MSU

 

RETURNING MATERIALS:
Place in book drop to

 

 

LJBRARJES remove this checkout from
your record. FINES wiII
be charged if book is
returned after the date
stamped below.

AUG 031923
(€353 ‘

Jvfzslar‘t

 

 

ASPECTS OF THE DAIRY COOPERATIVE'S ROLE IN THE VERTICAL
COORDINATION OF THE DAIRY SUBSECTOR

by

William Allan Knudson

A DISSERTATION

Submitted to
Michigan State University
in partial fulfillment of the requirements
for the degree of

DOCTOR OF PHILOSOPHY

Department of Agricultural Economics

1988

'r'

I)

I

ABSTRACT

ASPECTS OF THE DAIRY COOPERATIVE'S ROLE IN THE VERTICAL
COORDINATION OF THE DAIRY SUBSECTOR

by
Willian.Allan Knudson

Dairy cooperatives are actively involved in many
areas of the dairy subsector. This research concentrates
on the cooperative's coordinating activities within the
cooperative (micro - micro coordination); between the
cooperative and processors and handlers (micro
coordination): and the cooperative's efforts to match
aggregate supply and demand (macro coordination).

There are many impediments to coordination.
Milk is a perishable and bulky product in its raw state.
Furthermore, the seasonal supply and demand of dairy
products are unsyncronized. Also, there are biological
lags in output, and there is a great degree of asset
fixity throughout the entire dairy subsector. Dairy
cooperatives can enhance coordination by providing
services or instituting programs that address these
problems.

Cooperatives undertake a wide range of
coordinating activities. In order to make the research

manageable three activities: multiple component pricing

(MCP) systems, supply management programs, and the
marketwide services of seasonal balancing and marketwide
information are analyzed. The method used to test the
hypotheses concerning these activities is analysis by case
study. This method provides more in depth research results
than other methods when dealing with vertical coordination.

The research yielded the following results. It
was determined that coordination at all levels is improved
somewhat via MCP systems, because the quality of milk has
improved. Also, technical efficiency is improved and
surpluses can be reduced through supply management programs
administered by cooperatives. The marketwide services of
seasonal balancing and marketwide information also enhance
vertical coordination at all levels by reducing uncertainty
and adding stability to the subsector in a cost effective
manner.

This research uncovered four aspects of the
relationship between cooperatives and vertical
coordination. In order for a cooperative to effectively
enhance vertical coordination, it must have the support of
the membership and at least some degree of market control.
It was determined that cooperatives are uniquely qualified
to perform some coordinating activities. Also, in order
for cooperatives to perform some coordinating activities,
especially if they lack sufficient market control on their
own, regulation such as Marketing Orders, or national

pol icy have to be changed.

ACKNOWLEDGEMENTS

There are several people and organizations who
made this possible. I would like to thank the Agricultural
Cooperative Service for providing the financial support
that made this research possible. I am also indebted to
those who allowed me to interview them in order to collect
the data necessary to test the research hypotheses. I
would also like to thank those on my dissertation
committee; professors Hamm, Sorenson, Bonnen, and Ferris
for their time, patience, and input.

There are several others I would like to thank.
Denis Kwiatkowski and Dave Schweikhardt did much to make my
time here enjoyable and profitable. I' would also like to
thank John Haydu and Jim Caudill 'for the generous use of
their dart board. I would also like to thank Jim and
Crystal Douglas for their friendship. Special thanks go to
Jim Whitestone and his entire family for their kindness and
hospitality. I would also like to thank the Athletic
Department of Michigan State University for providing me
the opportunity to see an NCAA hockey championship team,
and a Rose Bowl winning football team during my stay.

This dissertation is dedicated to my parents, Al
and Jean. Without them, none of this would have been possible.

iv

TABLE OF CONTENTS

Page
LIST OF TABI‘ESOOOOIOOOO000.00.000.00..00.0.0.0.0000... ix

CHAPTER 1: INTRODUCTION...............................
1.1 Background...................................
1.2 Vertical Coordination........................
1.2 Impediments to Coordination..................
1.3 Performance Criteria.......... ....... ........
1.4 Synopsis of Research.........................

LOQUIUHH

CHAPTER 2: COORDINATION ACTIVITIES PURSUED BY DAIRY

COOPERATIVES.......................................... 11
2.1 Vertical Coordination and Coordinating

Activities................................... 11
2.2 Micro - Micro Coordination................... 14
2.3 Micro Coordination........................... 16
2.3.1 Contractual Agreements................ 16
2.3.2 Vertical and Horizontal Integration... 17
2.4 Macro Coordination........................... 20
2.4.1 Marketwide Services................... 20
2.4.2 other Macro Coordination Issues....... 22
2.5 Summary of Coordinating Activities........... 23

CHAPTER 3: CONCEPTUAL FRAMEWORK AND RESEARCH ISSUES.. 27
3.1 Hypotheses................................... 27

3.2 Multiple Component Pricing................... 30
3.2.1 Background............................ 30

Types of MCP Systems.................. 33
Impacts of MCP Systems................ 34
Impacts on the Fluid Market........... 36
Breadth of the Program................ 40
Management............................ 41
Background............................ 41
Impacts on Coordination............... 42
Types of Programs..................... 43
Basic Supply Management Considerations 45
Further Considerations................ 47

(I)
uuwuup’wuuu

'Uooeo
wuqu'UNNNN

3.3

ooooof—loooo
UhhtthPH<ifli5h’N

vi
Page

3.4 Seasonal Balancing and Marketwide Information 49
3.4.1 Theoretical Considerations............ 49
3.4.2 Seasonal Balancing.................... 51
3.4.3 Marketwide Information................ 58
3.4.4 Payment Issues........................ 60

3.5 The Role of Marketing 0rders................. 61

3.6 Summary...................................... 63

CHAPTER 4: RESEARCH METHODS AND CASE STUDIES......... 65
4.1 Methods...................................... 65

4.2 Selection of Individual Case Studies......... 66
4.2.1 MCP Case Studies...................... 66

4.2.2 Supply Management Case Studies........ 67

4.2.3 Marketwide Services Case Studies...... 69

4.3 Data Collection Techniques................... 71

4.4 Summary 74

CHAPTER 5: COOPERATIVES, COORDINATION, AND MULTIPLE

COMPONENT PRICING..................................... 76
5.1 Introduction................................. 76

5.2 Cooperative A................................ 77
5.2.1 Structure of the MCP System........... 77

5.2.2 Micro - Micro Coordination............ 80

5.2.3 Micro Coordination.................... 81

5.2.4 Macro Coordination.................... 84

5.3 Cooperative B................................ 86
5.3.1 Structure of the MCP System........... 86

5.3.2 Micro - Micro Coordination............ 88

5.3.3 Micro Coordination.................... 89

5.3.4 Macro Coordination.................... 91

5.4 Cooperative C................................ 93
5.4.1 Structure of the MCP System... ...... .. 93

5.4.2 Micro - Micro Coordination............ 95

5.4.3 Micro Coordination.................... 96

5.4.4 Macro Coordination.................... 97

5.5 Findings..................................... 99

5.6 Summary...................................... 103

CHAPTER 6: COOPERATIVES, COORDINATION AND SUPPLY
MANAGEMENT............................................ 105
6.1 Introduction................................. 105
6.2 Cooperative D................................ 106
6.2.1 Structure of the Program.............. 106
6.2.2 Micro - Micro Coordination............ 108
6.2.3 Macro Coordination.................... 111
6.3 Cooperative E................................ 114
6.3.1 Structure of the Program.............. 114
6.3.2 Micro - Micro Coordination............ 116
6.3.3 Macro Coordination.... ...... . ......... 119

vii
Page

6.4 Cooperative F................................ 121
6.4.1 Structure of the Program.............. 121
6.4.2 Micro - Micro Coordination............ 123
6.4.3 Macro Coordination.................... 125

6.5 Findings..................................... 127

6.6 Summary...................................... 130

CHAPTER 7: COOPERATIVES, COORDINATION AND MARKETWIDE
SERVICES.............................................. 132
7.1 Introduction................................. 132
7.2 Seasonal Balancing........................... 133
7.2.1 Cooperative G......................... 133
7.2.1 a Background..................... 133
1 b Micro - Micro Coordination..... 134
1 c Micro Coordination............. 136
1 d Macro Coordination............. 138
operative H......................... 139
.2 a Background..................... 139
.2 b Micro - Micro Coordination..... 139
.2 c Micro Coordination............. 140
.2 d Macro Coordination............. 141
operative I......................... 143
3 a Background..................... 143
3 b Micro - Micro Coordination..... 143
3 c Micro Coordination............. 144
2.3 d Macro Coordination............. 146
7.2.4 Cooperative J......................... 149
7.3 Marketwide Information....................... 150
7.3.1 Cooperative G......................... 150
7.3.1 a Background..................... 150
.3 1 b Micro - Micro Coordination..... 151
.3 1 c Micro Coordination............. 152
.3 1 d Macro Coordination............. 153
Cooperative H......................... 155
.3 2 a Background..................... 155
.3 2 b Micro - Micro Coordination..... 156
.3 2 c Micro Coordination............. 157
.3 2 d Macro Coordination............. 159
Cooperative I......................... 160
.3 3 a Background..................... 160
.3 3 b Micro - Micro Coordination..... 161
.3 3 c Micro Coordination............. 163
.3 3 d Macro Coordination............. 165
Cooperative J......................... 166
.3 4 a Background..................... 166
.3 4 b Micro - Micro Coordination..... 167
.3 4 c Micro Coordination............. 169
7.3.4 d Macro Coordination............. 171
7.4 Findings..................................... 172
7.5 Summary...................................... 175

viii
Page

CHAPTER 8: FURTHER ASPECTS OF COOPERATIVES AND

VERTICAL COORDINATION................................. 178
8.1 Introduction....................-..... ....... 178
8.2 Micro - Micro Coordination................... 179
8.2.1 Member Support........................ 179
8.2.2 Education............................. 180

8.2.3 Micro - Micro and Other Levels of
Coordination.......................... 181
8.3 Micro Coordination..................... ...... 182
8.3.1 The Uniqueness of Cooperatives........ 182
8.3.2 Economies of Scale.................... 183
8.3.3 Control and Cooperatives.............. 183
8.4 Macro Coordination........................... 185
8.4.1 The Importance of Control............. 185
8.4.2 Membership Issues..................... 187
8.4.3 Regulation............................ 187
8.4.4 Cooperatives and the Public Sector.... 190
8.5 Synopsis..................................... 191
8.6 Summary.......... ..... ....................... 193

CHAPTER 9: CONCLUSIONS, RESEARCH RESULTS, AND TOPICS
FOR FURTHER RESEARCH.................................. 196
The Cooperative's Place in the Dairy
Subsector.................................... 196
Research Methods............................. 197
Research Results............................. 199
9.3.1 Multiple Component Pricing............ 199
9.3.2 Supply Management..................... 203
9.3.3 Marketwide Services................... 206
9.3.4 Recommendations................ ..... .. 209
9.4 Further Aspects of Cooperatives and
Coordination................................ 211
9.4.1 Micro - Micro Coordination............ 211

UNH

9.
9.
9.

