.1

million, and Tampa Bay - $12.2 million. Other markets would be

expected to have lower estimated annual cash receipts over a sixyear analytical period of the years 2000-2005 from the baseline. 

The marketing orders with the largest reductions include: Texas (-

$39.7 million), Middle Atlantic (-$39.5 million), Eastern Colorado

(-$11.4 million), Southwest Plains (-$11.3 million) and Central

Arizona (-$10.4 million).

The USDA analytical model suggests that as the adopted Class

I pricing structure results in lower Class I prices in many

markets, the average annual impact on retail prices to the

consumer for fluid milk will be about 2 cents per gallon less, on

average, over the six-year period of the years 2000-2005 when

compared to the baseline. From a national perspective, this

translates into consumer savings of about $79 million for fluid

milk products annually. Sales of manufactured dairy products over

the same time period are expected to decrease somewhat, but
expenditures for these products will be higher.

While only summarized here, the complete USDA multi-regional

model analysis of Options 1A, modified Option 1B and the adopted

Class I pricing structure are included in the final RIA statement.

Comparison of Option 1A and the Adopted Class I Price Structure

Option 1A and the adopted Class I pricing structure have

similarities but rely on differing methods in constructing a

nationally coordinated Class I price structure. Both recognize

that milk has a location value. Both utilized the USDSS model

results to establish the price surface. Both establish Class I

prices by adding a fixed differential to the implied value of milk

used in manufacturing. Both establish a price surface that

assigns a price to every county in the United States and would

assure that a price at any particular location will not vary

depending upon the marketing order under which the milk is pooled.

Although similar in the above respects, they also differ. 

First, they differ in the method of determining the level of the

Class I differential. Option 1A relies on finding that Class I

differentials would be established at a level that more fully

reflects the additional value of Class I milk in the most surplus

regions. The adopted Class I pricing structure relies on the

finding that the national system of milk order needs to result in

prices that will generate sufficient revenue to bring forth an

adequate milk supply. 

Secondly, they differ in how the price surface should be

established regardless of the level. Option 1A provides for the

alignment of resulting Class I prices by evaluating the cost of

alternative supplies based upon the current Class I differential

structure. This results in a surface that is smoother and flows

primarily from north to south and west to east. However, the

adopted Class I pricing structure relies on a cost minimization

model to provide for a more efficient organization and structure

in milk supply and distribution. Thus, it results in more limited

relative price differences and in a price surface that is flatter.

Thirdly, they differ in their reliance on the USDSS model

results. Option 1A recognizes the value associated with the model

results but relies on knowledge of specific marketing conditions

and practices to make adjustments to existing differentials. The

adopted Class I pricing structure, on the other hand, relies more

directly on the USDSS model results that indicate the optimal

spatial values for fluid milk which serve to promote market

efficiencies, and implements this structure to encourage market

efficiency within the dairy industry.
Public Comments

The majority of comments received in response to the PR dealt

with the Class I price structure. In all, 4,217 comments were

received on this issue. Of this number, 3,579 comments indicated

support for the adoption of Option 1A and 436 comments supported

the adoption of Option 1B. Some supportUSDA of both Class I

pricing options called for changes in each of the Option’s

details. No comments were received that supported any sort of

transition programs suggested in adopting Option 1B. Some

comments, while supporting Option 1B in its general theme,

proposed adopting Option 1A initially and phasing in the adoption

of Option 1B over an extended time period.

It is clear from the comments received that there is broadbased support for adopting Option 1A. These commenters explained

what they thought were and should be the most important goals of

the milk marketing order program, the pricing policies and

features that it should contain to achieve these goals, and their

view of the legislative requirements that must be incorporated

into milk orders. Such was similarly expressed in explaining both

the support for, and opposition to, Option 1B.

Supporters for Option 1A generally saw it as the best Class I

pricing option that would properly reflect the fullest measure of

the AMAA’s articulated goals and requirements. These supporters

expressed the limitations of relying too much on the free market

in setting milk prices. For example, supporters of Option 1A

indicated that milk marketing orders exist because dairy farmers

are at a distinct disadvantage in their marketing relationship

with handlers who buy their milk. They cited the characteristics

of milk — that it is highly perishable, bulky, is produced daily

and must be marketed nearly as often, and is expensive to

transport — as making it a unique commodity. Unlike other

commodities, grains for example, milk cannot be withheld from the

market in the hope for a better price, nor can it be shipped long

distances in search of a higher price because transportation costs

quickly erode the benefits of a higher price. Dairy farmers don’t

even know the price they will receive for their milk in advance of

having to ship to market, they noted.

