We provided copies of a draft of this report to USDA and the Department of Defense for their review and comment. We met with officials from USDA’s Agricultural Marketing Service, Economic Research Service, and Rural Business Service, including the Associate Deputy Administrator, branch chiefs, and others, to discuss their comments on the draft report. These officials had several concerns about our use of USDA’s published data for the mailbox and announced cooperative price series as surrogates for farm- and cooperative-level prices, and our use of commissary prices as a surrogate for wholesale prices. Specifically, the officials made the following comments: Using the mailbox price as the farm-level price understates the amount that farmers receive for a gallon of fluid milk by different amounts for various markets. This is because the mailbox price is the average price received by all farmers in the market for all uses of milk, and the actual prices received by farmers for milk used in fluid products would vary by market, depending upon the proportion of milk used in that market for products other than fluid milk, the costs and profits from manufacturing milk, and other factors that are unrelated to the fluid milk market. During our meeting, Economic Research Service officials suggested what they believe is a better measure of farm-level prices for fluid milk. However, these officials stated that while their suggested method might provide a better estimate of the farm-level price for fluid milk, it would still not provide a perfect estimate because it is impossible to isolate the price for fluid milk in a market where there is concurrent demand for milk used for other products. We were aware of the limitations of using mailbox prices as a surrogate for farm-level prices for fluid milk and therefore included a discussion of these limitations in appendix I of the draft report. However, we chose to use the mailbox price in our analysis because it is routinely published and is, in the dairy industry, a relatively well-recognized estimate of the average price received by farmers. We continue to believe that it provides an adequate proxy for determining the relative portions of the retail price received by the various entities in the farm-to-retail milk marketing chain and the associated trends in changes to these portions. Our views were generally shared by the dairy industry experts who we spoke with. However, to provide additional perspectives on fluid milk prices, we calculated the farm-level prices for 24 of the 31 markets for which the necessary data were available using the method suggested by the Economic Research Service officials. We found that by using this methodology, farmers, on average, received 47 percent of the retail price for a gallon of 2-percent milk instead of the 43 percent that we calculated using the mailbox price, and cooperatives received 6 percent of the retail price instead of 10 percent in the 24 markets from January 1996 through February 1998. Appendix VI contains additional data and analysis of fluid milk prices using the Economic Research Service’s methodology. USDA officials also told us that the manner in which we used the announced cooperative price series overstates the cooperatives’ share of the retail price. In part, this is because the announced cooperative price includes certain revenues that are not retained by the cooperative but are used to cover costs such as hauling. The officials acknowledged, however, that it is difficult to calculate the actual share of the retail milk price that is received by cooperatives. We have revised the report to indicate that a portion of the announced cooperative price may be used to pay for some costs, such as hauling, in some markets. Finally, according to the officials, commissary prices may not be a good surrogate for wholesale prices because (1) some of the commissaries are not in close proximity to the markets we analyzed, (2) the wholesale price data were derived from a single store in each market we analyzed, and (3) the commissary price is based on contracts awarded to the lowest-cost bidder and is the result of a rigid bidding process that may not reflect the wholesale prices paid by retailers in a given market. Commissary prices were the best surrogate we could obtain for wholesale prices because of the proprietary nature of wholesale price data. We generally agree with USDA’s concerns that commissary prices may not be fully representative of wholesale prices because they are derived from a single store in each of the markets and are often based on contracts awarded to the lowest-cost bidder. However, we disagree with USDA’s comment that the commissaries we selected were not in close proximity to the markets we analyzed. As displayed in Figure I.1 in appendix I, for almost all of the 31 markets included in our analysis, the commissary that we selected was within the marketing area being analyzed. Moreover, according to industry representatives with whom we shared our analysis, the commissary prices appear to be a valid surrogate for actual wholesale prices. USDA officials also provided us with technical comments that we have incorporated into the report as appropriate. Department of Defense officials advised us that they agreed with the information included in