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Manage the Margin Rather Than Just the Milk Price

Apr 11, 2011

By analyzing your dairy’s financials, and creating a risk management strategy that protects your profit margin, you can reduce your farm’s exposure to price volatility.

Katie Krupa photoBy Katie Krupa, Rice Dairy

When creating a risk management strategy, dairy farmers should look at the complete milk price equation. Milk price risk management should include both the price the milk is sold for and the cost to produce the milk.

In order to consistently make a profit, many farms manage the margin between the milk price and the input costs. Current volatility in both the milk price and the input costs results in producers needing to manage more than just the milk price if they want to protect their profitability.

Currently on the exchange, the corn price is approaching $8.00 per bu., oil is trading over $110 per barrel, and the milk price is trading around $17.00 per cwt. (close to $18.00 for summer months).
The milk price and the input costs have been extremely volatile, and producers are becoming more anxious for the future profitability of their business. While a $17.00 Class III price looked extremely appealing at the beginning of the year, producers are now nervous that current milk prices and rising input costs will return negative margins.

It appears price volatility is here to stay, so many producers are taking matters into their own hands and taking the risk off the table for both milk income and expenses. Risk management plans are becoming more complete, encompassing both the milk price and the input costs.

Many producers don’t know how to manage the margin between the milk price and the input costs, but luckily the resources available to them are constantly expanding. Brokers, consultants, lenders and other industry professionals are creating and utilizing tools for dairy producers that enable them to analyze and then protect their profit margin.

Understanding the margin between milk price and cost of production is helpful to producers for many reasons. Firstly, if you don’t know what your cost structure is, you aren’t able to improve it. Many producers will be able to cut their costs once they know where the money is going. Secondly, knowing your income and current milk production can help producers realize their cows’ full potential. Understanding the value of an extra pound of milk per day per cow will help drive management decisions in the right direction for the farm. Even without a risk management plan, a complete margin analysis can help producers improve their profitability.

Once the analysis is complete, producers can review their risk management options and make a decision that is best suited for their farm business. Many producers are discouraged by the numerous risk management strategies available to them, and unfortunately this scares them away. Although the options seem overwhelming at first, knowing the farm’s current financials will help the decision-making process. By identifying the input costs and milk price, the producer and their decision making team will be able to identify which risk management strategies will best serve their farm. 
 
Producers now have various tools available to them to control price volatility in both the milk price and the input costs. New programs offered by the government and a growing number of programs offered by cooperatives help supplement the already vast contracting options available on the exchange. It is important to review and understand your risk management options and examine how they line up with your farm’s unique needs.

Many producers I work with find that analyzing their financials helps them better identify the appropriate risk management strategy, implement that strategy, and ultimately be happy with that decision. Implementing the strategy is very difficult for many producers. Fear that they are making the wrong decision is overwhelming. To combat this fear, analyze the numbers and make your risk management decisions based on farm financials. Take the emotions out of the decision-making process.

By basing your decisions on farm financials, you will be satisfied with your decision because it will be good for your farm business and ultimately good for you personally.

By analyzing your farm’s financials, and creating a risk management strategy that protects your farm’s profit margin, you can reduce your farm’s exposure to price volatility. Regardless of how the milk and input prices move, if your risk management strategy has protected the margin, your profitability will be protected. Creating, implementing, and being satisfied with your risk management strategy will be easier once you understand the farm’s financials, and protect the margin, rather than just the milk price. 
  
Katie Krupa is the Director of Producer Services with Chicago-based Rice Dairy, a boutique brokerage firm offering guidance, analysis, and execution services on futures, options, spot and forward markets. If you are interested in learning more, Katie offers monthly webinars on the basics of risk management. You can reach Katie at klk@ricedairy.com. Visit www.ricedairy.com.

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