CREATION & EVOLUTION: Business models are living organisms

Editor’s Update

By Dave Natzke

The second year of “Survivor: The Dairy Edition” initially teased us with improved cheese prices and lower feed prices, only to return to volatile ways. Whether the remainder of 2010 brings any meaningful recovery or not, it’s a good time to take the advice of several politicians: Never overlook the opportunity of a crisis.

It may be an aberration that resolves itself when the economy improves, but current conditions call into question a prevalent  “model” of dairy production – buy lots of feed and produce lots of milk.

Economies of scale have usually benefited larger numbers, with income per unit multiplied by greater numbers of units leading to higher income. But, as we’ve seen in the past 18 months or so, the reverse is also true. Losses per unit multiplied by a larger number of units can lead to greater losses.

USDA’s monthly milk-feed price ratio is one indicator of milk income relative to feed costs. The index represents the pounds of 16% mixed dairy feed (purchase price) equal in value to 1 lb. of whole milk (sales price). In the past, a ratio of 3.0 or higher was considered “positive” for milk production, but some sources say an index of 2.5 can still provide positive returns. However, March 2010’s index is the 28th straight month below 3.0 and, in fact, it’s been 26 months since the index reached 2.5. From the records I can find, that’s the longest and lowest stretch in more than 20 years. It will continue.

At least at first, price reactions to the 2010 Planting Intentions and quarterly Grain Stocks reports helped push feed prices lower – and the milk-feed price ratio higher. Several crystals balls I’ve seen predict positive – but small – margins beginning in the latter half of 2010.

However, countering that are federal policies, with direct and indirect impacts. As I write this column, legislation under consideration in Congress extends the ethanol blenders’ tax credit and the tariff on imported ethanol for five more years. Not only would that  ensure a continued long-term focus on corn acreage for energy, but it may also mean an erosion in acreage of other crops.

The economics and inequities of Milk Income Loss Contract (MILC) and (Dairy Economic Loss Assistance Payment (DELAP) programs – with payments based on production caps – means government payments do not cover losses equally on a per-unit basis (see related story).

Then, there’s the federal budget and politics. Looking at the mounting federal deficit, any expectation the government will step in to raise dairy product price supports or other safety nets to any meaningful level for any duration may be just a nice bedtime story. Throw in the schizophrenic nature of the U.S. voting public and the likelihood political backlash will bring fiscal conservatives back to leadership in the next election or two, and the bedtime story becomes a bigger fairy tale.

Supply/growth management may address the price side, but evolving business models must continue to manage the cost side, and the middle. Dairy business models that rely on government and ignore the impact of other policies and trends are not sustainable.

Every business model may be different. Some may lessen the dependence on corn and soybeans as the primary feed currency. Some may manage margins with insurance. Others may seek more vertical integration to capture value in each segment of the industry.

However you create your evolving business model, “hope” is no longer a strategy.

* The GLASS …

… is half empty

USDA’s monthly World Ag Supply and Demand Estimates report raises anticipated 2010 U.S. milk marketings to 188.8 billion lbs., an increase of about 500 million lbs. from a month earlier. With April’s forecast, USDA increased its 2010 milk marketing projections by 1 billion lbs. since February.

• March dairy cow numbers in the 23 major dairy states were up for a third consecutive month.

• The March USDA Cold Storage report estimates a total U.S. cheese inventory of more than 1 billion lbs.

Fuel prices are higher. As of April 19, U.S retail gasoline prices averaged $2.86/gallon, 80¢ more than the same week a year earlier. U.S retail diesel prices averaged $3.07/gallon, 85¢ more than the same week a year earlier.

… is half full

February 2010 dairy exports were equivalent to 9.8% of U.S. milk solids production for the month, up from 8.7% in January. Imports as a percent of milk solids production were 2.9% in February, down from 3.1% in January. The value of dairy exports exceeded the value of imports in six of the past seven months.

USDA estimated 256,500 culled dairy cows were slaughtered under federal inspection in March 2010, up about 33,500 head from February 2010, and 18,300 more than March 2009.

A new United Nations’ Food and Agriculture Organization report, “Greenhouse gas emissions from the dairy sector,” estimates global milk production, processing and transportation contributes just 2.7% of greenhouse gas emissions.

* Depending on your point of view