Low Costs Drive Production to Large Dairy Farms
Profits and losses lead
to fewer small dairy farms and more large operations.
James M.
MacDonald, William
D. McBride, and Erik
J. O’Donoghue
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Dairy
production is shifting to larger farms;
small dairy farms are exiting, and more
expect to leave in the
next decade. |
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Average
production costs per hundredweight of
milk produced fall sharply with herd
size. Large dairy farms earn substantial
profits, while most smaller operations
experience economic losses. |
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Given
their cost advantages, the shift of
dairy production to large farms contributes
to rising industry
productivity and lower real dairy prices. |
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| This
article is drawn from . . . |
| ERS
Data on Commodity Costs and Returns.
Profits,
Costs, and the Changing Structure of U.S.
Dairy Farming, by James M. MacDonald,
William D. McBride, Erik J. O’Donoghue,
Richard F. Nehring, Carmen L. Sandretto, and
Roberto Mosheim, ERR-47, USDA Economic Research
Service, September 2007.
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| You
may also be interested in . . . |
| Economic
Effects of U.S. Dairy Policy and Alternative
Approaches to Dairy Policy, U.S.
Department of Agriculture, Report to Congress,
July 2004, available at:
The
Changing Landscape of U.S. Milk Production,
by Don P. Blayney, SB-978, USDA, Economic
Research Service, June 2002.
The
ERS Briefing Room on Dairy.
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Dairy farming is undergoing striking
changes. In the 1970s, a large dairy farm had a
herd of 100 milk cows. Typically, the family operating
the farm provided most of the labor and grew most
of the herd’s feed on the farm. While thousands
of such farms remain in operation, their numbers,
as well as their production methods, are in sharp
decline.
During the 1970s, a different
type of dairy farm began appearing in Western States
such as California. These operations were much larger,
often with herds of 1,000-2,000 milk cows. Whereas
the smaller dairy farms tended to graze their cows
on pasture, the new larger ones often housed their
cows in large barns or drylot feedyards. While still
family owned and operated, the large farms relied
extensively on hired labor and on feed purchased
off the farm. As the larger dairy farms prospered,
milk production began to shift to Western States
and smaller dairies started to go out of business.
Larger dairy farms spread rapidly
in the 1990s, taking hold in traditional dairy regions,
like the Northeast and Upper Midwest. While only
15 dairies over 1,000 head operated in traditional
areas in 1992, this number grew to 176 over the
next 10 years. Meanwhile, farm sizes continued to
grow in the Western production regions, with farms
with as many as 5,000 cows increasingly commonplace.
The ongoing reorganization of
dairy farming increases productivity, meaning more
milk can be produced with an equivalent complement
of production inputs. This places downward pressure
on farm costs and milk prices. It also creates new
challenges for dairy and environmental policies,
especially regarding manure management. Recent ERS
research
documents the industry’s structural changes
and identifies their effect on production costs.
This article focuses on production costs for farms
producing conventional milk.
| Small
conventional dairies have higher average costs,
2005 |
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Herd
size (milk cows) |
| Item |
1-49 |
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|
| |
Dollars
per hundredweight of milk produced |
| Gross value of production |
17.87 |
17.56 |
17.20 |
17.25 |
16.56 |
16.54 |
| Operating costs |
12.30 |
12.94 |
11.51 |
11.31 |
11.07 |
9.74 |
| Overhead costs |
17.79 |
12.56 |
9.31 |
6.61 |
5.00 |
3.85 |
Unpaid labor
|
10.60 |
6.10 |
3.13 |
1.34 |
0.54 |
0.17 |
Capital recovery
|
5.26 |
4.56 |
3.89 |
2.55 |
2.03 |
1.66 |
| Total costs |
30.09 |
25.50 |
20.82 |
17.92 |
16.07 |
13.59 |
| Net returns |
-12.22 |
-7.94 |
-3.62 |
-0.67 |
0.49 |
2.95 |
Source:
ERS
estimates |
Dairy Farming Structure
Has Changed Rapidly
In 1992, about half of all milk
cows were on the approximately 135,000 U.S. dairy
farms operating with fewer than 100 cows. By 2006,
only about 58,000 dairy farms had fewer than 100
cows, accounting for less than one-quarter of all
dairy cows.
At the opposite end of the size
continuum, 560 dairy farms operated with at least
1,000 dairy cows in 1992. Fourteen years later,
over 1,400 such farms accounted for 35 percent of
all cows. This trend may be accelerating, as farms
with at least 1,000 head added 4 percentage points
to their share of cow inventory in 2004-06 alone.