Also, supporters of Option 1A were of the opinion that

marketing conditions faced by dairy farmers today are

fundamentally no different than they were when the order program

first began. They point out that even though there are fewer and

larger dairy farms with greater milk production, the number of

plants at which to sell milk are fewer than when the order program

first began. Implicit in this relationship, they said, is the

degree of uneven market power that handlers have over producers. 

One commenter noted that the ratio of dairy farmers to milk plants

today has increased threefold since 1960, an indicator of the
growth in the concentration of market power among handlers. Even

the prominence of dairy farmer cooperatives over the years has had

little significant impact on the relative bargaining power of

dairy farmers, noted many commenters. While these organizations

have served with varying degrees of success in negotiating for

higher milk prices for their members, they said, cooperatives do

not and cannot have the ability to significantly impact prices

because no entity can control or limit the supply of milk to the

marketplace. Because dairy farmers face such a skewed marketing

situation, most commenters view milk marketing orders as the only

practicable tool to assure farmers receive a fair price for their

milk.

Supporters of Option 1A indicated that because of the

continuing marketing situation they face, no basis exists for

concluding that more emphasis should be placed on a dairy farmer’s

ability to negotiate prices with handlers. According to these

commenters, relying too much on the marketplace would only provide

the incentive for producers to needlessly compete with each other

to supply the higher-valued fluid market. Those that are

successful might receive more for their milk than those who could

not, but to this end, there is no guarantee that all handlers

would pay the same price for milk. Nor is there a guarantee that

handlers would share the higher-valued use of milk equitably with

those producers. This, they said, results in disorderly marketing

conditions and the pitting of farmer against farmer in unnecessary

and destructive price competition. It was these conditions, they

note, that led to creation of milk orders and justified the

marketwide pooling and minimum pricing provisions contained in

milk orders today. Only Option 1A, say its supporters, best

establishes the proper value of milk that, together with

classified pricing and marketwide pooling, assures the highest

degree of equity for both producers and handlers.

Supporters of Option 1A agreed and recognized that it is

important to have a Class I pricing structure that is national and

more reflective of marketing conditions for milk. Some commenters

were of the opinion that the geographic pattern of milk production

can be expected to remain as it is today. They noted further that

Option 1A gives explicit recognition to more than a single reserve

supply area in the country, and that Option 1A would assign the

lowest differential in each of these reserve supply areas, what

many supporters of Option 1A viewed as significant pricing reform.

Option 1A supporters also thought that the USDSS model served

as an excellent tool in developing a Class I price structure. 

However, they also recognized the limitations of relying too much

on this analytical model because it does not bring into

consideration all of the other necessary judgements and factors

that cannot be included in a model. For example, many commenters
pointed out that while Option 1A used the USDSS model as a guide,

it cannot be relied upon for making adjustments to conform with

known relationships between and among geographic and actual plant

locations. Further, said supporters of Option 1A, the model is

static, and cannot estimate the dynamics of changes that may

result in supply and demand conditions over time.

In summary, Option 1A supporters indicated Option 1A best

assures the continuation of dairy farmers receiving a fair price

for their milk. Processors, they also pointed out, would not see

a significant change in their ability to compete for a milk supply

since most of the value of fluid milk would be contained in the

regulated minimum price. They concluded that any changes to milk

orders that would diminish these outcomes would be harmful to the

dairy industry and to the public interest.

Opponents to Option 1A view it as maintaining too much of the

status quo and not addressing the reform needed in Class I

pricing. The opponents of Option 1A also view the current Class I

pricing structure as seriously flawed. In their view, the current

system relies on recognizing the Upper Midwest region as the

reserve supply of milk for the country when this is no longer the

case. They see Option 1A as largely maintaining this viewpoint.

Opponents to Option 1A and the current Class I pricing

structure are of the opinion that today’s differential levels and

Option 1A differential levels are too high, or at least higher

than necessary to attract adequate milk supplies in many areas. 