9.4.2 Micro Coordination.............. ...... 212

9.4.3 Macro Coordination............... ..... 213

9.5 Further Research Needs.......... ....... ...... 216

9.6 Final Statement.......... .................... 217
APPENDIXOOOOOOOOOOOOOO0.0. OOOOOOOOOOOOOOOOOOOOOOOOOOOO 219

BIBLIOGRAPHYOOOOOOOOOO0.00....0. OOOOOOOOOOOOOOOOOOOOOO 224

Table

Table
Table

Table

Table

Table

Table
Table

Table

Table

Table
Table

Table

Table

LIST OF TABLES

Page
Cooperatives's Share of Milk Delivered to
Plants and Dealers, and Share of Total
Output of Selected Manufactured Dairy
PrOduCtSOOOOOOO......OOOOOOOOOOOOOOOOO ..... 2
Performance Goals and Measures. ............ 8
Synopsis of Coordinating Activities.. ...... 13
Taxonomy of Coordinating Activities and
Issues Facing Dairy Cooperatives........... 24-25

Cooperative Activities Studied in This
ResearChOO0.000.000.0000.0.0.0....0.0.0.... 28

Per Capita Commercial Use of Selected Dairy
PraductSOCOOOOOOOOOOOOOO......OOOOOOOOOO... 31

Existing Standards for Fluid Milk.......... 37
Net USDA Removals of Dairy Products........ 41
Assumed Estimated Annual Fixed and Overhead
Costs for a Butter - Powder Plant with a

Daily Capacity of 3.025 Million Pounds of

Milk Assuming an 11 Percent Interest Rate.. 55

Assumed Annual Fixed and Overhead Costs of
Balancing the Fluid Reserves of the Market. 56

Number of Persons Interviewed....... ....... 73
Cooperative A's Premiums and Deductions.... 79
Cooperative B's Quality Premiums and

Deductions............. ........... ... ...... 87
Cooperative C's Premiums and Deductions.... 94

ix

CHAPTER 1: INTRODUCTION

1.1 Background

Agricultural cooperatives can best be defined as
voluntary organizations comprised of farmers or other
farmer cooperatives. Cooperative arrangements can be
viewed as a general mode of organizing economic activity
between members of the cooperative and those subsector
participants who interact with the cooperative. The
majority of dairy farmers are members of cooperatives.

Cooperatives have been part of the dairy
subsector for many years. Cooperatives have been
associated with cheesemaking since 1860, and .have been
bargaining with other subsector participants since 1889
(Knapp, pp.69,71). These bargaining units were the
forerunners of today's marketing cooperative. By 1920
cooperatives were well established in all aspects of the
dairy subsector (Knapp, pp.222-223).

The role of cooperatives in the dairy subsector
has become larger with the passage of time. As Table 1
shows, cooperatives's share of all milk sold to plants and
dealers has risen from 59.1 percent in 1957 to 77 percent
by 1980 (Stafford and Roof, p.6; Manchester 1983, p.59).
Table 1 also shows that cooperatives's share of total

1

2
butter production has risen from 58 to 75 percent, and
cooperatives's market share of the dry milk industry has
risen from 57 to 90 percent from 1957 to 1981 (Manchester
1983, p.84). These figures serve as evidence of the
important role cooperatives play in the dairy subsector. A
more complete picture of this role, both past and present,

is shown in Table 1.

Table 1: COOPERATIVES'S SHARE OF MILK DELIVERED TO PLANTS
AND DEALERS, AND SHARE OF TOTAL OUTPUT OF SELECTED
MANUFACTURED DAIRY PRODUCTS

(percent of total)

Isa:
QQIIQQII! 1957 1964 1973 1981
Milk.Bau1ed 59.1 67.2 75.8 77.0a
Butter 58 65 66 ' 75b
Natural
Cheese 18 21 35 50b
Dry Milk
Products 57 72 85 90b
Cottage
Cheese 7 15 13 14b
Ice Cream.and
Ice Milk 4 5 5 5b

a = 1980 data; b = estimated
(Sources: Stafford and Roof, p.30: Manchester 1983,
pp. 59,84)
Table 1 shows that cooperatives are the primary source of

some commodities and their importance in terms of market

3
share has, for the most part, increased over time.
Cooperatives's large role in some industries may place them
in an unique position to affect the vertical coordination
of the entire subsector.
1.2 vertical Coordination

This research focuses on the cooperative's role
in the vertical coordination of the subsector. Vertical
coordination can be defined as "all the ways of harmonizing
the vertical stages of production and marketing" (Mighell
and Jones, p.1). A more simple way of defining vertical
coordination is the matching of supply and demand of a
commodity, or a set of commodities (like dairy products),
from the farm to the consumer. A well coordinated
subsector will match supply and. demand from the farm
through to the consumer across time, space, and form. This
is difficult for a subsector as complicated as the dairy
subsector.

There are several reasons for studying vertical
coordination. Analysis of the vertical coordination of a
subsector improves the understanding of those involved in
the subsector (Mighell and Jones, p.1) . This enhanced
understanding could lead to improved coordinating
mechanisms and institutions and therefore improve the
performance of the subsector. Another reason for analyzing
vertical coordination is to determine the effects of

various coordinating mechanisms on the subsector (Mighell

4

and Jones, p.1). Again, this allows those involved in the
subsector to alter their practices in a way that would
enhance coordination. However, the single most important
reason to analyze vertical coordination is to determine the
fundamental problems the subsector faces and to institute
mechanisms and programs which would address these problems.
This would improve the matching of supply and demand within
a subsector. The next section deals with the impediments
to coordination facing the dairy subsector.

As the previous section outlined, dairy
cooperatives are major actors in the subsector. They are
an instrument that farmers can use to exercise control over
marketing stages beyond the farm (Mighell and Jones, p.2).
They can be used to enhance or impede the coordination of
the subsector. Given problems facing the dairy subsector
such as asset fixity and the seasonality of production and
consumption, to name two, dairy cooperatives may have a
role to play in improving the vertical coordination of the
subsector. They can address these problems to the benefit
of all subsector participants.

vUnfortunately, traditional welfare economics
cannot be used to analyze vertical coordination in the
dairy subsector. Institutional restrictions such as
oligopolistic markets and imperfect resource mobility, to
name a few, make achieving Pareto Optimality impossible.

Furthermore, given the theorem of second best: if one of

5
the conditions for Pareto Optimality do not hold, it is
therefore not necessary nor desirable to satisfy the
remaining conditions (Henderson and Quandt, p.316) to
maximize the welfare of subsector' participants. This
complicates the analysis and forces a researcher to look
for other performance criteria in determining the role the
cooperative plays in the coordination of the dairy
subsector.
1.3 Impediments to Coordination

There are several aspects of the dairy subsector
that make coordination difficult. In its raw state, milk
is highly perishable and has a high potential for
transmitting diseases. Therefore, milk must be handled
carefully. Furthermore, milk is bulky which also makes it
difficult to handle (Fallert, Miller and Sleight, p.2).

There are several biological aspects of dairy
production that also makes coordination difficult. The
seasonality of supply and demand is unsyncronized. The
output of milk is highest in the spring and summer when
demand is at its lowest, and the output of milk is lowest
in the fall and winter when demand is highest.
Furthermore, there are biological lags in output and there
is a high degree of asset fixity throughout the entire
dairy subsector. Inputs used for the production of dairy
products have few, and in many cases, no alternative uses.

This makes investment and disinvestment decisions critical

6
in enhancing or harming the coordination of the subsector.
Dairy cooperatives can enhance coordination at various
levels by providing services or instituting programs that
address some of these problems.

In addition, there are some fundamental market
relationships that need to be considered. Demand for some
dairy products is highly inelastic (Fallert, Miller and
Sleight, p.2), and output per cow has been steadily
increasing. This helps explain the existence of downward
price pressure, the exit of dairy farmers out of the
market, and the continued large surpluses of dairy
products. If dairy cooperatives can find a way to curb
these surpluses, or develop new markets for dairy products
they will have served a crucial role in improving
coordination.

A potential difficulty that affects dairy
cooperatives directly is the free rider. Free riders are
subsector participants that benefit from the activities
full service cooperatives undertake without sharing the
costs. An example is those participants who benefit from a
cooperative's seasonal balancing operations but do not
share the costs of transportation or operating
manufacturing plants. Dairy cooperatives may face three
types of free riders. Producers who do not belong to the
cooperative, limited service cooperatives who do not offer

the wide variety of services provided by full service

7
cooperatives, and some processors and handlers. Free
riders may reduce the ability and desire of cooperatives to
engage in some coordinating activities.
1.3 Performance Criteria

In order to determine how well coordinated the
subsector is, or areas where coordination could be
improved, performance goals must be determined. These
performance criteria are useful in determining how well
coordinated a subsector is from the farm to the consumer.
If a subsector meets these criteria it would be strong
evidence that the subsector is well coordinated. If one or
more of these goals is not met, then performance probably
could be improved. The following measures will be useful:
the extent to which supply matches demand at prices
consistent with the opportunity cost of resources: the
level‘ of technical and operational efficienCy of the
entire subsector: and accessibility to the subsector,
including market foreclosures and opportunities such as the
condition of entry: and perhaps most importantly, the
reliability and stability of the subsector (Marion, p.51).
Table 2 lists performance goals and measures.

Measurement of some of these performance criteria
will be difficult. Potential performance measures are also
listed in Table 2. The degree to which supply matches

demand can be determined by analyzing the existence of

8

Table 2: PERFORMANCE GOALS AND MEASURES

EQAL HZASHBEfi

Supply Matches Demand at Degree of Surpluses or
Prices Consistent with Shortages; Comparing
the Opportunity Cost Returns Within the

of Resources Subsector to Returns

in Other Subsectors

Technical and Economies of Scale;

Operational Efficiency Per Unit Costs:
Introduction of new
Technologies and

Institutions
Accessibility to the Extent/Existence of
Subsector Barriers to Entry and
Exit
Reliability and Degree of Price and
Stability of the Output Volatility:
Subsector Amount of Resource
Movement
shortages or surpluses in a market. Determining the

opportunity cost of resources is complicated by the fact
that there is a high degree of asset fixity in the dairy
subsector. Probably the best proxy is comparing returns
within the dairy subsector to those outside the subsector.
Technical efficiency is always difficult to measure.
Technical efficiency is improved in the dairy subsector if
the cost of dairy products is reduced by improving the
physical flow and timing between links of a marketing chain
(Campbell and Clevenger, p.5).

How cooperatives adapt to changes in the
environment, as well as the introduction of new products

and institutions is one way to analyze technical efficiency

9
and progressiveness. Economies of scale are another aspect
of technical and operational efficiency. The question of
accessibility can be analyzed by the barriers to entry and
exit within the subsector; the ease .of exit may be
particularly important given recent surpluses in the dairy
subsector. Stability can be analyzed by a study of price
volatility and resource movement within a particular
market.
1.4 Synopsis of Research

Given this backdrop, two questions emerge. The
first is what activities do dairy cooperatives currently
pursue that enhance vertical coordination? The second is
what activities could cooperatives potentially pursue to
enhance the vertical coordination of the subsector? As
previously mentioned, cooperatives are a major actor in the
dairy subsector, and they may be in a position to improve
vertical coordination through a number of activities.

The research will use a subsector approach,
analyzing the various participants in the dairy subsector
and how cooperatives interact with them at the different
levels of coordination. This approach is useful when
analyzing vertical coordination. It allows a researcher to
view the relationship cooperatives have with their members,
and with other subsector participants. Furthermore, it
allows a researcher to analyze the cooperative's role in

matching the aggregate supply and demand of dairy products.

10
The research will use case studies and personal interviews
to gather data and test hypotheses.

The research focuses on three different
coordination activities: multiple component pricing,
supply management, and the marketwide services of seasonal
balancing and marketwide information. These activities
will be discusSed in much more detail in Chapter 3.
Cooperatives undertake a wide range of coordinating
activities as outlined in the next chapter. Through
.careful analysis of multiple component pricing, supply
management, and the two marketwide services, generalities
concerning dairy cooperatives and coordination can be

obtained.

CHAPTER 2 : COORDINATION ACTIVITIES PURSUED BY

DAIRY COOPERATIVES

2.1 vertical Coordination and Coordinating Activities

Stated in simple terms, vertical coordination is
matching the supply and demand of a commodity from the farm
to the consumer. The subsector participant that is the
focus of this research is the dairy cooperative. How it
interacts with producers, processors and handlers, and the
fundamental forces that determine supply and demand.

The research is based on coordination at three
different levels. The first level is coordination within
the cooperative (micro - micro coordination). ,Aspects of
micro - micro coordination include relations between the
different areas of management within the cooperative.
However, the most fundamental aspect of micro - micro
coordination is the relationship between the management of
the cooperative and the membership of the cooperative. How
they interact with each other in administering various
activities the cooperative undertakes.