Larger Farms Have Lower
Costs
Large dairy farms have significant
cost advantages over smaller operations, and those
cost advantages are a powerful force for consolidation.
Average costs of production per hundredweight of
milk fell sharply as herd sizes increased. Large
farms with at least 1,000 milk cows had 15 percent
lower dairy enterprise costs in 2005 than farms
with 500-999 cows, and 25-35 percent less than farms
with 200-499 and 100-199 cows.
Overhead costs comprise the major
cost advantage held by larger dairy enterprises,
as these operations are able to use capital and
labor far more intensively than smaller operations.
Although most operators and their families do not
pay themselves a cash wage for their labor, their
labor still has an opportunity cost—they forego
other money-earning activities when they work on
the farm. An estimate of this opportunity cost is
included in a measure of overhead and full economic
costs even though the operation does not pay an
explicit labor expense.
Costs Are Only One Side
of Financial Performance
A complete financial evaluation
looks at net returns, or the difference between
a dairy enterprise’s gross value of production
and total costs of production. Gross value of production
is largely milk sales (89 percent), as well as the
value of joint products like cull cow and calf sales
and the value of manure produced. Small farms generally
realize higher gross values of production per hundredweight
of milk because milk prices tend to be higher in
regions where small dairy farms predominate.
Despite the price advantage held
by smaller farms, the cost advantage of larger enterprises
enables them to achieve much higher net returns.
In fact, small and mid-size dairy enterprises (with
100-499 cows) had negative net returns, on average,
in 2005.
With the largest dairy enterprises
providing returns that substantially exceed total
costs (including capital recovery and the value
of operators’ time), those businesses have
attracted investment and are expanding rapidly.
Since the returns to small dairy enterprises do
not cover all of their costs, many more small enterprises
are leaving dairy farming than
are entering.
The evidence from net returns
is also consistent with operator plans. In a recent
USDA survey, dairy farmers were asked how long they
expected their operations to continue producing
milk. Seventy percent of the farms with fewer than
50 cows expected to end milk production within 10
years. Exit expectations fell steadily as farm size
increased, from 48 percent among farms with 50-99
cows to 20 percent of those with at least 1,000
cows.
Many small operations will continue
producing milk. Some may be exceptionally well managed
or may have favorable input or product prices that
provide them with above-average profits. Others
may venture into related profit-making opportunities,
or niche markets, for higher valued dairy products,
such as organic dairy products (see
box, “Comparing Costs: Organic and Conventional
Dairy Enterprises”). Even though small
farms show losses on average, 25 percent of farms
with 100-199 cows realized positive net returns
in 2005. These farms earned enough to cover all
costs, including capital replacement costs and estimated
costs for operators’ unpaid labor. Six percent
of farms with fewer than 100 head and 41 percent
of farms with 200-499 head earned positive net returns
in 2005.
Some other small and midsized
operations may continue to operate, even though
net returns are negative. Net returns drive investment
decisions. Farmers are unlikely to invest capital
and labor in new farms or farm expansions that are
unlikely to cover the costs of those commitments.
But other financial indicators may be more relevant
for the decision to continue operating an existing
farm. Operators of existing farms have already committed
their equipment and structures, and that capital
may have a very low salvage value. Capital recovery
costs may be irrelevant to their decision to continue
operating; what matters is not whether the value
of production exceeds total costs, but whether it
exceeds all costs except for capital recovery. Fifty
percent of farms with 100-199 cows met that financial
performance standard in 2005, as did 25 percent
of those with 50-99 cows and 73 percent with 200-499
cows. Operations that cannot meet that financial
standard are more likely to close because their
operators can earn a better return on their labor
from off-farm work.
Will Large Farms Get Larger?
On average, large dairy farms
exhibit better financial performance than small.
But ongoing structural change has led to even larger
farms, with 5,000 and 10,000 cows. ERS’s financial
database is not comprehensive enough to tell whether
farms of that size have financial advantages over
farms with 1,000 cows, but other evidence suggests
that they might.
Specifically, patterns of expansion
among large farms changed sharply in recent years,
suggesting that the largest farms might have further
cost advantages. Between 1992 and 1997, most capacity
expansion at large farms occurred in farms with
1,000-3,000 head. But after 1997, most new capacity
at large dairy farms was added on farms with more
than 3,000 head, with some going to operations with
over 10,000 head. Operators may have discovered
ways to more effectively manage much larger dairy
farms in recent years, and the bulk of new large
farm investment appears directed at those much larger
farms. In turn, those investments may place even
greater cost pressures on smaller operations.
