4 pp., 3 tablesThis publication discusses the federal orders that govern the marketing of milk. The production location and form of the milk product affect the way it is priced. The different classes of milk and their prices are  explained in detail

Anderson, David P.

Haigh, Michael

Schwart Jr., Robert B.

Stockton, Matthew

Texas A&amp;M Repository

Milk PricingDavid Anderson, Michael Haigh, Matthew Stockton and Robert Schwart*Milk is as an important human food because it is so versatile. It is consumed asan unadulterated beverage and as an ingredient in other beverages. In addition,many food products are derived from its components.  Because milk is perishable and can be a disease-carrying agent, special systemshave been developed for marketing it. In 1937 the United States developed thefederal order system for milk; some states also operate milk orders. About 64 per-cent of the milk produced and marketed in the United States moves through afederal milk marketing order, and an additional 18 to 20 percent is marketedthrough state marketing orders. The largest of the state orders is the Californiasystem. California produces almost 19 percent of the nation’s milk. PoolingThe development of milk marketing orders over the last 4 decades has beeninfluenced largely by the cooperatives that market beverage milk, but the dairycooperative movement really came into being to market the main productsderived from milk, butter and cheese. About 80 percent of the milk marketedtoday moves through cooperatives. Cooperatives developed the practice of pool-ing. A cooperative pools the milk from many producers; each producer contribut-ing milk into the pool receives an average price that is derived from the pool. Inthe order system this average price is referred to as the uniform blend price. Theorder determines a minimum uniform price for milk to be paid by all regulatedprocessors. Producers who are cooperative members and those who are not bothreceive this minimum uniform price set by the order, plus any premiums the milkprocessor may pay milk suppliers.   Cooperatives represent their members, so processors deal directly with thecooperative rather than with individual producers. Order regulations recognize acooperative as a single milk supplier. Cooperatives may sell milk to processorsacross many regions and regulated by many orders. Each order requires the coop-erative to receive that order’s uniform producer price. Cooperatives develop theirown pool price to determine a uniform price to pay members from the co-op’stotal receipts.Location and FormMilk must be moved quickly from dairy to market because it isso perishable. For this reason processors became localized.Processors had to offer prices high enough to encourage sup-pliers to deliver milk to their docks. Product characteristicsand local supply-demand conditions led to a natural pricingdifferentiation for raw milk. Processors tended to specialize in different milk products.Beverage milk is the most perishable form, so its market was themost localized, with producer deliveries subject to weekly and sea-sonal demand. Beverage milk processors often had to pay higherprices to lure milk into their plants. Processors manufacturing other prod-RiskManagement Education™L-5403RM2-41.08-01*Assistant Professor and Extension Economist, Assistant Professor, Extension Assistant, and Professor andExtension Economist, The Texas A&M University System.ucts had the advantage of being able to storetheir manufactured products. Their productswere less perishable and, in some instances, lesssubject to weekly and seasonal demand variabil-ity. Their product inventory was also slower toturn over. These nonfluid processors tended tolocate in areas where milk supplies were sub-stantial, so no location differential developed formilk used in manufacturing. Classified PricingThe concept of classified pricing developedinformally, but was made part of the order regu-lations. All milk associated with a federal orderis eligible for beverage use, but not all eligiblemilk is bottled. Some milk is used for otherproducts. Only Grade A milk is regulatedthrough a federal order. Classified pricingrequires that Grade A milk, marketed to aprocessor regulated by an order, be valued as itis used. Milk sellers and beverage processorschoose to keep the milk that goes into otherproducts associated with the order so that itsvalue goes into the pool and producers receivethe uniform price for it. The uniform price paidto producers is the weighted average of the classprices. The weights are the amounts of milkassociated with each use class. A very simpleexample (Table 1) will illustrate.In this example, 10 million pounds of milk ismarketed and its total value is $1,407,000. Theuniform price is $14.07 per hundredweight.Table 1. The uniform price. Thousand ThousandClass Price cwts. dollarsI $16.00 50 $800 II $14.00 15 $210 III $11.00 29 $319 IV $13.00 6 $78 Total 100 $1,407 Uniform $14.07(average)priceClass I PricesIn the federal order program, Class I milk isused as a beverage. Regulated Class I milkprocessors pay the Class I price for the milkthey bottle. Since the federal order regulationsare written to ensure an adequate supply of bev-erage milk, the Class I price has a location dif-ferential added to both the skim portion and thebutterfat portion of the Class I price. The Class Iprice is announced in advance of the month towhich it applies.  