this report on milk prices obtained from defense commissaries and had no other comments. To identify the major factors that influence the price of milk as it moves from the farm to the consumer, we obtained and analyzed studies performed by USDA, universities, and private entities, and spoke to state government and industry representatives and officials at USDA. To report on the various relationships among prices at the farm through retail levels, we obtained information on milk prices in 31 selected markets throughout the United States. These markets were selected because (1) data were available for these locations, (2) they provided geographical coverage for the nation, and (3) they represented a cross section of state- and federally regulated markets. For these markets, we obtained data from USDA, state milk control agencies, the Department of Defense, and a private data collection company on the prices received by farmers, cooperatives, wholesalers, and retailers for January 1996 through February 1998. We limited our data collection efforts to the sale of whole, 2-percent, 1-percent, and fat-free fluid milk sold in gallon containers, which represents about 64 percent of the fluid milk sold in the United States, and we limited our data analysis to 2-percent milk sold in gallon containers. Our analysis of 2-percent milk may not reflect pricing patterns and trends for the other kinds of milk. A more detailed description of our scope and methodology is presented in appendix I. We have attributed all of the data used in our analysis to the source from which they were obtained and have not verified the accuracy of these data because the information from which they were compiled was not available to us. We conducted our review from November 1997 through September 1998 in accordance with generally accepted government auditing standards. As arranged with your offices, unless you publicly announce its contents earlier, we will make no further distribution of this report until 30 days after the date of this letter. At that time, we will send copies to the Senate Committee on Agriculture, Nutrition, and Forestry; the House Committee on Agriculture; other appropriate congressional committees; interested Members of Congress; the Secretary of Agriculture; the Director, Office of Management and Budget; and other interested parties. We will also make copies available to others upon request. Please contact me at (202) 512-5138 if you or your staff have any questions about this report. Major contributors to this report are listed in appendix VII. In August 1997, Senators Jeffords and Leahy requested GAO to examine a number of issues concerning the pricing and marketing of fluid drinking milk (fluid milk) in the United States. This report provides information on (1) the factors that influence the price of fluid milk as it moves from the farm to the consumer, (2) the portion of the average retail price of fluid milk that is received by farmers, cooperatives, wholesalers, and retailers in selected markets nationwide, (3) changes in farm and retail prices and their effect on the farm-to-retail price spread—which is the difference between the retail and farm prices, (4) the way changes in prices at any given level in the milk marketing chain are reflected in changes in prices at the other levels, and (5) different retail pricing relationships that exist in selected markets among the four kinds of milk—whole, reduced-fat (2-percent), low-fat (1-percent), and fat-free (skim). To identify the major factors that influence the price of milk as it moves from the farm to the consumer, we obtained and analyzed studies performed by researchers at the U.S. Department of Agriculture (USDA), universities, and private entities. These included milk marketing cost studies performed by USDA’s Economic Research Service and researchers at Cornell University, and studies on retail pricing strategies performed by Texas A&M University researchers and various state and private entities. We interviewed officials at USDA, academic researchers, and industry representatives. We were also referred by the International Dairy Foods Association, Food Marketing Institute, and National Milk Producers Federation to some of their members, who spoke to us about the factors that they believe influence the price of milk as it moves from the farm to the consumer. To obtain information on the portion of the retail price received by farmers, cooperatives, wholesalers, and retailers; changes in farm and retail prices and their effect on farm-to-retail price spreads; and the relationship among price changes at different marketing levels, we obtained information on milk prices in 31 selected markets throughout the United States. These markets were selected because (1) data were available for these locations, (2) they provided geographical coverage for the nation, and (3) they represented a cross section of state- and federally regulated markets. For these markets, we collected data on the prices received by farmers, cooperatives, wholesalers, and retailers for January 1996 through February 1998. We limited our data collection efforts to the sale of whole, 2- percent, 1-percent, and fat-free fluid milk sold in gallon containers, which represent about 64 percent of the fluid milk sold in the United States.