The second level of coordination is that between
individual firms at different levels of the marketing chain
and the cooperative (micro coordination). The fundamental
micro coordination relationship is that between the

11

12
cooperative and proprietary firms: fluid handlers and firms
which manufacture dairy products. Aspects of this
relationship include meeting the needs of proprietary firms
and various operating agreements between a cooperative and
fluid handlers and manufacturers.

The last level of coordination analyzed is
matching total supply and demand (macro coordination),
which is a critical issue in the dairy subsector. It deals
with the interaction between a dairy cooperative and
fundamental market conditions. Macro coordination issues
include methods to reduce or eliminate shortages and
surpluses in a market. The final level of coordination
deals with matching aggregate demand with aggregate supply
for the economy as a whole (macro - macro coordination)
(Shaffer, p.2) . Macro - macro coordination is'beyond the
scope of this research.

It appears that dairy cooperatives have the
potential to improve the coordination of the subsector by
performing certain activities. Some of these coordinating
mechanisms viewed in the broadest sense are: pricing,
contractual agreements, vertical and horizontal
integration, collective organization, and information
systems (Cook et al., p.62). Table 3 lists the various
broad coordinating activities and the different levels of

coordination that are affected by these activities.

13
Table 3: SYNOPSIS OF COORDINATING ACTIVITIES

Level of Coordination

Coordination '

Issue or Micro - Macro -
mun Micro Micro Macro Macro
Pricing x x x x
Contractual

Agreements x x x

vertical and

Horizontal

Integration x x

Collective

Organization x x x

Information

Systems X x X x

Pricing and information systems affect all levels
of coordination. Pricing is the prime coordinating
mechanism in most U.S. subsectors and affects the economy
as a whole. Information systems promote coordination at
all levels by aiding the decisionmaking abilities of
subsector participants. A Vertical and horizontal
integration are important activities at the micro and macro
levels. Collective organization and contractual agreements
affect micro - micro, micro and macro coordination.
Specific examples of the various coordinating activities
dairy cooperatives perform, and how they affect the
coordination of the subsector, is the focus of this

chapter.

14
2.2 Micro - Micro Coordination

Cooperatives offer a wide array of services that
affect vertical coordination. Some of these benefit their
members and may be seen as a type of micro - :micro
coordination: examples would be: check weight and testing,
undertaking field services and quality improvement, and
furthermore, guarantees of markets and payment (Cook et
al., pp.21-23). Most of these, however, aid more than just
the farmer members who appear to receive most of the direct
benefits. They ensure product quality which reduces
uncertainty and may increase demand. Guaranteed payment
and a market source for a dairyman's product may reduce the
risk and uncertainty faced by producers and may lead to
improved decisionmaking. These services may also lead to
improved stability in the subsector as well. The services
just outlined benefit many subsector participants.

Perhaps the most fundamental relationship facing
those involved with dairy cooperatives is that between the
owner members and their cooperative management. This is
another aspect of micro - micro coordination. The farmer
members attempt to control management through political
processes, purchases of stocks, and through entering or
exiting the cooperative (Shaffer, p.6). Depending on the
relative size of the cooperative, the individual member,
and other factors, these attempts of control may fail.

If the cooperative is very large, and undertakes

15

many tasks, it is possible that the cooperative's
management is too far removed from the producer to be
responsive to his desires. Whether or not member producers
can effectively voice their concerns may be a problem,
especially for large cooperatives. Information flows
between management and producers may also be difficult for
large cooperatives. Management may not feel that
interaction with membership is as important as other
activities. However, the information infrastructure may be
better for a large cooperative than a small one. The
marginal cost of supplying an additional member information
is probably low, and the information gathering capabilities
of a large cooperative may be greater than those of a small
cooperative.

Sound micro - micro coordination may be critical
if the cooperative is to be effective in enhancing vertical
coordination. Management and membership must agree to, and
understand, the activities the cooperative undertakes.
Misunderstanding will lead to a loss of membership, which
will cause the cooperative to lose its market control, and
eventually lead to a break down of the cooperative's
ability to affect vertical coordination through the various

activities it pursues.

16
2.3 Micro Coordination
2.3.1 Contractual Agreements

Dairy cooperatives also provide services that
benefit handlers relative to others. Cooperatives are in a
position to provide milk in a given quantity, at a
specified time (Cook et al., pp.21-23). Some cooperatives
also balance cream supplies. They assemble and find
outlets for the cream that fluid handlers do not need.
These services also act to reduce risk and uncertainty, and
may also reduce transaction costs. These agreements may
also help promote stability in the market which may be
beneficial to other market participants.

These agreements are contractual in nature. A
major type of contractual agreement is full supply
arrangements. Since the 19405, cooperatives have agreed to
meet the exact demand of processors, especially for fluid
use (Manchester 1978, p.6) . These agreements reduce the
cost of obtaining' milk and reduce the uncertainty' and
instability in the market because demands are known and
accounted for before the product is actually marketed. The
reduced uncertainty and increased stability improves
coordination at all levels: guesswork is reduced, and
investment or disinvestment decisions for fluid handlers
and manufacturers, as well as producers, can be made with
greater confidence.

Cooperatives also enter into contractual

17

agreements with each other when bargaining for super pools
and through the use of such institutions as the Associated
Reserve Standby Pool Cooperative (Cook et al., p.72).
These last two types of agreements tend to be more useful
for macro coordination because they deal with the subsector
as a whole. These contractual agreements make it difficult
for one subsector participant to exploit another: once the
agreement is signed, participants have committed
themselves. Moreover, they serve to reduce transaction
costs, and they provide information which may lead to a
better coordinated market.

While contractual arrangements may reduce
uncertainty and transaction costs, they do not eliminate
them. Furthermore, the cost to those who are liable for
obligations that cannot be fulfilled can be quite high.
Possibly in an attempt to reduce these costs, cooperatives
have vertically integrated into the dairy subsector. In
addition to vertical integration, they have also entered
into joint ventures with processors and handlers. Vertical
integration and joint ventures are becoming an increasingly
important aspect of the dairy subsector.

2.3.2 vertical and Horizontal
Integration

Vertical integration can be defined as
"coordinating technically separable activities in the
‘vertical sequence of production and distribution of

products under the control of a single entity" (Shaffer,

18

p.3) . There are many reasons for vertical integration.
Some of them are as follows: it centralizes control and
reduces transaction costs, internalizes externalities, and
captures economies of scale (Shaffer, p.3). The ‘most
important coordination aspect of vertical integration,
however, is the reduction of uncertainty (Shaffer and
Staatz, pp.55-56).

Cooperatives have integrated forward in a number
of areas (Marion, p.85). In the dairy subsector they
appear to have integrated into butter powder and have more
recently expanded their cheese ‘manufacturing operations
(Manchester 1983, p.197). Some argue that the reason
cooperatives have vertically integrated in the dairy
subsector is due to dairymen's perceptions of the market
power that is derived from processing and handling
commodities and not from a desire to improve the
coordination of the dairy subsector (Marion, p.85).
Nonetheless, cooperative plants apparently have a lower
cost structure than proprietary plants (Schader et a1. ,
p.18). If this is the case, cooperatives are probably
improving the coordination of the subsector as long as they
stand ready to market all the milk made available to them.
They are probably increasing the degree of competition at
the processor level.

A related way of improving micro coordination may

be through joint ventures; dairy cooperatives entering

19

into business arrangements with proprietary firms. This is
also a 'type of contractual agreement. This obviously
reduces the risk that each organization bears and may allow
for greater investment and market expansion. Cooperatives
have undertaken joint ventures in the past (Cook et al. ,
p.52) . These arrangements allow a cooperative to expand
its geographic area, as well as increases access and
expertise beyond the processing level. In exchange, the
proprietary handler receives a secure source of product
(USDA, ERS 1984B, p.56).

Another related aspect of vertical integration is
the growth of cooperatives into areas where they have not
traditionally been active. As previously mentioned, over
the years, they have become active in processing Grade B
milk and surplus manufacturing of Grade A milk (Cook et
al., p.75). Mbreover, the responsibility for assembly of
milk supplies has shifted to cooperatives over time (Cook
et al., p.81). It may be argued that cooperatives have
filled in as a "missing hero," a market participant that
steps in and provides a service or performs a function that
no other participant is willing to undertake. Dairy
cooperatives were the only' participants willing to
undertake the activities outlined above where the
coordination of the subsector was in need of improvement or
where performance was declining.

A type of horizontal integration is the

20

cooperative federation. These federations first began in
the Midwest during the 19605 (Manchester 1978, p.6). This
entails a contractual agreement between cooperatives.
Under the agreement, the federation contracts to perform a
particular function or group of functions for the
cooperative. Some of these functions include: the
exchange of information, bargaining, operating a mechanism
for movement of milk from surplus to deficit areas at a
known price, and moving manufacturing grade and Grade A
milk to manufacturing facilities. These functions help
provide information that reduces uncertainty and helps
balance supply and demand which is the critical aspect of
macro coordination. Federations are discussed in further
detail in Chapters 7 and 8.

Mergers are another type of ‘horizontal
integration. The 1960s witnessed the creation of Dairymen,
Inc. and Mid - American Dairymen, Inc. (Williams et al.,
pp.67-68). These large regional cooperatives are a result
of mergers involving smaller cooperatives.

2.4 Macro Coordination
2.4.1 Marketwide Services

Currently, dairy cooperatives undertake several
tasks which benefit many participants in the dairy
subsector. Many of these activities have been discussed in
the micro - micro and micro sections of this chapter.

These services may have a positive impact on macro

21

coordination. Some of these functions include: managing
and routing the milk supply, and providing for disposition
of milk used for fluid products (Manchester 1983, p.281).
The fact that cooperatives stand ready to purchase all of
their membership's milk reduces uncertainty and ensures a
market for dairymen and a source of product for handlers.
Cooperatives also supply market information and may be the
only subsector participant willing to balance and manage
supplies. If this is the case, cooperatives play a major
role in macro coordination by stabilizing markets.

Cooperatives ”incur costs when they provide
marketwide services. The costs of providing these services
rose 427 percent between 1973 and 1980 (Babb, p.1).
However, it is difficult for cooperatives to charge those
who benefit from these services. Marketwide services have
public good characteristics. Some cooperatives, through
bargaining, have been able to offset some of these costs
through negotiating over - order premiums.

Over - order premiums are simply the difference
between the price a cooperative negotiates and the minimum
fluid milk price set by the Federal Milk Marketing Order.
The Orders do not set the maximum fluid milk price. Some
argue that the existence of over - order premiums are
evidence that cooperatives are generating excess profits
(Manchester 1983, p.207). However, as long as cooperatives

stand ready to take all the milk that is offered them,

22

their ability to charge high prices will be severely
limited (Jesse and Johnson 1980, pp.7,31-33). Competition
also plays a role. In highly competitive markets, a full
service cooperative is probably unable to recover the costs
of providing marketwide services. The price the
cooperative receives will be too low for it to cover the
costs of providing these services. If a cooperative, or
cooperative federation, dominates a market it may be able
to recover all the costs of the services through over-
order premiums (Manchester 1987, p.4).

A possible solution to this issue would be to
develop a way to pay cooperatives for the marketwide
services they perform. This would help distinguish the
cost of these services from other cooperative charges
(Manchester 1983, p.281), and help determine whether or not
cooperatives exert monopoly power. Furthermore, these
charges would reduce the free rider problem. Free riders
may make it difficult for cooperatives to improve
coordination. Most of these issues will be discussed in
more detail in Chapter 3.

2.4.2 Other Macro Coordination
Issues

Another major issue in dealing with macro
coordination is supply' management. .As pointed out in
Chapter 1, the biological and fundamental market aspects of
the dairy subsector make macro coordination difficult.

Recent surpluses, coupled with high government

23

expenditures, have caused some to question the
effectiveness of dairy policy. It appears that at recent
price levels surpluses will result: a sign of poor macro
coordination. Cooperatives may be able to administer some
type of direct supply management program to alleviate this
problem. Dairy cooperatives have a history of
administering supply management programs.

Perhaps the greatest coordination mechanism that
affects all levels of coordination is pricing. Agents
react to price signals and adjust. If, for some reason,
prices do not reflect actual supply and demand conditions,
coordination, particularly at the macro level, will be
adversely affected; surpluses or shortages will result. If
a cooperative is able to price effectively, coordination
would improve. Currently, this may not be the Case.