Because Class I differentials are too high, they said, improper

economic incentives exist in many areas for increased milk

production -- in fact overproduction -- beyond what is needed to

meet Class I demand. When this happens, opponents to the current

system and Option 1A said, all producers nationally are negatively

impacted because the overproduced milk supply drives down prices

for milk used in manufactured dairy products which compete in a

national market. They noted this is especially injurious to dairy

farmers in markets where most of the milk produced is used in

manufactured dairy products.

Adding to this, the opponents of the current Class I pricing

system and Option 1A are also of the opinion that technology is

available today to meet the supplemental milk needs of any milkdeficit area. Not only do they think that higher-than-necessary

Class I differentials result in artificially-induced

overproduction, they also believe that resulting high Class I

prices may be reducing fluid milk consumption by consumers. They

are of the opinion that it is more appropriate and efficient to

attract milk to meet fluid demands by compensating those who incur

the cost of shipping milk from surplus areas rather than paying a

high price to local producers in milk-deficit areas to bring forth

a sufficient supply of local milk to meet fluid demands.
Supporters of Option 1B indicated support for the more

market-oriented theme reflected in this Class I pricing option. 

These supporters commented that Option 1B will allow milk prices

to respond more appropriately to changing supply and demand

conditions. Because of this, they said, the milk order program

will become more market-oriented. The overall pricing structure

offered in Option 1B, they say, flattens the resulting level of

Class I prices throughout a larger portion of the country, thereby

providing more of a level playing field for producers everywhere.

Supporters of Option 1B view the increased market-oriented

theme as the proper direction in which to bring the Class I

pricing structure as the milk order program is reformed. Not only

is it consistent, in their view, with the reform mandates

established by Congress in enacting the 1996 Farm Bill, the

movement to a more market-oriented milk order program will provide

incentives for private sector innovations that will benefit dairy

farmers and consumers.

Supporters of Option 1B take a fundamentally different view

than supporters of Option 1A on the appropriate level of the Class

I differential. Supporters of Option 1A are of the opinion that

Class I differential levels should be set high enough to assure

the least amount of price inequity among handlers and should also

be at levels high enough to not lower returns to producers. 

However, the supporters of Option 1B think that Class I

differential levels should be set at minimum levels that will

allow the effective price for milk to be much more determined by

the marketplace. In this way, they said, milk production and

prices would respond more effectively to changing supply and

demand conditions. By taking this approach, they say, Option 1B

Class I differential levels will provide a sufficient degree of

the structure needed for producers and handlers, while reducing

market distortions that result from regulation-induced prices that

discriminate against producers, especially in the Upper Midwest

region.

As mentioned above, supporters of Option 1B called for

certain modifications. The most significant change included the

lowering of the Class I differential level for Minneapolis,

Minnesota. These commenters offered a $1.08 per hundredweight

Class I differential level for this location. They based this

recommendation on their own study and survey of prevailing

conditions in the Minneapolis area. This proposal is consistent

with their view that Class I differential levels should be set at

minimum levels. This level included, they said, premiums above

the Upper Midwest’s order blend price, quantity and quality

premiums, and hauling subsidies. From this level, all other

differential levels should be set and adjusted.

These commenters also cited the USDSS model’s limitation in
determining the proper alignment of Class I differential levels, a

similar criticism voiced by Option 1A supporters. These

commenters are also of the opinion that, due to more than 60 years

of Federal regulation, the relative value differences implied in

the model results were too much like existing value differences

than would be the case in an unregulated market. They indicated

that the USDSS model’s optimal solution values should be used

conservatively as maximums in setting relative geographic

differences to the Class I pricing structure. Some commenters

suggested that because the model establishes geographic values for

all milk uses, a bias results toward higher Class I values

relative to manufacturing values in many markets. 

Opponents to Option 1B did not the idea of making the milk

order program more market-oriented by reducing Class I

differentials in setting Class I milk prices. If this is done,

say Option 1B opponents, a cascading series of events will result

that seem not only contrary to why marketing orders exist, but

will return the dairy industry to the marketing situations that

led to their establishment. Most important, they said, Option 1B

would result in, and in fact calls for, the altering of current

supply and demand conditions for milk. These commenters are of

the opinion that the Department should not act to cause changes in

either prices or marketing conditions. Additionally, they are

also of the opinion that it was not the intent of Congress to have

milk order reform result in either an increase or decrease in

returns to dairy farmers.