The Class I skim price is the higher of anadvanced Class III skim price or an advancedClass IV skim price. The advanced Class IIIskim price is based on a USDA survey of cheeseand whey prices. The Class IV skim price isbased on a USDA survey of nonfat dry milkprices. The Class I butterfat price is based on aUSDA survey of butter prices. Surveys of theClass III and IV advanced skim prices and theClass I butterfat price are conducted during thefirst 2 weeks of the preceding month.Class II PricesIn the federal order program, Class II milk isused to manufacture soft products such asfrozen desserts and yogurt. Regulated Class IImilk processors pay the Class II price for themilk they convert to these soft products. TheClass II price is announced in advance of themonth to which it applies. The Class II price isbased on a USDA survey of nonfat dry milkprices and butter prices conducted during thefirst 2 weeks of the preceding month. There is aquality adjustment based on somatic cell count.Class III PricesIn the federal order program, Class III milk isused to manufacture products such as cheese.Regulated Class III milk processors pay theClass III price for the milk they convert to thesehard products. The Class III price is announcedaround the 5th of the month following themonth to which the Class III price pertains. Forexample, on May 5th the April Class III price isannounced. The Class III price is based on aUSDA survey of cheddar cheese, butter, and drywhey prices. The survey covers the entiremonth to which the Class III price pertains.  The Class III price is the price linked to themilk futures contract traded on the ChicagoMercantile Exchange. At the expiration of eachcontract, the contract closeout price is forced tothe announced Class III price. This process offorcing the closeout price to the Class III price isreferred to as cash settling. Cash settlementtakes the place of settling an open contractthrough performance of the contract obligation.As with Class II milk, there is a quality adjust-ment based on somatic cell count.Class IV PricesIn the federal order program, Class IV milk isused to manufacture nonfat dry milk and butter.Regulated Class IV milk processors pay theClass IV price for the milk they convert to theseproducts. The Class IV price is announcedaround the 5th of the month following themonth to which the Class IV price pertains. TheClass IV price is based on a USDA survey ofnonfat dry milk prices and butter prices. Thesurvey covers the entire month to which theClass IV price pertains. The Class IV price isadjusted based on somatic cell count and islinked to the Class IV futures contract traded on the Chicago Mercantile Exchange.Producer PriceOf the eleven federal orders, four orders payproducers based on a uniform butterfat skimprice derived as described in the discussion ofclassified pricing.  Seven orders pay producersbased on Class III component prices. The ClassIII component prices for butterfat, true protein,and other solids are derived from USDA pricesurveys. (See the discussion of Class III pricesabove). In the component markets, producersreceive a butterfat price for the pounds of but-terfat sold, a true protein price for pounds oftrue protein sold, and an “other solids” price forthe pounds of other solids sold. Additionally,producers receive a producer price differential(PPD). The PPD is quoted on a hundredweightbasis and is paid on all the milk sold. The PPDcaptures the value of location and is the sum ofmilk used in Class I, Class II, and Class IV mul-tiplied by the difference between the Class Iprice, the Class II price, the Class III price, andthe Class IV price. A quality adjustment isadded to the price if the somatic cell count isbelow 350,000 and subtracted from the price ifthe count is above 350,000. Table 2 illustratesthe quality premium and the component andPDF portion of the producer price. Table 3 illus-trates the calculation of the producer pay priceusing the information in Table 2.Table 2: Producer price.Component portion of the producer priceComponent Price Quantity ValueButterfat $1.590 3.5 $5.57 True protein $1.630 2.99 $4.87 Other solids $0.099 5.69 $0.56 $11.00 PPD portion of the producer priceClass Price Difference Class use ValueClass III $11.00 $ - 29% $ -   Class I $16.00 $5.00 50% $2.50 Class II $14.00 $3.00 15% $0.45 Class IV $13.00 $2.00 6% $0.12 $3.07 Quality premiumProducer SCC Standard Difference Rate Value200 350 150 0.00064 $0.10 Table 3. Producer pay price.Producer pay price per cwt.Component $11.00 PPD $3.07 Quality $0.10 Cwt. price $14.17SummaryThe key elements to remember about currentmilk pricing are that most Grade A milk is mar-keted and priced within a regulated system. In aregulated marketing system, milk is classifiedand priced by use, not quality. The class pricesare based on USDA product prices. Milk ispooled and a uniform price is paid to dairy pro-ducers.        For additional information:“Federal Milk Order Market Statistics.” 1999Annual Summary. AMS, USDA. September2000.“Milk Production.” NASS, USDA. February 16,2001.“Marketing Operations of Dairy Cooperatives.”Research Report 173. RBS, USDA. June1999.Partial funding support has been provided by the Texas Wheat Producers Board, the Texas Corn Producers Board, the Texas Farm Bureau, and the Houston Livestock Show and Rodeo.