2.5 Summary of Coordinating Activities

Table 4 lists the various coordination issues and
activities that dairy cooperatives undertake. Table 4 is
an expansion of Table 3. A major difference between Tables
3 and 4 is the inclusion of supply management as a
coordinating activity. Another difference between Tables 3
and 4 is that collective organization is not listed in
Table 4. This is because dairy cooperatives, by their very
nature, are a type of collective organization that
undertakes all these activities. Table 4 lists

coordination activities and issues at a more specific

24

Table 4: TAXONGHY OF COORDINATING ACTIVITIES AND ISSUES
FACING DAIRY COOPERATIVES

Level of Coordination

Cooperative
Issue or Micro -

5;ch 112:2 Masts

Pricing
1. Pricing by

butterfat x x x
2. Multiple

Component

Pricing x x x

Contractual
Agreements
1. Farmer -
Management X
2. Full Supply
Arrangements
3. Joint Ventures
4. Marketwide
Services
a) check
weight and
testing x x
b) field
service and
quality
improvement x x
c) guarantees of
market and
payment
d) transportation
e) balancing
f) marketwide
information
9) cream balancing

N><
><N

N ><Nfi<
Nfifl N><X
Xifi N><N

25
Table 4: continued
Level of Coordination

Cooperative
Issue or Micro -

mm Micro Micro

vertical and
Horizontal
Integration
1. Mergers x
2. Cooperative

Federations X
3 . Vertical

Integration X

Information
Services
1. Flaws of
Information
Between
Members and
Management X
2. Educational
Programs X X
3. Advertising and
Other Market
Development
Programs

Supply Management X

26
level: it deals with the activities dairy cooperatives
perform that affect the coordination of the dairy
subsector. Table 3, for the most part, provides a general
structure to analyze coordination. Table 4 lists concrete
aspects of dairy cooperatives and coordination.

As Table 4 shows, cooperatives pursue many
activities that affect coordination at different levels.
The preceding discussion was based primarily on the level
or levels of coordination that are most affected by the
activity. This chapter provides a background for
coordination and the mechanisms that influence
coordination. A subset of these coordinating activities
that cooperatives perform will be the focus of this

research.

CHAPTER 3: CONCEPTUAL FRAMEWORK AND RESEARCH ISSUES

3.1 Hypotheses

The first two chapters have provided the
background on vertical coordination and some of the issues
involved with respect to dairy cooperatives. The taxonomy,
as shown in Table 4, outlined a number of coordination
activities and issues facing dairy' cooperatives at ‘the
various levels of coordination. A complete analysis of all
these activities is beyond the scope of this research.

The research will focus its efforts on the
following activities: multiple component pricing, supply
management, and the marketwide services of balancing
seasonal supplies and marketwide information. Table 5
shows the different levels of coordination that are
affected by these activities. This is a subset of Table 4.
The focus of Chapter 5 will be multiple component pricing,
the focus of Chapter 6 will be supply management, and the
focus of Chapter 7 will be the two marketwide services of

seasonal balancing and marketwide information.

27

28
Table 5: COOPERATIVE ACTIVITIES STUDIED IN THIS RESEARCH

Level of Coordination

Cooperative Micro - .
Acting Micro Lora M_r_ac 0
Multiple
Component
Pricing X X X
Supply Management X X
Marketwide
Services
1. Seasonal

Balancing X X X
2. Marketwide

Information X X X

Each of these activities are controversial issues
facing those in the subsector. All these activities affect
more than one level of coordination. Furthermore, each of
these activities seek to match supply and demand in various
ways and in the case of seasonal balancing at various times
and at various locations. Dairy cooperatives may be able
to enhance coordination through these activities. In order
to analyze aspects of vertical coordination in more detail,
the following hypotheses will be tested.

Hypothg§i§_1: Given that there has been a shift
away from dairy products with a high butterfat content,
pricing by butterfat content may give an incorrect market
signal and lead to the misallocation of resources. If
dairy cooperatives administer a multiple component pricing

(MCP) system then coordination at all levels would be

29

improved because the price signal would more closely
reflect current demand conditions. Furthermore, MCP may
improve the quality of the milk supply, which would also
enhance coordination. Manufacturing plants may be able to
process milk more efficiently. Cooperatives, if they have
sufficient support and control, may be uniquely qualified
to administer an MCP system.

Mthesis II: At current farm price levels
there appears to be a tendency for overproduction of dairy
products. Quantity supplied exceeds quantity demanded. If
cooperatives are able to administer some type of supply
management program then macro coordination will be
improved: surpluses would be reduced or eliminated. Supply
management would also affect micro - micro coordination by
controlling the amount of milk a dairymen could market.

thes I: If cooperatives perform the
marketwide services of seasonal balancing and marketwide
information then coordination is enhanced by reducing
uncertainty, improving decisionmaking, reducing costs, and
increasing stability. Both of these services are performed
by cooperatives and benefit more than just their
membership.

However, once the service is jprovided, it is
difficult to exclude those who do not pay for the service
from benefitting from it. Furthermore, these services once

provided, can be used by many, if not all, market

30
participants. These facts make it difficult for
cooperatives to be adequately compensated for the costs
they incur when providing these services. If cooperatives
currently are not adequately remunerated for these services
then performance may be enhanced through alternative
payment schemes.
3.2 Multiple Component Pricing

3.2.1 Background

One type of pricing system is pricing by
butterfat content. Consumer tastes appear to be changing
toward those products that have a low butterfat content.
The single most important reason why butterfat pricing is
no longer the effective price mechaniSm it was at one time,
is because it no longer reflects consumer and processor
preferences. Over the past two decades, ’per capita
consumption of cheese, yogurt, lowfat and skim milk has
increased while per capita consumption of whole milk,
cream, and butter has declined (Harrington, p.1: Graf
1974, p.4). This situation has led to an increase in the
value of other milk constituents relative to butterfat
(Graf 1977A, p.5). Table 6 shows the changing consumption

patterns of selected dairy products.

31

Table 6: PER CAPITA COMMERCIAL USE OF SELECTED DAIRY

PRODUCTS
(pounds)
122:

ngmggity 1970 1975 1980 1983 1986*
Whole Milk 214 179 145 130 117
Lowfat and
Skin Milk 51 78 96 101 119
Butter 4.4 4.4 3.9 3.8 3.8
American
Cheese 6.8 7.9 8.9 8.9 9.8
Other ‘
Cheese 4.4 6.1 7.9 9.0 11.0

(* = estimated)

(Source: Fallert, Miller and Sleight, p.36:
USDA, ERS 1987A, p.16)
Consumers have evidently substituted lowfat and skim milk
for whole milk, reduced their consumption of butter and
increased their consumption of cheeses. However, butterfat
pricing encourages the production of milk high in fat and
ignores those components, such as protein, that
manufacturers and consumers-want, and may be willing to pay
for.

If cooperatives could institute a pricing regime
that would compensate dairymen for producing milk that has
characteristics that consumers and processors want,
coordination at all levels may be improved. Micro

coordination would be improved because technical efficiency

32

could be enhanced if the composition of milk were altered
so that more manufactured dairy products could be produced
with a given hundredweight of milk. -Macro coordination
would be enhanced because the changed composition of milk
would more accurately reflect current consumer demand. This
would help match supply with demand and change the makeup
of products in the market. It could contribute to
progressiveness in the subsector.

Perhaps in an attempt to meet these changing
demand conditions, cooperatives are increasingly using
another type of pricing mechanism, multiple component
pricing. under this type of system, the price of milk is
partly determined on its protein or solids - not - fat
(SNF) content (Manchester 1983, p.280). This would reduce
the incentive to produce milk with a high butterfat content
and increase the incentive for dairymen to produce milk
with the characteristics desired by processors and
consumers.

Cooperatives may be in an unique position to
administer MCP systems. Their functions usually include
writing member checks and testing members's milk.
Cooperatives usually meet the basic requirements needed to
institute an MCP system. If a cooperative assigns values
to protein or SNF which reflect consumer and processor
preferences, then coordination at all levels would be

improved.

33
3.2.2 Types of MCP Systems

There are several types of component pricing
mechanisms currently in use. One type is end use pricing;
a producer's milk price is based on the price received for
the final product. Another type of component pricing is
premium systems; a dairyman receives a premium for the
production of milk that exceeds a certain protein or SNF
level. A third type of component pricing system is
through the use of deductions: a deduction system is the
opposite of a premium, a dairyman is penalized if the
protein or SNF content of his milk is below the threshold
level. Another mechanism that combines the premium and
deduction programs is neutral zone systems. Under a
neutral zone system, no money is deducted nor is a premium
paid for milk that falls within the established range. The
final MCP system is a premium incentive: this pays a
premium to a producer who has increased his protein or SNF
level from the same time in the previous year (Covington,
p.1057).

These systems are based either on cheese yield,
protein content, or SNF content. Under cheese yield or end
use product pricing a processor can determine a dairyman's
price by multiplying the yield by the price of cheese and
subtracting the processing margin (Alexander and Novakovic,
p.1103). Producers which have herds that produce milk with

a high protein content would automatically receive more for

34
their milk than other producers because the higher the
protein content the greater the cheese yield.

Protein and SNF systems increase or decrease the
amount a producer receives based on the protein or SNF
content of the milk he produces. Both of these programs
generally supplement and not replace butterfat pricing
(Graf 1984A, p.1).

Another aspect of most MCP systems are quality
controls. High somatic cell counts reduce the yield
potential of milk. Some plans penalize producers whose
milk's somatic cell and bacteria count is above a
threshold. Other plans pay premiums to producers whose
milk has a low somatic cell or bacteria count. These
quality controls may work as a market signal and give
producers another reason to control mastitis and other
dairy herd health problems. These quality control programs
may serve to improve the quality of milk which would, in
turn, affect coordination by improving consumer acceptance,
enhancing efficiency of manufacturing plants, and improving
the uniformity of the milk supply.

3.2.3 Impacts of MCP Systems

Most of these pricing plans encourage producers
to produce milk. with desirable characteristics. They
either penalize producers who do not meet the standards
and/or they pay a premium to those producers who exceed the

standards. This type of pricing appears to be an

35
increasingly accepted part of the dairy industry with about
50 percent of all milk marketed now subject to multiple
component pricing (Covington, p.1091).

Multiple component pricing may give the dairy
subsector a more accurate market signal and improve the
matching of supply with demand. Some argue that MCP will
provide a market signal to dairymen and that they will
change their breeding and management practices (Alexander
and Novakovic, p.1112: Zurborg, p.4). Also, MCP systems
may indicate what. processors as well as consumers are
willing to pay (Harrington, p.14). An MCP system will
give processors a better signal if the system improves the
relationship between raw milk and the yields of
manufactured dairy products (OMMB, p.28).

The adoption of an MCP system will affect most
dairy subsector participants. Most MCP systems have been
instituted and supported by cooperatives. Some producers,
especially those who follow good management practices, will
benefit from an MCP system. The profitability of those who
follow poor management practices will probably be reduced.
MCP could alter management and breeding practices due to
the changed market signal. MCP could eventually lead to
production of more protein and SNF in the entire
subsector. MCP systems will be close to a zero sum game
for dairymen unless the increased nutritional value of milk

leads to an increase in demand for dairy products. If this

36
happens the majority of dairymen will benefit.

The greatest impact of MCP systems will be felt
by manufacturers and fluid milk processors. Manufacturers
could pay more for high protein or SNF milk and pay less
for low protein or SNF milk. Again, the profitability of
the manufacturing industry as a whole does not appear to be
dramatically affected by MCP systems, the increased cost of
high protein or SNF milk will be offset by its capacity to
yield more manufactured product. However, there is the
potential for significant impacts on the fluid market.

