Milk market regulations are like a balloon, poke it here and it pops there. Fights over dairy policy are about where and how deep to poke and who gets the pop. Milk payment timing is one of those pokes and pops. Consider this: It is the 15th of the month, and the final check for the previous month has not yet arrived.
In the meantime you have shipped an additional 15 days worth of milk since the end of the month, and payment for that is weeks away. It is a common situation in dairy land. Even at $10 milk prices, producers nationwide at the middle of the month are sitting on an accounts receivable in excess of $1.5 billion. The situation never changes, except the amount. When the check does arrive, only half of the exposure for nonpayment is reduced as the shipments during the current month still remain unpaid. As the checks regularly come the same time every month, over time the fact that money is owed is often forgotten.
This delay between delivery and payment is both good and bad for producers. It is good because this extension of such a sum of money as credit to milk buyers has allowed them to succeed and grow. If producers did not give them the credit they would have to get it somewhere else, if they could. But that would come at a cost, a cost that would ultimately reduce the value of the milk to producers. We have all seen recently the impact of contraction on credit in a number of industries. Now imagine banks withdrawing $1.5 billion dollars from processors and how that would affect producers. Dairy producers not only keep plants full of milk but are their major creditors.
With this extension comes risk – the risk of slow payment or nonpayment. In my experience, I am unaware of any slow-paying plant that did not become a no-paying plant. In the end, producers were left holding empty bank accounts. For the last several decades, the risk has not materialized. But such has not always been the case. In the early and mid-1980s, the industry was rocked with the bankruptcies of Knudsen-Foremost, mostly in California, and Northeast Dairy Cooperative (NEDCO) in the Northeast along with a number of smaller operations, both cooperative and proprietary.
Still, today, it is unlikely such an event will happen soon in the dairy industry. There are a number of factors that contribute to this low risk.
1. Strict payment deadlines and enforcement by federal and state marketing orders expose weak companies early on, forcing plants unable to pay bills to quit before exposure to producers increases.
2. The pricing programs under the marketing orders assure that all plants have roughly the same cost of raw product. That, coupled with pricing that is tied to changing market values, substantially reduces the risk that milk buyers will be on the wrong side of the market with too high of a milk cost and too low of a product price. The volatility of raw product costs and end product prices poses the single, highest risk of failure to an otherwise sound company. The orders greatly minimize that risk.
3. Most producer milk is sold through cooperatives. The cooperatives have the ability to monitor creditworthiness and enforce collection programs producers could not do individually.
4. Consolidation of operations has resulted in higher quality management with better tools to keep the operations in the black. Among other things, plants manage unsold inventory better. By limiting milk purchases to product production and product production to actual sales, plants do not find themselves paying more for the milk than the inventory is worth.
5. Many states have laws requiring bonds, security funds, disclosure of financial statements and other similar measures that limit permits to buy milk to companies that show the wherewithal to pay producers. Some have implemented “producer lien laws“ that give producers a lien on raw agricultural products above finished products until they are paid for. None of these guarantee full, on-time payment but would assure some payment, sometime in the case of a plant default. A large-scale default would swamp all of them.
From mistakes in managing raw product cost to sales cost volatility, failure of plant customers to pay is a major cause of plant default. For example, if a major client of a cheese plant goes into bankruptcy, the cheese plant is left holding the bag for unpaid-for cheese. Depending on the strength of its own capital, the cheese plant may not be able to sustain the loss and unwillingly be unable to pay producers or producer settlement funds for the milk received.
Today a new risk is showing – lack of credit. Virtually every business today works with a line of credit, just like most modern dairy farms. Even if the operation is profitable, denial of access to a line of credit at payroll time can result in default without the plant being at fault. Fear of widespread credit contraction was a major contributor to efforts to “bail out” financial institutions.
Such exposure to credit risk, unique to the dairy industry among the major agricultural commodities, is something that needs to be considered whenever discussions of dairy policy occur. This is because the credit risk is a product of pricing regulations and tradition, which itself has its roots in regulation.
To get from tanker pickup at the farm to check in your mailbox, many steps have to take place. The hauler has to accurately weigh the milk and sample it. The weight is recorded on manifests or pickup slips. The pickup slips are delivered to the buyer of the milk and the agent who pays the producer (the cooperative). In the meantime, the samples are delivered to a lab for the producer. The plant takes its own load samples. Reports of these tests are sent to the cooperative. Cooperatives and plants have to reconcile each load and test. Cooperatives want to be paid for every drop of milk delivered, and plants do not want to pay for any drops not delivered. The same goes for components.