Milk Pricing

Texas A&M University

Milk Pricing
David Anderson, Michael Haigh, Matthew Stockton and Robert Schwart*
Milk is as an important human food because it is so versatile. It is consumed as
an unadulterated beverage and as an ingredient in other beverages. In addition,
many food products are derived from its components.  
Because milk is perishable and can be a disease-carrying agent, special systems
have been developed for marketing it. In 1937 the United States developed the
federal order system for milk; some states also operate milk orders. About 64 per-
cent of the milk produced and marketed in the United States moves through a
federal milk marketing order, and an additional 18 to 20 percent is marketed
through state marketing orders. The largest of the state orders is the California
system. California produces almost 19 percent of the nation’s milk. 
Pooling
The development of milk marketing orders over the last 4 decades has been
influenced largely by the cooperatives that market beverage milk, but the dairy
cooperative movement really came into being to market the main products
derived from milk, butter and cheese. About 80 percent of the milk marketed
today moves through cooperatives. Cooperatives developed the practice of pool-
ing. A cooperative pools the milk from many producers; each producer contribut-
ing milk into the pool receives an average price that is derived from the pool. In
the order system this average price is referred to as the uniform blend price. The
order determines a minimum uniform price for milk to be paid by all regulated
processors. Producers who are cooperative members and those who are not both
receive this minimum uniform price set by the order, plus any premiums the milk
processor may pay milk suppliers.   
Cooperatives represent their members, so processors deal directly with the
cooperative rather than with individual producers. Order regulations recognize a
cooperative as a single milk supplier. Cooperatives may sell milk to processors
across many regions and regulated by many orders. Each order requires the coop-
erative to receive that order’s uniform producer price. Cooperatives develop their
own pool price to determine a uniform price to pay members from the co-op’s
total receipts.
Location and Form
Milk must be moved quickly from dairy to market because it is
so perishable. For this reason processors became localized.
Processors had to offer prices high enough to encourage sup-
pliers to deliver milk to their docks. Product characteristics
and local supply-demand conditions led to a natural pricing
differentiation for raw milk. 
Processors tended to specialize in different milk products.
Beverage milk is the most perishable form, so its market was the
most localized, with producer deliveries subject to weekly and sea-
sonal demand. Beverage milk processors often had to pay higher
prices to lure milk into their plants. Processors manufacturing other prod-
Ri
sk
Ma
nagement Education
™
L-5403
RM2-41.0
8-01
*Assistant Professor and Extension Economist, Assistant Professor, Extension Assistant, and Professor and
Extension Economist, The Texas A&M University System.
ucts had the advantage of being able to store
their manufactured products. Their products
were less perishable and, in some instances, less
subject to weekly and seasonal demand variabil-
ity. Their product inventory was also slower to
turn over. These nonfluid processors tended to
locate in areas where milk supplies were sub-
stantial, so no location differential developed for
milk used in manufacturing. 
Classified Pricing
The concept of classified pricing developed
informally, but was made part of the order regu-
lations. All milk associated with a federal order
is eligible for beverage use, but not all eligible
milk is bottled. Some milk is used for other
products. Only Grade A milk is regulated
through a federal order. Classified pricing
requires that Grade A milk, marketed to a
processor regulated by an order, be valued as it
is used. Milk sellers and beverage processors
choose to keep the milk that goes into other
products associated with the order so that its
value goes into the pool and producers receive
the uniform price for it. The uniform price paid
to producers is the weighted average of the class
prices. The weights are the amounts of milk
associated with each use class. A very simple
example (Table 1) will illustrate.
In this example, 10 million pounds of milk is
marketed and its total value is $1,407,000. The
uniform price is $14.07 per hundredweight.
Table 1. The uniform price. 
Thousand Thousand
Class Price cwts. dollars
I $16.00 50 $800 
II $14.00 15 $210 
III $11.00 29 $319 
IV $13.00 6 $78 
Total 100 $1,407 
Uniform $14.07
(average)
price
Class I Prices
In the federal order program, Class I milk is
used as a beverage. Regulated Class I milk
processors pay the Class I price for the milk
they bottle. Since the federal order regulations
are written to ensure an adequate supply of bev-
erage milk, the Class I price has a location dif-
ferential added to both the skim portion and the
butterfat portion of the Class I price. The Class I
price is announced in advance of the month to
which it applies.  
The Class I skim price is the higher of an
advanced Class III skim price or an advanced
Class IV skim price. The advanced Class III
skim price is based on a USDA survey of cheese
and whey prices. The Class IV skim price is