3.2.4 Impacts on the
Fluid Market

The single biggest problem with MCP systems is
the possible disruption of the fluid milk market. MCP
systems could raise the price for fluid milk handlers.
Unlike cheese manufacturers, fluid milk processors may not
receive any benefit from a greater protein or SNF content.
However, fluid milk plants that compete with manufacturing
plants which have an MCP system for raw product will be
under pressure to include some type of MCP system. If
fluid plants do not utilize an MCP system they may lose
some of their source of product (Graf 1984B, p.773). MCP
has the potential to drive Grade A milk from fluid to
manufacturing uses if the incentive is great enough
(Christensen, p.10).

Perhaps a more fundamental issue is the potential

impact an MCP system would have on the quality of fluid

37
milk. The current FDA and California standards for fluid

products are shown in Table 7.

Table 7: EXISTING STANDARDS FOR FLUID MILK

FDA Standards California Standards
BEEEQIIQL §NE BBLLQIIQL SHE
(percent)
mm
Whole Milk 3.25 8.25 3.5a 8.7b
LOWfat Milk 0.5 - 2.0 8.25 1.9 - 2.1 10.0
Skin Milk (0.5 8.25 50.25 9.0

a - allowed to equal 3.4 provided total solids are 12.2
b - allowed to equal 8.6 provided total solids are 12.2

(Source: USDA, ERS 1984A, p.2)

The FDA standards are less than the average for raw milk
from the farm. In its raw state, milk contains on the
average, 3.7 percent butterfat, 3.3 percent protein, 87.6
percent water, with the rest made up of other solids - not
-fat besides protein. Total SNF levels, on the average,
comprise 8.7 percent of milk (USDA, ERS 1984A, p.1). The
California standards are included because some believe that
they should become the FDA standards.

It may be difficult for fluid handlers to meet
the FDA requirements if high SNF milk goes to manufacturing
uses. If the incentives are great enough, milk with a high

SNF content or milk high in protein and with low somatic

38

cell and bacteria counts will go to manufacturing uses and
poor quality milk will go to the fluid market. This would
most likely lead to a reduction in the demand for fluid
milk and an eventual reduction in fluid handler income,
which would eventually adversely affect the incomes of
dairymen. There is the potential for underutilization of
fluid processing plant and a reduction in coordination of
the entire subsector if the issue of how fluid handlers
should be treated is not addressed.

There are several ways to deal with fluid
handler concerns. One way is through the negotiation of
Class I premiums. Class I milk is milk that is used in the
fluid market. The Class I premium reflects the additional
costs of meeting Grade A requirements, the cost of
transporting milk for fluid consumption, the cost of
producing milk in the market, and the supply and demand
conditions for milk including the cost of alternative
supplies (USDA, AMS 1981, p.25). This is the. plan
currently advocated by the National Milk Producers
Federation (NMPF) (Graf 1984B, p.773). If the Class I
differential is great enough then the needs of the fluid
market will always be met first.

Another alternative is to use the money from
overall plant profits and using them to fund an MCP system
(Graf 1984B, p.773). For example, this would be possible

for a vertically integrated cooperative that operated

39
fluid and manufacturing plants. However, the method most
often discussed in handling this potential disparity
between fluid and manufacturing processors is by raising
the SNF standard for fluid milk.

A study by the Ontario Milk Marketing Board
(OMMB) states that the most equitable system would be to
standardize the SNF of fluid milk through fortification if
necessary (OMMB, p.21). Ultrafiltration can be used for
this purpose (Poulsen, p.814). Standardization would
ensure that fluid handlers and manufacturers would utilize
the same raw product. Fluid handlers would be able to pass
the cost of fortification on to consumers.

However, there are some aspects of
standardization that may adversely affect fluid handlers.
The profitability of some fluid handlers may decline if
the market they operate in is competitive or if they cannot
pass all of the increased cost of standardization on to
consumers. In the period from 1969 - 1981, the percentage
of fortified lowfat skim milk sold in Federal Milk Order
markets fell from 76 to 20 percent (Boynton, p.11).
Consumers are moving away from fortified products. Some
argue that consumption would drop and prices would rise if
the standards for fluid milk were increased.

Others argue that raising the fluid milk
standards would increase consumption. Raising the

standards would increase the uniformity of the product and

4O

improve its taste. Furthermore, it would improve the
nutritional value of milk (Zurborg, pp.7—8). It is felt
that these attributes will make milk more popular among
consumers, which would increase demand, and that their
welfare, along with the welfare of processors and
producers, will improve if standards are raised.
3.2.5 Breadth of the Program

An issue that affects coordination and makes
instituting an MCP system more difficult is how large an
area the system should cover. Some favor a national
program (Hoard's Dairyman 1983, p.1420). In order to have
such a national system several things would have to occur.
The most important condition that must be met is that the
program would have to be acceptable to all regions of the
country. As part of this system, uniform price
relationships will have to be determined. However, a
national program may not be needed. Many MCP systems have
evolved on their own, and could be incorporated into the
Federal Milk Marketing Order system.

It has also been argued that if the Federal Milk
Marketing Orders were amended for MCP systems they would
become more standardized and consistency would be improved
(NMPF, p.1). All milk in the market would be treated the
same. The USDA has recently recommended that a protein
program become part of the Great Basin and Lake Mead

Marketing Order. This is the first instance of an MCP

41
system becoming part of a Milk Marketing Order. A major
reason for this recommendation is that uniformity among
processors both in, and near, the Order area would be
improved (USDA, AMS 1987, p.26). Uniformity of MCP systems
within a market area would probably promote stability.
However, it may not be necessary to amend the Federal
Orders in all areas to achieve this.
3.3 Supply Management

3.3.1 Background

At the current price levels, there appears to be
a tendency for overproduction in the dairy subsector.
Table 8 shows net ‘USDA removals of dairy’ products in

selected years.

Table 8: NET USDA REMOVAL OF DAIRY PRODUCTS

Year

 

1960 1965 1970 1975 1980 1983 1985 1986*

Net Removals 3.1 5.7 5.8 2.0 8.8 16.8 13.2 10.6
(billion

pounds)
(* = estimated)

(Source: Fallert, Miller and Sleight p.40: USDA, ERS 1987B
P-23)

Table 8 shows that there has been a surplus of dairy
products in the recent past and the problem has gotten
worse over time. The fact that there was a reduction in

USDA purchases in 1986 was due to the effects of the Dairy

42

Termination Program (DTP), which was an attempt by the
government to curb surpluses. Macro coordination (the
matching of aggregate supply and demand) could be improved
given this situation. In order to eliminate
overproduction, while at the same time keeping prices at
the same level, supply management programs have been
introduced.

In the U.S., supply management has tended to be
administered by cooperatives, although there has been a
history of state programs. Cooperatives have used either
quotas, base - excess plans, or Class I plans to manage the
supply of their members's production. Although supply
management programs vary in structure, their basic purpose
is to determine a producer's market share by setting a
limit on how much he can produce or market (Secretary of
Agriculture, p.22).

3.3.2 Impacts on Coordination

Direct supply management would improve vertical
coordination for a number of reasons. Supply management
would reduce uncertainty and make investment and
disinvestment decisions in plant and equipment easier. It
may’ place an. emphasis on cost reduction and therefore
improve technical efficiency at the farm level. However,
it may also fix production patterns (Nott and Hamm, p.1),
and make some technical efficiencies which would be gained

from economies of size impossible to obtain. However, the

43
most fundamental way supply control would improve
coordination is that it would eliminate surpluses at price
levels that society apparently feels are equitable or at
least politically feasible.

As previously stated, if cooperatives could
manage supply, surpluses could be reduced or eliminated.
This would be evidence of enhanced macro coordination.
Perhaps cooperatives can reduce the incentive to
overproduce through levies or other penalties for
overproduction.

3.3.3 Types of Programs

Many supply management programs use some type of
quota or allocation system. A milk quota or allocation
places a limit on the amount of product a dairyman can
bring to market during a certain period of time (Secretary
of Agriculture, p.22). Any milk a dairyman markets in
excess of his quota or allotment receives a lower price.
An extremely difficult task however, is assigning the
amount of milk that each producer is allowed to market.

Another supply management system is the base-
excess plan. In the past, base - excess plans have been
used to manage seasonal or intrayear supply fluctuations.
The first base - excess plan was established in 1918 by the
Maryland State Dairyman's Association. This type of
program was adopted by several other cooperatives during

the 1910s and 19208 (Metzger, p.64) although they have been

44
used more recently as well.

Under a base - excess plan, a producer
establishes a base during the low production months, or
during the time of year when fluid demand and output are
approximately equal. During the high production months a
producer is paid one price for output equal to his base and
a lower price for milk in excess of his base (USDA, AMS
1981, p.29). This plan would encourage producers to
increase output during the fall and winter, and may
discourage increased output in the spring and summer.

Several conditions must be met in order for a
base - excess plan to be successful. In order to control
production, a base - excess plan must limit entry of new
producers, limit base transfers, and limit revisions of
bases. Also, the price for excess milk must be below the
marginal cost of producing it (Lough and Fallert, p.6) .
There are very few recent examples of base - excess plans
administered by cooperatives. Most base - excess programs
are incorporated into the various Federal Milk Marketing
Orders.

Another type of seasonal supply management
program which is part of some Federal Orders are
"Louisville plans". This type of supply management program
withholds money due producers in the flush production
period and pays the producers back in the short period

(USDA, AMS 1981, p.29). This creates an incentive for a

45

producer to increase production in the short period as
compared to the flush season.

Another type of supply management program is
Class I plans. This type of program attempts to tailor
production to meet the demand for fluid milk. A producer
is given a share of the fluid market. This becomes the
producer's Class I base. All the milk he produces up to
this amount usually receives the Class I price. All
production in excess of his Class I share receives a lower
price, usually the Class III price. Class I plans are very
similar to base - excess plans, the difference being that
Class I plans attempt to curb chronic surpluses whereas
base - excess plans are focused more on seasonal surpluses.

Establishing Class I plans for Federal Milk
Marketing Orders was part of the 1965 farm” bill. The
programs were popular in some areas in the late 19603 and
early 1970s, but interest. has waned since then. The
authorization for Class I plans was discontinued in the
1981 farm bill (Kaiser, p.2).

3.3.4 Basic Supply Management
Considerations

There are several conditions that must be met in
order for a supply management program to be effective.
Estimates of supply and demand must be accurate for both
present and future time periods. This is needed in order
to ensure that supply and demand are, and will be, well

matched. Another necessary condition is that entry must be

46
limited: if this is not the case, new entrants will come
into the market. This will eventually increase supplies
and put downward pressure on prices.

Another important aspect of any supply management
program that is effective is that producers cannot have any
incentive to produce more than they are allowed. If the
system is constructed in such a way that the marginal
revenue of producing an extra hundredweight of milk above
the allotment is greater than the marginal cost of
producing that extra hundredweight then the system may
break up. If there is not sufficient incentive for
producers to stay within their allotments, output will not
be curbed, and downward price pressure will result. The
legal entity that administers the program, whether or not
it is a cooperative, must have the power to limit entry and
to eliminate the incentive to overproduce. Finally, legal
authority may have to be established which allows output to
be controlled and monitored. It appears that the dairy
subsector either meets or can meet these criteria.

Most. of the :milk. produced in the ‘U.S. flows
through cooperatives. Cooperatives may be in a position to
manage the supply of their members's milk. Cooperatives
are in almost daily contact with their members and are in a
position to measure output. Also, due to the fact that
most cooperatives write member checks and market their

membership's milk, they are in a position to penalize those

47
producers who may be responsible for the surplus.
Furthermore, in some markets, a single cooperative has
almost complete control over the market. This would make a
supply management program easier to maintain and enforce.
These factors make cooperatives potential administrators
of supply management programs.

There are two types of supply management programs
that need to be considered: seasonal, intrayear supply
management, which attempts to mitigate seasonal
fluctuations in supply; and interyear supply management,
which attempts to eliminate chronic surpluses. Seasonal
supply fluctuations may be controlled through a seasonal or
monthly allotment for each producer. Many programs have
some type of seasonal supply management mechanism. If
these programs are effective then chronic problems are
less likely to develop.

