Financial stress in the dairy industry in 2009, brought on largely by sharply lower milk prices, activated standing federal programs to support dairy farmers. In calendar year 2009, the federal government spent more than $1 billion to support the industry through the Milk Income Loss Contract (MILC) Program, the Dairy Product Price Support Program (DPPSP), and the Dairy Export Incentive Program (DEIP). After appeals from dairy farmers for more financial assistance, Congress granted another $350 million in October 2009 in the form of supplemental payments to dairy farmers and government purchases of dairy products for domestic feeding programs. Under financial pressure, many dairy farmers sent milk cows to slaughter and some went out of business. The subsequent decline in milk production and a simultaneous rebound in foreign demand have lifted the farm price for milk. Still, financial concerns remain for dairy farmers who lost significant amounts of farm equity during the milk price collapse. According to the U.S. Department of Agriculture (USDA), the number of dairy farms in the United States declined from 67,000 to 65,000 during 2009. The total fell to 62,500 as of December 31, 2010. The financial stress of 2009 and similar episodes over the years have led the industry and Congress to reconsider how to handle fluctuations in milk prices and financial prospects for dairy farmers. Some members have voiced interest in developing alternatives to current polices (which expire in 2012) and incorporating them in the next omnibus farm bill in the 112 th Congress or enacting the policies separately before then. As part of groundwork for the next farm bill, the House Committee on Agriculture held a hearing on dairy policy on April 20, 2010. Similarly, the Administration has been collecting information through the USDA-established Dairy Industry Advisory Committee (DIAC). On March 3, 2011, the DIAC approved its final report with recommendations to Secretary of Agriculture. This report provides background on the U.S. dairy industry, including an overview of dairy farm numbers and industry structure, and a brief history of dairy marketing and policy. Next, current dairy policy is reviewed. Finally, the report examines options for federal dairy policy being considered by the industry and/or Congress. Increased dairy cow output and advances in dairy farm technology and management have led to a sharp reduction of the number of dairy farms, particularly during the 1960s and 1970s ( Figure 1 ). Larger operations tend to have lower per-unit costs, and as firms reduce their costs, they become more competitive and can increase sales and market share. Firm size is a limiting factor for growth, however, once the gains to economies of scale have been exhausted. For the dairy industry, the number of farms continues on a downward trajectory, though at a much slower pace during the last decade than in the late 1960s and 1970s. Annual losses averaged 96,000 operations in the late 1960s and 37,000 in the 1970s. In recent years, the annual drop in dairy farm operations has slowed to about 2,000 to 5,000 farms per year, with operations totaling 62,500 on December 31, 2010. Increases in productivity have more than offset declines in the numbers of dairy farms and cows, resulting in a steady upward trend in total milk production ( Figure 2 ). Meanwhile, domestic demand for milk, on a per-capita basis, has grown slowly, at 0.4 % per year since 1990. Rising consumption of dairy products such as cheese has offset a decline in fluid milk consumption. Exports of dairy products have increased in recent years, reaching record levels in 2008. The trend in farm numbers depends on farm size. Between 2005 and 2009, farms with fewer than 500 cows registered declines, while farms with 500 to 999 cows held steady ( Table 1 ). In contrast, the number of farms with 1,000 or more cows increased 20%, driven by significantly lower costs of production. In 2005, dairy farms with 1,000 cows or more had average costs of production of $13.59 per cwt, 15% below the average for farms with 400-999 head and 35% below the cost for farms with 100-199 head. Average costs were much higher for even smaller operations. The structure of dairy farms also varies by region of the country ( Table 2 ). The average farm size in western states (e.g., California, with 850 cows per farm) is well above the U.S. average of 133 cows per farm. In contrast, Wisconsin has many small farms and an average farm size of 88 cows. Cost structure varies by state ( Figure 3 ). In the western states, where large dairy farms dominate the industry, operating costs have been affected by high feed costs in recent years because these farms purchase much of their feed (alfalfa and grain prices reached record levels in 2008). However, per-unit overhead costs tend to be relatively low for these operations because fixed costs (e.g., buildings/equipment) can be spread over a large number of animals. In other parts of the country, such as Wisconsin, where producers feed more grain and hay that is produced on the farm, operating