Opponents of Option 1B were of the opinion that too much

reliance was placed on directly applying the USDSS model results

as the Class I pricing structure, and that inappropriate reliance

was also placed on the role of over-order premiums in achieving a

more market-oriented pricing plan for the milk order program. 

Opponents argued that today’s over-order premiums are directly

tied to the differential levels and the alignment of Class I

prices established under the existing orders. Additionally noted,

current and consolidated markets have, and will continue to have,

different circumstances that will disproportionately affect the

ability of producers to negotiate over-order premiums, especially

in those markets where Class I differentials are lowered most from

current levels.

Because Option 1B calls for reductions from current

differential levels nearly everywhere, they observed, less of a

minimum order price is assured to producers. In those markets

where minimum order Class I prices are reduced the most, a greater

burden is placed on producers and handlers in negotiating actual

prices relative to those orders where price levels are not as

affected, they said. In other words, noted one commenter,

producers in milk-deficit areas would have Class I differentials
reduced the most and would be required to be much more marketoriented than producers in milk-surplus area where the

differential level is maintained or increased. One commenter

noted, that once over-order premiums are established, they can

easily collapse because no one has the ability to control or limit

milk production or the flow of milk to market. Very small

additional volumes of milk to a market can destroy over-order

premiums, this commenter added. On the producer side of relying

too much on over-order premiums, they said, prices received would

be much less equitably shared and uniform, and would tend to force

dairy farmers to engage in ruinous price competition in seeking

Class I outlets. On the handler side, they noted, order prices

will not be high enough to bring forth that mix of local and

distant milk supplies to meet Class I needs. Related to this,

some commenters noted that the relative differences in prices that

would be set under Option 1B would not provide enough of a price

difference to cause milk to move from surplus to deficit areas as

would be provided in Option 1A. Relying too much on over-order

premiums will benefit large handlers to the competitive

disadvantage of small handlers, they said. Because actual milk

prices paid by handlers would increasingly be determined outside

of the order’s minimum pricing provisions, they concluded,

handlers would be much less assured of the price their competitors

are paying for milk.

Conclusion

Milk is a unique agricultural commodity and faces unique

marketing circumstances. It is highly perishable, is produced

daily and therefore needs to be marketed in a very committed and

continuous production-and-marketing cycle. These characteristics,

together with the fact that there are many more dairy farmers than

milk buyers, presents the opportunity for marketing problems to

occur that can be disruptive and destructive to dairy farmers. 

This sort of marketing situation places producers at a marketing

disadvantage relative to handlers, and without some government

involvement, equitable terms of trade between these two entities

can be difficult to achieve. These unique features of milk and

the marketing situation faced by dairy farmers were noted in

public comments and are reflected in the legislation authorizing

milk marketing orders. Milk marketing orders, using the tools of

classified pricing and marketwide pooling, can significantly

mitigate the undesirable effects of this marketing situation and

still satisfy the public interest by having an adequate supply of

milk at reasonable prices.

As noted in public comments, the structure of today’s dairy

industry, characterized by many dairy farmers and relatively few

buyers, is basically the same as it was when the milk order

program first began. No dairy farmer, dairy farmer cooperative or
bargaining organization can effectively serve to either control

milk production or limit the supply of milk to the marketplace to

achieve a measure of reasonable price certainty. This can, from

time-to-time, be achieved but such instances are generally shortlived and cannot be relied upon for serving the public’s interest

in having a sustainable, stable and reliable milk supply at

reasonable prices.

It is clear from the many public comments received that dairy

farmers are largely content with the current way the Federal milk

order program has approached Class I milk pricing, both in its

structure and the degree to which it is has returned equitable

prices to producers and handlers. But some changes are needed to

assure that this program remains viable to serve the needs of the

dairy industry and the public well into the 21st century.

The need to reform the milk order program is clearly and

uniformly recognized by industry participants and the public. To

this end, most producers and handler entities are of the opinion

that the reform effort should result in limited change in the

prices that are established under the orders, and that any changes

to the system be governed by a minimum of change in the prices and

the terms of trade between producers and handlers. Other producer

and handler entities are of the opinion that the “traditional”

methods of Class I milk pricing are seriously flawed, resulting in

a program that has become viewed as economically discriminatory to

dairy farmers in certain regions of the country and is

institutionally resistant to change. The public too, expects that

the program should be operated in a manner that will provide and

promote efficiency and offer the potential for a less expensive

milk supply.