3.3.5 Further Considerations

There are several issues involved with quota,
base - excess, and Class I programs. If entry is blocked,
the quota or base will likely acquire value. The value of
quota or base will change' for' a number' of‘ :reasons.
Changes in the price of milk will affect quota or base
values, as will changes in the supply or demand of quota or
base (Hubbard, p.7). If these values get too high it may
be a signal for the agency administering the program to

increase the amount of quota or base. However,

48
technological advances and the effect they have on the
costs of producing milk probably will have the greatest
impact on the value of quota or base (Hubbard, p.9). Also,
other input cost changes, especially changes in the price
of feed, will affect the profitability of dairy farming and
will affect quota or base values.

Once a quota program or base - excess plan is
instituted, it could be difficult to eliminate because of
the values that quota or base will likely acquire and the
lost wealth the holders of the bases would face if the
program was eliminated (Lough and Fallert, p.15).
Furthermore, these programs may be difficult to eliminate
even if the quotas or bases are not transferable. The
wealth of those currently engaged in dairy farming would
increase through higher land, cows, and ‘other input
values. The profitability of dairy farming would be
capitalized through the value of farmer owned inputs.

There are also structural matters involving these
programs that need to be analyzed because they probably
affect vertical coordination. Most of these programs are
very similar but they are not identical. An important
matter is the price of excess or overquota milk. How this
price is determined by cooperatives, and whether or not it
provides sufficient incentive to curb production is a
critical issue in determining how effective a program is

in improving macro coordination. Another issue is what

49
type of allotment is used and how well the program matches
supply with demand.

Another important consideration is whether or not
there is a "use it or lose it" aspect. of ‘the supply
management program. This ensures that quotas or bases are
used and not owned purely for speculative purposes. If
producers are forced to utilize the quota or base then the
market will be assured of a constant supply, there will be
no shortfall in production. If the quota is not used, it
may lead to market disruptions. A related issue is the
methods used to transfer quotas or bases. If quotas or
bases are nontransferable, the structure of dairy farming
may become fixed. Technical efficiency may be constrained
if quotas or bases are not easily transferred. How these
are transferred may affect the progressiveness and resource
structure of dairy farming.

3.4 Seasonal Balancing and Marketwide Information
3.4.1 Theoretical Considerations

Some aspects of marketwide services have been
discussed in Chapter 2. This section will focus its
attention on the marketwide services of seasonal balancing
and. marketwide information. There are two aspects of
seasonal balancing and marketwide information that make it
difficult for cooperatives to receive payment for providing
these services. Once a cooperative provides these services,

it is usually prohibitively expensive for the cooperative

50

to keep others from using or benefitting from them. They
are high exclusion cost services (Schmid, pp. 43-44). This
is especially true for seasonal balancing. It is somewhat
easier to block others from using individual types of
information such as annual reports or member publications.
Another aspect of these services is that they are joint-
impact goods (Schmid, p.70). The additional cost of
providing the service to another user is zero. This is
true for seasonal balancing and many types of information
services. .

Another problem is establishing costs. It is
difficult to determine the costs of some services and to
identify payment for services from milk price quotations
(Carley et al., p.2). This leads to problems between the
cooperative and other subsector participants which could
adversely affect vertical coordination.

The fact that it is expensive to exclude others
from utilizing these services leads to the problem of the
free rider: those who benefit from the service but do not
bear any of the cost of providing the service. There are
three types of free riders. The first is the individual
producer who does not belong to the cooperative. He
benefits from the stability the cooperative provides
through its marketwide services without bearing the cost.
The second is the limited service cooperative, which does

not pay for the service but benefits from the fact that

51

another cooperative does provide the service. An example
of this is a limited service cooperative which does not
operate manufacturing facilities because another
cooperative operates manufacturing plants to balance
supplies. The third type of free rider is the processors
and handlers who do not pay for the service. An example
of this would be proprietary firms that avail themselves
to some of the marketwide information services provided by
the cooperative without paying for them.

Vertical coordination may be improved if the cost
of these services was shared by the beneficiaries.
Apparently cooperatives will not expand these services if
they have to bear the entire cost (Graf 1977B, p.9). The
existence of the free rider may adversely affect vertical
coordination.

3.4.2 Seasonal Balancing

Production of milk is highest in the spring
whereas the demand for dairy products is strongest in the
fall and winter. This fact leads to surpluses and
shortages. In the spring, the surpluses become reserve
supplies which are disposed of in manufacturing plants. In
the fall, these reserves are used for Class I use (NMPF
1986, p.I-l). In high Class I utilization markets seasonal
balancing entails obtaining milk from other areas in the
short season and finding outside :markets for ‘temporary

surpluses. Seasonal balancing in these markets basically

52
entails transporting milk from surplus areas in the fall
and winter and transporting milk to areas with excess
processing capacity in other times of the year (Jesse and
Johnson 1985, p.11). The major cost borne by the
cooperative is the cost of transporting milk.

In low Class I utilization markets seasonal
balancing costs are usually highest in the fall and winter
because manufacturing plants are underutilized. The per
unit plant cost is highest during this time of year (Jesse
and Johnson 1985, p.11). Cooperatives are often involved
in managing manufacturing plants and transportation and
therefore bear much of the cost of balancing supplies.
Most of the costs involved with balancing seasonal supplies
are a result of the costs of transportation or managing
manufacturing plants (Ling 1985, p.1).

Cooperatives that undertake seasonal balancing
activities save processors and handlers the trouble of
finding markets themselves. In the southern region of
Associated Milk Producers, Inc.'s market area it was
estimated that centralizing supplies reduced needed reserve
supplies by 25 percent (Keltke and Blakley, p.20). This
reduces uncertainty and improves the flow of product within
a market. It frees up resources that would have been used
for balancing to be employed in other ways.

If an organization, such as a cooperative, did

not balance supplies the market would become unstable.

53

Prices would rise in the short period and fall during the
flush period. Seasonal balancing does not increase or
decrease prices and incomes throughout a year: instead it
reduces price variance within a year. The cooperative's
membership, as well as other subsector participants,
benefit from this reduced price variance and market
stability which is the major reason why it is willing to
perform seasonal balancing activities.

If a cooperative is balancing seasonal supplies,
it usually must be vertically integrated into processing
and manufacturing. This is particularly true in low Class
I utilization areas such as the Upper Midwest. An
alternative is to contract with processors to handle these
surpluses but this does not appear to have occurred. In
order for a cooperative to qualify for payment for its
balancing activities it should probably be vertically
integrated.

In order to determine the costs of balancing
seasonal supplies three things must be considered. The
first is to determine the amount of reserves needed for the
fluid market, excess reserves (output beyond that needed
for Class I use in the short season) should not be
considered. The second thing needed is the costs of
balancing reserves, which naturally vary from month to
month (Ling 1985, p.16). The cost of balancing could be

estimated either through engineering or actual cost data

54
(NMPF 1986, p.4). The final thing needed is to calculate
the value of the reserve balancing pool so it can be
deducted from the marketwide producer pool and credited to
the cooperative that undertakes the balancing service
(Ling 1985, p.16).

For example, assume that there is a market where
on average, daily production exceeds daily fluid demand by
6.05 million pounds. Furthermore, assume that there exists
two butter - powder plants that each have a daily capacity
of 3.025 million pounds that balance the market. Assume
each plant has the same cost structure, the same seasonal
fluctuations, and they split the market evenly between each
other. The total annual necessary reserves (that amount
needed to ensure that the fluid market's needs are met in
the short season) is assumed to be 4,202,390 hundredweight.
Furthermore, it is assumed that necessary reserves are at a
maximum of 1.854 million pounds per day in June and are at
a minimum of .52 million pounds per day in November (Ling
1985, p.4).

The cost structure of such a plant could look

like that in Table 9.

55

Table 9: ASSUMED ESTIMATED ANNUAL FIXED AND OVERHEAD
COSTS FOR.A BUTTER - POWDER PLANT WITH A DAILY CAPACITY
OF 3.025 MILLION POUNDS OF MILK ASSUMING AN 11
PERCENT INTEREST RATE

Assumed Present ' Assumed Annual

Item 17311.19 £281;
(Dollars)

Land 126,170 13,879
Building 5,046,800 555,148
Machinery and
Equipment 8,831,900 971,509
Automobiles and
Fixtures 252,240 27,757
Taxes , Licenses ,
Administration,
Insurance, etc. 757,920

Total Annual Fixed and Overhead Cost 2,325,313

(Source: Ling 1985, p.6)

These are the fixed and overhead expenses borne by an
organization such as a cooperative which operates a butter-
powder plant. They are only an example used for
explanation and should not be thought of as representing
any of the case study cooperatives analyzed later. If this
cooperative does not operate at full capacity because it
gives up milk to ensure that the fluid market's needs are
met, these fixed costs may not be fully covered. Table 10
shows the assumed fixed and overhead costs borne by this

plant for balancing the seasonal reserves of a market.

56

Table 10: ASSUMED ANNUAL FIXED AND OVERHEAD COSTS OF
BALANCING THE FLUID RESERVES OF THE MARKET

 

Undercapacity Caused Fixed and
Manta by Necessary Reserves Overhead Costs
(Million lbs.) (Dollars)
Jan. 15.128 31,860
Feb. 12.096 25,474
March 7.874 16,583
April 1.680 3,538
may 1.364 2,873
June 0 0
July 6.603 13,906
Aug. 10.850 22,850
Sept. 16.500 34,749
Oct. 18.941 39,890
NOV. 20.010 42,142
D39. 17.205 36.2;_
Total 128.251 270,089

(Source: Ling 1985, p.6)

57

The cost of balancing is zero in June because the
plant is operating at full capacity. The cost of balancing
is highest in November' because that is the ‘month the
organization must give up the most milk to meet fluid
needs. The total cost of 270,099 dollars is the total
fixed and overhead costs that are not covered because the
plant is operating at less than full capacity (Ling 1985,
pp. 4,6), because it surrendered milk to meet the fluid
market. Again, this is only an example. These are the
types of costs borne by cooperatives when they undertake
seasonal balancing activities in low Class I utilization
markets. It is these costs that have also led to payment
issues involving cooperatives and this marketwide service.

If cooperatives are unable to recoup the costs of
balancing, the performance of the cooperative . along with
the quality of the service may decline. Member producers
will have to subsidize nonmembers who may be the source of
part of the supply fluctuations. Member producers may also
subsidize processors and fluid handlers whose demands vary
seasonally but do not pay for the cooperative's balancing
activities (Ling 1982, p.18). If these are chronic
problems, the cooperative's financial strength will decline
(Ling 1982, p.18) and producers may leave the cooperative.

Producers who do not belong to the cooperative
providing the service, limited service cooperatives, and

proprietary firms benefit from seasonal balancing but they

58
may not have to pay for it. They are free riders.
Government intervention may be needed to insure that
cooperatives do not bear a disproportionate share of the
cost (Strain et a1. p.xi).
3.4.3 Marketwide Information

Another service cooperatives provide that benefit
other subsector participants is :marketwide information.
Information is data that is processed, organized, or
interpreted in such a way as to improve decisionmaking
(Bonnen, p.7). The demand for information is derived from
its value in reducing uncertainty faced by decisionmakers
(Bonnen, p.7). Those who use information will tend to
underinvest in obtaining it: the value of information ex
ante is unknown. It is only after the information has been
utilized that its value to the decisionmaker becomes known
(Bonnen, p.8).

Despite the propensity for ‘underinvestment in
information, some feel that it is one of the most valuable
of all marketwide services. The NMPF believes that well
informed producers will make better decisions (NMPF 1986,
p.6). Participating in Federal Order hearings has also
been singled out as an important task cooperatives
undertake (Graf 1977B, p.2). A survey showed that
marketing and outlook information was also considered to be
a relatively important service that cooperatives provided

(Babb, p.12).

59

Marketwide information improves coordination in a
number of ways. Reduced uncertainty adds stability to the
subsector at all levels. Furthermore, participation in
Federal Order hearings leads to improved macro
coordination. Information flows between a cooperative and
its membership leads to good relations and sound micro-
micro coordination. Also, information flows through market
analysis improves micro coordination.

There are several types of information that
cooperatives provide. Virtually every dairy cooperative
issues an annual report which contains a message from the
President and General Manager, along with a discussion of
the past year's events in addition to the various financial
statements. Many cooperatives also print publications such
as magazines. The annual reports and other publications
tend to be focused more on the cooperative's membership.
There are other information services that are wider in
scope.