based on a USDA survey of nonfat dry milk
prices. The Class I butterfat price is based on a
USDA survey of butter prices. Surveys of the
Class III and IV advanced skim prices and the
Class I butterfat price are conducted during the
first 2 weeks of the preceding month.
Class II Prices
In the federal order program, Class II milk is
used to manufacture soft products such as
frozen desserts and yogurt. Regulated Class II
milk processors pay the Class II price for the
milk they convert to these soft products. The
Class II price is announced in advance of the
month to which it applies. The Class II price is
based on a USDA survey of nonfat dry milk
prices and butter prices conducted during the
first 2 weeks of the preceding month. There is a
quality adjustment based on somatic cell count.
Class III Prices
In the federal order program, Class III milk is
used to manufacture products such as cheese.
Regulated Class III milk processors pay the
Class III price for the milk they convert to these
hard products. The Class III price is announced
around the 5th of the month following the
month to which the Class III price pertains. For
example, on May 5th the April Class III price is
announced. The Class III price is based on a
USDA survey of cheddar cheese, butter, and dry
whey prices. The survey covers the entire
month to which the Class III price pertains.  
The Class III price is the price linked to the
milk futures contract traded on the Chicago
Mercantile Exchange. At the expiration of each
contract, the contract closeout price is forced to
the announced Class III price. This process of
forcing the closeout price to the Class III price is
referred to as cash settling. Cash settlement
takes the place of settling an open contract
through performance of the contract obligation.
As with Class II milk, there is a quality adjust-
ment based on somatic cell count.
Class IV Prices
In the federal order program, Class IV milk is
used to manufacture nonfat dry milk and butter.
Regulated Class IV milk processors pay the
Class IV price for the milk they convert to these
products. The Class IV price is announced
around the 5th of the month following the
month to which the Class IV price pertains. The
Class IV price is based on a USDA survey of
nonfat dry milk prices and butter prices. The
survey covers the entire month to which the
Class IV price pertains. The Class IV price is
adjusted based on somatic cell count and is
linked to the Class IV futures contract traded 
on the Chicago Mercantile Exchange.
Producer Price
Of the eleven federal orders, four orders pay
producers based on a uniform butterfat skim
price derived as described in the discussion of
classified pricing.  Seven orders pay producers
based on Class III component prices. The Class
III component prices for butterfat, true protein,
and other solids are derived from USDA price
surveys. (See the discussion of Class III prices
above). In the component markets, producers
receive a butterfat price for the pounds of but-
terfat sold, a true protein price for pounds of
true protein sold, and an “other solids” price for
the pounds of other solids sold. Additionally,
producers receive a producer price differential
(PPD). The PPD is quoted on a hundredweight
basis and is paid on all the milk sold. The PPD
captures the value of location and is the sum of
milk used in Class I, Class II, and Class IV mul-
tiplied by the difference between the Class I
price, the Class II price, the Class III price, and
the Class IV price. A quality adjustment is
added to the price if the somatic cell count is
below 350,000 and subtracted from the price if
the count is above 350,000. Table 2 illustrates
the quality premium and the component and
PDF portion of the producer price. Table 3 illus-
trates the calculation of the producer pay price
using the information in Table 2.
Table 2: Producer price.
Component portion of the producer price
Component Price Quantity Value
Butterfat $1.590 3.5 $5.57 
True protein $1.630 2.99 $4.87 
Other solids $0.099 5.69 $0.56 
$11.00 
PPD portion of the producer price
Class Price Difference Class use Value
Class III $11.00 $ - 29% $ -   
Class I $16.00 $5.00 50% $2.50 
Class II $14.00 $3.00 15% $0.45 
Class IV $13.00 $2.00 6% $0.12 
$3.07 
Quality premium
Producer 
SCC Standard Difference Rate Value
200 350 150 0.00064 $0.10 
Table 3. Producer pay price.
Producer pay price per cwt.
Component $11.00 
PPD $3.07 
Quality $0.10 
Cwt. price $14.17
Summary
The key elements to remember about current
milk pricing are that most Grade A milk is mar-
keted and priced within a regulated system. In a
regulated marketing system, milk is classified
and priced by use, not quality. The class prices
are based on USDA product prices. Milk is
pooled and a uniform price is paid to dairy pro-
ducers.        
For additional information:
“Federal Milk Order Market Statistics.” 1999
Annual Summary. AMS, USDA. September
2000.
“Milk Production.” NASS, USDA. February 16,
2001.
“Marketing Operations of Dairy Cooperatives.”
Research Report 173. RBS, USDA. June
1999.
Partial funding support has been provided by the Texas Wheat Producers Board, the Texas Corn Producers Board, 
the Texas Farm Bureau, and the Houston Livestock Show and Rodeo.


English

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Milk Pricing

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Milk Pricing

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