costs tend to be lower when grain and feed prices rise. However, these farms tend to have fewer dairy cows, so per-unit overhead costs are relatively high. In the mid-1850s, most milk was consumed on farms by the family or fed to livestock; some was sold for very local use. As urban areas grew, milk was sent to processors to supply these areas with both fluid and manufactured products. By the turn of the century, producers banded together into cooperative associations to bargain with milk handlers (fluid milk processors) as a way to offset handler market power stemming from a large number of producers facing a small number of processors. In the early 1900s, dairy farmers increasingly looked toward cooperatives as a means of marketing their milk, specifically by negotiating with milk buyers using collective bargaining. By 1925, handlers were paying farmers for milk according to its use (fluid or manufactured products). This concept is known as "classified pricing" and is still in use today. Milk for fluid use has the highest value, reflecting higher transportation and handling costs. When the Great Depression hit, demand dropped sharply and the voluntary classified pricing system broke down. Federal milk marketing orders were established (and continue to function today) to stabilize the market and help equalize the market power of dairy farmers with dairy processors (see " Federal Milk Marketing Orders (FMMOs) ," below). Another motivation for establishing FMMOs was to ensure that consumers had adequate and dependable supplies of milk at reasonable prices. During this same period, legislators enacted import quotas on dairy products to protect producers from foreign competition. Eventually, during World War II, demand increased for farm commodities, including milk. In the late 1940s, the government began supporting the price of milk (and other commodities) to protect against price declines through a price support program for milk, now called the Dairy Product Price Support Program (DPPSP). Current federal dairy policy has essentially five components: (1) dairy product price support (through the DPPSP), (2) federal milk marketing orders (FMMOs), (3) direct payments under the Milk Income Loss Contract (MILC) Program, (4) the Dairy Export Incentive Program (DEIP), and (5) tariff-rate quotas on dairy imports. A nongovernment program that has been used in recent years and can affect milk production (called Cooperatives Working Together or CWT) is also described below. This section concludes with the Livestock Gross Margin for Dairy Cattle, an insurance policy that the federal government recently began subsidizing, which has lowered the cost of purchase for producers. Under the DPPSP, the federal government stands ready to purchase butter, American cheese, and nonfat dry milk from dairy manufacturers at specified minimum prices. Purchases under the DPPSP, which occurred during FY2009 when demand declined, essentially prevent market prices for dairy products from dropping below support levels, which indirectly supports the farm price of milk. In contrast, when product prices are above support levels, the DPPSP is not a factor in the market and farm milk prices reflect prevailing supply and demand conditions. Year-to-year changes in farm milk prices have increased since the mid-1990s because price support levels have been reduced below typical market-average prices through legislation. USDA's Farm Service Agency administers the DPPSP. Section 1501 of the enacted 2008 farm bill ( P.L. 110-246 ) extended the program through December 31, 2012. Marketing orders were created in the 1930s to balance market power between farmers and milk handlers while reducing "destructive competition" between milk producers that can drive down prices to their mutual detriment. FMMOs mandate minimum prices that processors in milk marketing areas must pay producers or their agents (like the dairy cooperatives) for delivered milk depending on its end use. Under FMMOs, the farm price of approximately two-thirds of the nation's fluid milk is regulated in 10 geographic marketing areas. Some states, California being the largest, have their own milk marketing regulations instead of federal rules. Unlike other dairy programs, FMMOs are permanently authorized under the Agricultural Marketing Agreement Act of 1937, as amended, (7 U.S.C. § 601-674), and therefore do not require periodic reauthorization by Congress. The authorizing statute requires USDA to use formal rulemaking procedures to make changes to orders. Congress also makes periodic revisions (e.g., the 2008 farm bill streamlined the rulemaking process). Any interested party can petition USDA to create a new order or amend an existing one. USDA's Agricultural Marketing Service administers the federal order system. Minimum FMMO milk prices are based on current wholesale dairy product prices collected by USDA's National Agricultural Statistics Service in a weekly survey of manufacturers. As such, FMMO minimum prices rise and fall each month with overall changes in the wholesale dairy product market.