Cooperatives analyze milk marketing problems and
conduct market research. They also collect data pertaining
to prices and marketing conditions and process this data
into information. Data are the product of measurement or
counting that represent concepts, quantities or actions.
Information is data that is processed in a way that
enhances the decisionmaking abilities of a particular

subsector participant (Bonnen, p.7). They also determine

60

and propose amendments to the Federal Orders as well as
participate in meetings involving the Orders. They also
conduct education programs for members and nonmembers (NMPF
1986, pp.V-2,3). Cooperative management also serves as
sources of expert information for the media, such as
magazines, newspapers and radio. These information
services tend to be high exclusion cost, joint - impact
services which makes it difficult for a cooperative to
recoup the costs of providing them.

3.4.4 Payment Issues

Cooperatives, in an attempt to offset some of the
costs of providing these services, have negotiated over-
order premiums. Milk Marketing Orders establish the
minimum price that handlers must pay producers for Grade A
milk (USDA, ERS 1984B, p.1). Cooperatives may negotiate
prices higher than the Order minimums. These are known as
over - order premiums.

Public authority has also been used to help
cooperatives recover some of the cost of providing these
services. The AMAA has been amended to allow those who
perform seasonal balancing activities to be paid from
Federal Order Pool Funds (NMPF 1986, p.I-2). Currently,
there are several methods for determining seasonal reserves
and for paying cooperatives for performing this service.
Charges for balancing seasonal reserves should be used by

the cooperative to offset the costs of transportation and

61
manufacturing (Ling 1982, p.15). Good performance is
guaranteed if charges are based on efficient utilization of
inputs (Ling 1985, p.21).

The situation for information is much the same as
that for balancing. The payment should be based on the
cost of providing the service. If the cooperative is not
adequately compensated then performance will decline.

Public authority has also been used to help
cooperatives offset some of the costs of providing
marketwide information. The New York - New Jersey Federal
Milk Order allows cooperatives to be compensated for this
service (NMPF 1986, p.V-3). The Order explicitly specifies
the activities) a cooperative must. perform in order to
receive compensation (Market Administrator, p.23).
Currently, cooperatives that qualify for payment receive 3
cents a hundredweight for providing this service which does
not cover the full cost of the service.

3.5 The Role of Marketing Orders

The previous sections have outlined three
coordination activities that cooperatives pursue. A
common issue in each of these activities is the potential
need for government involvement through changes in the Milk
Marketing Orders. Cooperatives may not have the power to
affect these changes on their own. Other forces, such as
free riders, may' disrupt the Icooperative's attempts to

improve vertical coordination through multiple component

62
pricing, supply management, seasonal balancing, marketwide
information, as well as other activities.

Milk Marketing Orders and dairy cooperatives tend
to go hand in hand. Cooperatives are usually the force
behind the creation of Marketing Orders, and are often the
force behind amending Marketing Orders. Many cooperatives
operate in several Market Order regions and therefore
affect several Marketing Orders. Through amendments, the
Orders may be a tool cooperatives can use to affect
vertical coordination.

The Orders can be amended to include MCP systems,
various types of supply management programs, and payments
for marketwide services. In the case of marketwide
services this has already happened in some cases. Adoption
of an MCP system within a given area could improve
uniformity and enhance stability. All subsector
participants would be treated the same. If a supply
management program were made part of the Federal Order, or
part of a national dairy policy, then cooperative control
over a market would be improved which would make it easier
for a cooperative to institute a supply management program
which would effectively eliminate surpluses. If
cooperatives are to effectively enhance vertical
coordination through any of these activities, the Federal

Milk Marketing Orders may have to be changed.

63
3.6 Summary

The first three chapters have outlined some
vertical coordination issues facing' dairy cooperatives.
Cooperatives are important subsector participants. Some of
the problems that make vertical coordination in the dairy
subsector difficult have also been discussed. The second
chapter outlined a basic taxonomy of coordination issues
and activities that dairy cooperatives are involved with at
the various levels of vertical coordination. The focus of
this chapter has been a statement of the hypotheses, as
well as a development of a conceptual framework of
cooperatives in regards to three coordinating activities
they undertake.

The research will attempt to determine whether or
not the evidence supports the hypotheses. If hypothesis I
holds, then vertical coordination is enhanced by the price
signal MCP systems administered by cooperatives relay to
producers and other subsector participants. The altered
price signal will more closely reflect current demand
conditions. If hypothesis II holds, then perhaps
cooperatives can match aggregate supply and demand in a
market via supply management programs. This would enhance
macro coordination and affect micro - micro coordination.
If 'the evidence supports hypothesis III, ‘then ‘vertical
coordination is likely enhanced at all levels through the

marketwide services of seasonal balancing and marketwide

information.

64

CHAPTER 4: RESEARCH METHODS AND CASE STUDIES

4.1 Methods

Each of the hypotheses will be tested by
analyzing case studies. Case studies are useful in
analyzing whether or not cooperatives can improve vertical
coordination through MCP systems, supply management
programs, and the marketwide services of seasonal balancing
and marketwide information. This will give insight into
some of the problems cooperatives have with the different
activities.

Case studies provide evidence of whether or not
the hypotheses outlined in Chapter 3 hold. Other research
methods would be less effective in testing these particular
hypotheses. case studies enable a researcher to study an
issue in greater depth than other research methods. Case
studies using interviews 'with relevant. personnel add. a
richness to the analysis that other research methods lack
and allow a researcher to study the relationships between
market participants in greater detail. A disadvantage of
case studies is that one's ability to generalize is
limited. Nonetheless, the best way to determine the
impact cooperatives have on coordination via MCP, supply
management, and the marketwide services discussed in

65

66
Chapter 3 is by studying those cooperatives that actually
undertake these activities. This provides evidence that
supports or rejects the hypotheses.

The case study cooperatives were selected after
careful consideration. Officials at the Agricultural
Cooperative Service (ACS) were contacted in order to
discuss potential case studies. These discussions also
helped the researcher identify relevant personnel. Most
case study cooperatives were selected after an extensive
review of the literature.

A wide range of personnel were interviewed in
gathering' the data and information needed to test the
hypotheses. The researcher personally identified and
interviewed the relevant personnel. Many of the interviews
included the cooperative's General Manager. Additionally,
some interviews included those involved with milk sales and
milk procurement, as well as several Vice Presidents, and
staff economists. Some interviews were also conducted with
Directors of Member Services and those involved with
planning and technical services. A wide range of personnel
with a wide range of experiences were utilized in this
research. I

4.2 Selection of Individual Case Studies
4.2.1 MCP Case Studies

The case studies were selected for several

reasons. Each of the three MCP case studies use premiums

67

or deductions for milk testing above or below a certain SNF
or protein level. Two cooperatives have SNF systems: the
other has a protein system. Also, each of the case studies
have quality standards on somatic cell counts, bacteria
counts, or both. These case studies are typical of the
vast. majority' of‘ MCP systems that are administered by
cooperatives. They constitute a representative sample.

The case study MCP systems all operate in the
Great lakes region. It is this part of the country that
has been the most affected by MCP systems. The Great Lakes
region provided the widest range of possible case studies.
It may also give insight into the future direction of the
dairy subsector in regards to MCP systems.

Two of these cooperatives operate in highly
competitive markets with a very low Class I utilization.
Micro - micro coordination considerations are particularly
important in these cases. The other cooperative is the
largest in its market and the market has a higher Class I
utilization. MCP systems affect coordination at the
micro - micro, micro, and macro levels in a number of ways.
Chapter 5 analyzes the case studies to determine whether or
not the evidence supports hypothesis I.

4.2.2 Supply Management Case
Studies

There are very few recent examples of
cooperatively administered supply management programs. The

Class I base program discussed in Chapter 6 is the best

68
known example of this type of program. This program, which
was used by a cooperative in the Southwest, was eliminated
10 years ago. It is one of the few attempts to eliminate
chronic surpluses in an area east of the Rockies. Micro—
micro coordination is of particular importance in this
case, especially as it also affected macro coordination.

The allocation program also outlined in Chapter
6 is unique. The cooperative that administers this program
is based in the Northwest. It is the largest cooperative
in this geographically isolated area. This program, which
was initiated in 1987, is a very recent example of a supply
management program. An interesting aspect of this program
is its flexibility which affects micro - micro and macro
coordination.

The seasonal supply management program was also
one of the few administered by a cooperative in existence.
Most seasonal supply management programs are part of the
Federal Orders. This was not the case for this cooperative
which operates in the Northeast. This program was also
flexible, and was eliminated after the DTP tightened
supplies in this market. This program also affected
micro - micro and macro coordination.

These case studies cover the range of supply
management programs both past and present. They contain
much of the population that could have possibly been

selected. There are very few recent examples of supply

69
management programs that are, or were, administered by
cooperatives. Chapter 6 analyzes these supply management
case studies in order to determine whether or not the
evidence supports hypothesis II.

4.2.3 Marketwide Services Case
Studies

The case studies used to analyze marketwide
services are also representative. They cover several parts
of the country and they utilize several different methods
in an attempt to recover the costs of providing marketwide
information and seasonal balancing. Two of these
cooperatives belong to cooperative federations. Some have
also attempted, or are currently attempting, to amend the
Federal Orders in order to recoup some of the costs of
providing these services. One cooperative is compensated
through the Federal Order for providing the marketwide
service of seasonal balancing and marketwide information.

One cooperative operates in a high Class I
utilization area. Transportation is a somewhat more
important seasonal balancing activity than operating
manufacturing plants. Another cooperative also transports
milk as a balancing activity. The other cooperatives do
not transport milk to balance supplies. The primary
mechanism. they use to balance seasonal supplies is
operating manufacturing plants.

All of the case study cooperatives provide a wide

range of marketwide information services. These services

70
benefit many subsector participants. The four cooperatives
chosen provide a good sample of cooperatives that
undertake these services.

Marketwide services affect coordination at the
micro - micro, micro, and macro levels. The issue of the
free rider is particularly important in dealing with
marketwide services. As a general rule, these cooperatives
are placed at a competitive disadvantage because they
perform the marketwide services of seasonal balancing and
marketwide information. This also leads to effects on
coordination. Chapter 7 analyzes each of the case study
cooperatives to determine whether or not the evidence
supports hypothesis III.

The number of cooperatives that pursue these
activities is becoming increasingly small. Dairy
cooperatives, like much of the rest of the economy, are
becoming increasingly concentrated. All of the case study
cooperatives are amongst the 25 largest in the country
(USDA, ACS, p.9). This group of 25 handled more that half
the milk produced, and their membership includes more than
half of the dairy farmers in the U.S. (USDA, ACS, p.9).
Cooperatives are becoming larger and more regional in
nature. Market areas are also becoming larger. The case
study cooperatives reflect these facts.

As a general rule, there are two reasons for

selecting each of these case study cooperatives. The first

71
is that many of the programs have been in existence for a
number of years. There is an historical base to draw upon.
Secondly, most of the cooperatives chosen are leaders in
their particular markets, and studying them may give
insight into the future direction of the dairy subsector.
4.3 Data Collection Techniques

The questions used to gather the data were
complete. Originally, a large questionnaire was developed
and analyzed. From this questionnaire some questions were
dropped and others were combined in order to make the
interview manageable. These questionnaires were analyzed
by researchers at Michigan State University, and were also
checked for completeness by those actually interviewed. It
was felt by all those interviewed that the questionnaires
covered the major issues.

Each questionnaire followed the same pattern.
The general questions served as a check to make sure that
the cooperative's current operating procedures matched
those found in the literature review. This allowed the
researcher to update current cooperative practices and
provided more factual information. Each interview then
addressed micro - micro, micro (in the MCP and marketwide
services case studies), and macro coordination issues in
turn. These short, outline questionnaires are found in the
appendix.

The researcher followed the questionnaires

72

closely. This ensured uniformity of responses and research
results. It also ensured consistency between case studies.
However, the interview process did allow for some
flexibility. In some instances follow up questions were
asked in order to obtain greater background information
concerning individual case study cooperative practices and
issues.