It is the Class I pricing structure that provides additional

revenue above the basic value for milk to producers. Because of

this, Class I pricing is often viewed as the cornerstone of the

milk order program’s pricing policy. This is so because the Class

I fluid use of milk commands the highest-valued use in the

marketplace and is the preferred outlet for milk by producers. It

is also this use of milk that has the greatest effect on

determining the location value of all milk and in determining the

differences in blend prices that are received by producers.

Because milk value varies by location, it is appropriate, in

using a classified pricing plan, to establish Class I prices that

reflect these location value differences. Supporters of Option 1A

and Option 1B agree this is best accomplished with a system of

Class I differentials that properly links and aligns milk value. 

In evaluating how best to accomplish this, it is also important to

recognize the significant changes that have taken place within the

dairy industry since the full measure of Class I pricing was last

undertaken at a 43-day national hearing in 1990.
Today, and as evidenced in the hearing record of 1990, there

was general satisfaction with the way Class I milk pricing was

developed and employed in a system of orders that had evolved over

nearly 60 years. The record of that hearing evidenced that

technological and structural changes were underway, but the record

did not contain sufficient evidence for changes at that time. The

Upper Midwest region of the country can no longer be considered

the single reserve supply of milk that the country can rely upon

for a supply of milk to meet fluid needs in deficit areas. In

fact, the reform effort has clearly revealed that there are

several reserve supply areas, and the Class I pricing structure

changes adopted are reflective of this change. Other issues --

technological factors, improved assembly and distribution systems

allowing for sales competition of ever-larger geographic areas,

the growing importance of milk value based on the value of its

components -- all speak to the need for reforming the Federal

order system.

The PR preliminarily narrowed the Class I pricing structure

to two options. Both have similarities and differences that have

been discussed in detail. The adopted Class I pricing structure

will work in conjunction with other reforms to milk order

provisions, especially the more transparent product price formulas

and the reduced amount of advance notice for Class I and Class II

prices. Taken as a whole, the package of reforms retain the

features that are desired and needed to achieve the goals of the

AMAA articulated by Option 1A supporters while also providing the

appropriate changes needed to obtain greater economic efficiency

and equity - an objective voiced by supporters of Option 1B. The

adopted class I pricing structure will establish Class I milk

prices that will result in a sufficient supply of milk for the

national system of reformed and consolidated milk orders. 

The adopted Class I pricing structure recognizes and

addresses the concerns of Option 1A supporters in their view of

the limitations of relying on the marketplace in establishing milk

prices to producers that are equitable and reasonable given the

marketing situation they face. Similarly, the adopted Class I

pricing structure recognizes that handlers will be assured a

higher degree of minimum price equity. As importantly, the

adopted Class I pricing structure provides the necessary

structural reform needed in the dairy industry. The adopted

structure provides the incentives necessary for increased

efficiency in the organization and distribution of the milk supply

and dairy products that is not offered by the price structure of

Option 1A. 

As discussed earlier, it is important and appropriate that

the Class I price structure recognize all uses of milk. The

classified pricing system of the Federal milk order program will
continue to value fluid milk in the highest-priced class. The

higher-priced classification encourages all milk to first satisfy

Class I needs and the adopted Class I pricing structure

accomplishes this. Additionally, it continues to consider the

cost of moving milk from an alternate location for Class I use, a

consideration important to both Option 1A and Option 1B

supporters. This is reflected in its aligned structure,

recognizing that in supplying milk for manufactured products,

demand for manufactured products influences a market's ability to

procure milk for Class I needs. In this way, the adopted Class I

pricing structure appropriately considers all uses of milk as a

national Class I pricing structure.

Finally, the adopted Class I pricing structure meets the

requirements of the AMAA. The broad tenet of the AMAA is to

establish and maintain marketing stability and orderly marketing

conditions for milk. The Federal milk order program will continue

to achieve these goals primarily through classified pricing and

marketwide pooling. As to pricing requirements, the AMAA

objective to stabilize the marketplace with minimum prices and not

set market prices is also achieved. As a national Class I pricing

structure, it specifically addresses, and adequately sets,

appropriate Class I differential levels that will result in milk

prices that are high enough to generate sufficient revenue for

producers so that an adequate supply of milk can be maintained

while continuing to provide equity to handlers.

Class I Price Structure Maps - [west b&w gif, central b&w gif, east b&w

gif,color PDF]