The manifests have to be posted to each producer as do the tests – the more producers the more posting, the more pickups the more posting. These totals have be reconciled with what was shipped, meaning even more time.
Because we have classified pricing (plants pay based on what the milk is used to make), plants have to keep track of products and trace the milk they purchased to their sales. They report their usage to the pooling authorities, such as federal market administrators or milk pooling in state orders. The personnel in these offices receive these reports from all of the plants in their marketing area. They are totaled, priced and averaged. Expenses, charges and reserves are taken out of the pool, and an average pool price is computed. None of that can be done until all of the milk has been delivered (by the end of the month), usage is determined (days later), usage is priced (prices announced by the third of the following month), usage and price are reported, values from all plants are blended (more days later), a blend price is announced, plants finish obligations to settle against the blend (another day) or receive from the blend (yet another day), co-ops do their own blending of sales between marketing areas and markets not pooled, co-ops deduct their own expenses, and a pool price is determined (still more days).
Only then, and we are well into the second or third week of the month, can cooperatives or plants pay producers for the pounds delivered. In short, payment to producers is delayed because it takes time to process all of the deliveries and because the classified and pooling pricing systems impose at least a week into the process.
Fewer, larger producers and fewer, larger buyers have helped in getting through this process. So have computers and the Internet.
My first professional connection with milk marketing began more than 35 years ago when as a calculator salesman I walked into an office that was doing dairy payroll. Spread out on desks were huge spreadsheets. Manually, the clerks would take the pounds of milk off of load tickets, pencil them one load pickup per producer per day at a time. Once all were posted, they would cross-foot, catch and correct errors and finally balance them. It took time, lots of time.
The butterfat tests were then posted. We only did five per month. There was no component pricing then. An average of the five tests was then computed. Next, the clerk posted assignments. There were assignments for insurance, Farm Credit, other banks and a host of other needs. Hauling, stop and promotion assessments were made. It took all of the first 10 days of the month to accomplish this. Once we knew the blend price for the order, we could announce our price, compute checks and mail them. Using mechanical and a few, then new, electronic calculators, each producer’s pay was manually computed, posted and paid in checks that were hand-typed.
My entry into this office was because they were taking on more producer payroll and they needed more desks, more clerks, and for me, more calculators. I suggested something else and my small contribution to dairy began. Together we automated the process with new, then modern, programmable calculators. Penciling in large spreadsheets was replaced with keying data and storing on magnetic cards. Checks were printed by modified IBM electric typewriters at an incredible speed of 10 characters per second. That office’s demands grew; its staff did not grow. The magnetic cards were replaced with large floppy disks, the typewriter with a high-speed printer. Then those were replaced by a full-fledged IBM computer. It meant more checks, faster, more accurately produced with fewer people.
In other offices, the hand checks were replaced by punch card, then keyed input stored on floppy disk, reeled tape memory and state-of-the-art computers with a whopping 128K of memory. The computers got bigger, more powerful, faster. The workers were fewer, and the tasks done quicker. Powerful personal computers came along and with them spreadsheet programs like VisiCalc, Lotus, Quattro and Excel.
The transitions went on throughout the industry. Mailed, faxed and telephoned reports to market administrators were replaced with e-mails and posting data online. Computers in plants talked with computers in the pooling offices that talked with the co-ops. Checks were no longer mailed but deposited directly. The result is: What was a tedious, time-consuming task of many became the time-consuming task of a few. Despite the rapid computation and reporting, the bottlenecks remained. Manifests and test results are still keyed manually. Classified and uniform pricing still require all plants to report and settle with the pool before checks can be paid. Growing efforts of using bar coding, scanning and other technology is speeding up the first, but the second bottleneck will remain.
Some of the risk could be reduced, however. Today, advance payments for the first 15 days at a percentage of the prior month’s prices reduce exposure from 45 to 50 days to 30 days or less. This model could be done on weekly, rather than semi-monthly, cycles and reduce the risk to one or two weeks. Final settlement of the blend values could come later. That would require regulatory changes.
But if we were successful in moving payments closer to delivery, the risk is not removed, just restated and reallocated because the plants now using $1.5 billion of producer money will have to find other capital or credit. Absent that, they will close. Without sales, there is no credit, and with no credit there is no risk of non-payment. A poke here, a pop there. PD
Attorney at Yale Law Officeben@yalelawoffice