Structural Change Has
Market, Environmental, and Policy Impacts
The improved efficiency of large
farms frees resources for other uses and exerts
downward pressure on milk prices. While the prices
that dairy farmers pay for inputs like feed has
continued to increase, efficiency improvements in
dairy production have kept farm-level milk prices
from rising. USDA’s index of prices paid for
livestock inputs rose by 43 percent between 1992
and 2006. While farm-level milk prices fluctuated
over the same period, they showed very little trend.
That performance reflects steady improvements in
genetics, feed formulation, equipment design, and
management, as well as a shift of production from
smaller to larger farms.
The average farm-level milk price
in 2005 was $15.14 per hundredweight. Prices fell
to $12.90 in 2006, before rising to $20 in June
2007. Higher prices in 2007 were driven by ethanol-fueled
increases in feed prices and by greater world demand
for dry dairy products. However, the cost relationships
outlined in this article have not been fundamentally
altered. Larger operations still have substantial
cost advantages, and shifts of production to larger
enterprises will place downward pressure on industry-wide
costs and prices, thus offsetting some of the impact
of any long-term increases in feed expenses.
While structural change has led
to improved efficiency and lower milk prices, it
also concentrates milk cows and their manure onto
a smaller land base. Large farms operate less land
per cow, heightening the risk of environmental damages
from manure nutrients being applied beyond the capacity
of crops to assimilate them. In response to structural
change in livestock and poultry production, State
and Federal regulators have promulgated sets of
regulations to guide manure and wastewater management
in large confined animal feeding operations (CAFOs),
including large dairy farms. At present, the costs
of conforming to such regulation at large dairies
appear unlikely to offset the production cost advantages
held by those operations, so structural change will
likely continue.
Structural change can also complicate
the effects of dairy policy. Traditionally, dairy
policies have been designed to improve farm operator
incomes by influencing the prices that producers
receive for their milk. For example, price support
programs were designed to raise the minimum prices
received by all producers—regardless of herd
size. But with wide disparities in production costs,
prices that might cover costs for midsize farms
would yield large profits, and very strong expansion
incentives for large dairies.
Congress introduced counter-cyclical
payments in the 2002 farm bill under the Milk Income
Loss Contract (MILC) program (extended with some
modifications in 2005), under which farmers can
receive direct payments in months when market prices
fall below a targeted level. Payments are restricted
to the first 2.4 million pounds of production on
a farm, the approximate annual amount that a farm
with about 120 cows (at 2006 average milk yields)
can produce in a year.
Payments under the program commence
when milk prices fall below a reference level, and
increase, although not dollar for dollar, as prices
fall further. The payments cushion producers against
price declines and provide stronger revenue support
during periods of low prices to small operations
and to regions where such farms predominate. This
may help some small producers cover their operating
costs during market downswings and avoid closure.
Still, given the powerful cost advantages of large
dairies, the payments have not counteracted the
pronounced shift of production to larger farms.
Comparing
Costs: Organic and Conventional Dairy Enterprises
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Organic dairy production offers a promising
alternative for some producers. Over 87,000
dairy cows were certified organic in 2005,
up from 38,000 in 2000, and they accounted
for about 1 percent of the nationwide inventory
of dairy cows.
Organic dairy costs of production tend
to exceed conventional costs, in part because
organic feed costs more than conventional
feed, and in part because organic production
uses more labor and capital, per hundredweight
of milk produced. On the other hand, organic
milk commands premium prices, so revenues
are higher on organic operations. Organic
systems may lead to improved financial returns
for some small farms: in 2005, about 37
percent of organic operations with 50-99
cows covered all their costs, except for
capital recovery, compared with 25 percent
of conventional dairy enterprises in that
size class.
Herd size matters to organic costs, and
to the future development of organic dairy
markets. Estimated total costs, per hundredweight
of milk produced, fall sharply as herd sizes
increase. In 2005, there were several very
large organic dairy enterprises, with several
thousand cows each. Current organic standards
require that dairy cows have access to pasture.
Like most other large dairy farms, these
large organic dairies purchased most of
their feed and tended to rely very little
on pasture. Since 2005, USDA has decertified
at least one large organic dairy farm for
failing to meet pasture requirements. Expanded
organic pasture requirements will likely
leave more production on small operations,
but also will lead to higher organic production
costs and prices.
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