In order to ensure the objectivity of the
responses of those interviewed anonymity had to be insured.
This allowed those interviewed the freedom to be completely
honest and ferthcoming in their responses without fearing
any repercussions from others in the subsector. Those
interviewed represented a wide background and each was an
expert in the issues that were addressed. They represented
a good cross section of the cooperative leadership in the
dairy subsector. Their views accurately reflect the
current state of affairs concerning dairy cooperatives and
the vertical coordination of the subsector.

Table 11 lists the number of persons interviewed
by cooperative and coordination issue. Each interview can
be thought of as a data point used to test each of the
hypotheses. While there are not a large number of persons
interviewed there are a sufficient number of degrees of

freedom in each instance for a researcher to be fairly

73
Table 11: NUMBER OF PERSONS INTERVIEWED

Number of Persons

Cooperatiyg Interviewed
Multiple Component 4
Pricing
Cooperative A 2
Cooperative B 2
Cooperative C 1
Total 5
Supply Management
Cooperative D 2
Cooperative E 2
Cooperative F 1
Total 5
Marketwide Services
Cooperative G 2
Cooperative H 1
Cooperative I 4
Cooperative J 1
Total ' 8

GRAND TOTAL 18

74
confident that the results and conclusions are accurate.
This is especially true given the fact that there are few
potential case studies to choose from, and the researcher
closely followed the questionnaires to ensure uniformity.
4.4 Summary

The research method used to collect information
to test the hypotheses is analysis by case study. This
allows a researcher to study a subsector in greater depth
than other methods. Personal interviews with a wide range
of relevant cooperative personnel were used to gather data.
The cooperatives selected reflect a wide range of
experiences.

The case study cooperatives were selected after
an exhaustive literature review and discussion with members
of the ACS. The case study cooperatives ‘were useful
because they provided an historical base to draw upon.
They also tended to be market leaders. They represented a
cross section of the country. The MCP systems and
marketwide service cooperatives represent the typical
experience with these issues. The supply management
cooperatives represent most of the population of
cooperatives which could have been chosen.

Chapters 5, 6, and 7 analyze the case study
cooperatives and their experiences with MCP, supply
management, and the marketwide services of seasonal

balancing and marketwide information. These chapters

75
provide evidence which supports or rejects each of the

hypotheses.

CHAPTER 5: COOPERATIVES, COORDINATION, AND MULTIPLE

COMPONENT PRICING

5.1 Introduction

This chapter analyzes the case study
cooperatives's experiences with MCP systems. This chapter
analyzes the effects of‘ MCP systems at all levels of
coordination. At the micro - micro level, it considers the
educational program the cooperative used for its membership
and what feedback management received from its membership
when the system was instituted. It also discusses whether
or not the system is currently an issue with the
membership, and if any producers left the cooperative as a
result of dissatisfaction with the system. This chapter
also analyzes what changes in dairy farm management
practices, if any, resulted from the system.

Another focus of the research deals with micro
coordination. The response of manufacturers and fluid
handlers to the system, as well as altered operating
procedures resulting from the system are discussed.
Another issue that is analyzed is whether or not
proprietary firms have attempted to obtain other sources of
milk as a result of the system. Another question addressed
in this chapter is whether or not cooperatives are uniquely

76

77
qualified to administer an MCP system or if proprietary
firms can also effectively administer this type of pricing
system.

The critical macro coordination issue addressed
is the fluid market. This chapter analyzes the effects, or
lack thereof, of MCP systems on the fluid market. Another
macro coordination aspect of MCP systems are their effects
on the seasonality of SNF or protein production. Issues,
such as the cooperatives's views on making MCP systems part
of the Marketing Order, and the issue of standardization of
fluid milk are also addressed. Furthermore, the effects of
the quality aspects of these systems are discussed.

This chapter discusses each of the three case
study cooperatives in turn. The background and structure
of each of the systems and their effects on- the various
levels of coordination are analyzed. Research findings are
also included in this chapter.

5.2 Cooperative A
5.2.1 Structure of the MCP System

Cooperative A introduced the quality aspects of
its MCP system before it introduced its protein premium.
In fact, the quality aspects of the system are the dominant
characteristics of the MCP system. This cooperative is
based in Wisconsin and has members in several states. The
majority of the milk produced in this area, particularly

Wisconsin, is covered by some type of MCP system.

78

This program commenced in 1980. At the time, the
premium for milk which had a plate loop bacteria count of
25,000 per milliliter or less and a somatic cell count
level of 250,000 per milliliter or less was 10 cents a
hundredweight. Inf the somatic cell count was 500,000 or
less, then the premium was 5 cents a hundredweight
provided that the bacteria standard was met. These
premiums have slowly changed over time. Today, a producer
can receive a premium for both protein and quality. The
quality program is shown in Table 12. Additionally, a
producer is not allowed to add water or antibiotics, and a
10 cent deduction is added if the plate loop bacteria count
is 300,000 or greater. A producer is paid 10 cents a
hundredweight for each .1 percent of protein above 3.2
percent if his bacteria count is 25,000 or less, and his
somatic cell count is between 400,000 and 301,000. If the
somatic cell count is between 300,000 and 201,000 the
protein premium starts at 3.1 percent, and if the somatic
cell count is 200,000 or less, the protein premium starts

at 3 percent.

Table 12:

30 cents
25 cents
20 cents

15 cents

Deduction

15 cents
20 cents
25 cents

30 cents

79

Premiums

Standard
Plate
Count

15,000
or less

25,000
or less

25,000
or less

25,000
or less

Deductions

Somatic
Cell

C01!!! L's

701,000
to 800,000

801,000
to 900,000

901,000
to 1,000,000

More than
1,000,000

COOPERATIVE A'S PREMIUMS AND STANDARDS

Somatic
Cell

C0111! E

100,000
or less

101,000
to 200,000

201,000
to 300,000

301,000
to 400,000

(Source: Cooperative A's Qual PACK)

80

This is one of the most structured MCP systems in
existence and it puts an emphasis on quality. The protein
aspects of the program are fairly typical. This is an
important case study because of the market this
cooperative operates in: the large Class III utilization in
this market makes component pricing particularly important.
5.2.2 Micro - Micro Coordination

Cooperative A operates in a highly competitive
environment. Its quality and protein standards would not
have been enacted without member support. In fact, when
this program was first enacted in 1980, the cooperative
increased its membership. This program was established
before most others in the market.

This cooperative gave a considerable amount of
feedback to producers through testing for bacteria, somatic
cells, and protein. Producers knew the constitution of
their milk and could have adjusted their management
practices before the premium or deduction programs were put
into effect. This testing continues. Cooperative A has a
good knowledge of the constitution of their membership's
milk and individual producers receive test results which
allows them to discover herd problems and adjust their
management practices.

Producers have changed their management
practices and have reduced the level of bacteria and

somatic cells in their milk. This is particularly true of

81

dairymen whose herds are comprised of Guernsey cows. These
producers are particularly interested in the program
because they benefit the most from the protein premiums.
Due to the fact that the technology does not exist for a
producer to vary protein in the short run, and for the most
part producers grow their own feed, there has not been any
change in management practices to increase the protein
content of milk.

This program was never an issue with producers.
Few, if any, producers left the cooperative as a result of
the program. In fact, producers joined the cooperative as
a result of the program. Evidently, the management of the
cooperative responded to the interest of the membership and
adopted the MCP system. Cooperative A also responded to
the competitive nature of the market and- offered the
system. In this part of the country a cooperative or
proprietary handler needs to have an MCP system in order to
keep its membership or to secure its milk supply. However,
it should also be noted that total premiums paid out to
producers are greater than deductions. In order to
compensate those producers that meet the requirements for
protein and quality, the blend price has been reduced for
all producers.
5.2.3 Micro Coordination

There are few issues with MCP systems in

cooperative A's market. This cooperative feels that

82

manufacturers do not have any real problems with MCP
systems. It should be noted that about 80 percent of the
milk produced in this area goes into manufacturing uses,
and the greater the protein level in milk the more cheese
that can be produced. There is little, if any, reason for
manufacturers to be opposed to these programs. The quality
controls and protein premiums go together. Milk with a
high somatic cell count also has a high protein content,
but that protein is whey, which is not useful in cheese
production. In order to offset this fact, there is a
penalty for producers that have a high somatic cell count
in their milk. It appears that manufacturers have not been
adversely affected by this program.

This apparently cannot be said of fluid handlers.
According to some in this cooperative, the profitability
of fluid handlers has been reduced slightly as a result of
these programs. Unlike manufacturers, fluid handlers do
not receive any direct benefit from these MCP programs.
Furthermore, due to the nature of the market, they are
unable to go to other sources of milk. Due to the high
Class III utilization in this market, and the fact that
manufacturers as well as cooperatives offer these quality
and protein premiums, fluid handlers are not in a position
to find outside sources of milk. They must evidently bear
some of the cost of these MCP systems or they may lose

their source of milk.

83

The operating procedures of manufacturers and
fluid handlers have not changed a great deal as a result of
the program. It has been suggested that manufacturing
plants have become more efficient since the program was put
into effect. However, cooperative A and others may be
directly responsible for this increased efficiency because
it is vertically integrated into most forms of dairy
products and markets them under its own brand. This
increased efficiency of manufacturers and fluid handlers
may be due to changes in plant and equipment as a response
to the competitive nature of the market and not as a result
of the MCP system.

In this market, cooperatives are not the only
organizations that administer MCP systems. There is some
type of MCP system administered by manufacturers as well.
However, some feel that it may be the case that the market
signal to producers is greater with a cooperative system
because cooperatives are more responsive to producer
concerns. It may be the case that the feedback between
cooperative management and producers is stronger than the
feedback between processors and producers. Coordination
via information flows could be superior in the producer-
cooperative case than in the producer - proprietary firm

case .

84
5.2.4 Macro Coordination

The critical issue in macro coordination involves
the fluid market. There is no reason to believe that the
MCP system has caused any disruption of the fluid market.
This is most likely due to the fact that MCP systems have
become part of the market. It should also be noted that in
this market area Class I utilization is only 20 percent.
It is not difficult for the cooperative to meet fluid
handler concerns nor is the fluid market the force in this
part of the country that it is in other areas.
Furthermore, the cooperative believes that the fluid
standards do not have to be raised in order to ensure that
the demands of the fluid market are met. It was mentioned
in passing that the MCP system has improved the quality and
palatability of the milk produced by cooperative A's
membership. Coordination may be enhanced because of the
characteristics that milk has obtained as a result of the
penalties and premiums of the MCP system's quality
standards.

It should be noted that manufacturers and fluid
handlers have been willing to pay for the increased
quality. Manufacturers, because they get an economic
benefit in the form of higher yielding milk, and fluid
handlers, because they have to pay in order to ensure their
milk supply. Currently, fluid handlers have not faced any

problems in obtaining supplies. Coordination in

85
manufacturing has been improved through the market signal
that the MCP system sends, and there has not been any real
significant change in the fluid market.'

It does not appear that MCP systems have to be
part of the Marketing Order in this cooperative's operating
area. Most of the MCP systems in this area are very
similar, and these programs started and evolved on their
own. Furthermore, these systems are responsive to the
competitive nature of the market and this fact has
fostered uniformity amongst the different cooperative and
processor MCP systems. However, it was felt that if the
fluid standards were raised, MCP systems should become
part of the Federal Milk Marketing Order.

There are other macro coordination issues that
need to be addressed. The premium levels of cooperative A
were determined by basically two things. The most
important consideration was the cheese yield. The protein
premium was determined primarily by the value of cheese and
the amount of cheese that could be produced by milk with a
given protein level. In this market, protein is the solid
that has the most value. Other solid constituents are
evidently not valued by this cooperative or this market.
The other determinate of the premiums and deductions is
competition. Competition has forced a degree of
uniformity amongst the MCP systems. It should also be

noted that ten cents for each .1 percent protein is easy

86
for producers to understand.

A problem is the seasonality of protein levels in
milk. The protein content of milk is highest in the fall
and winter, and the lowest in the spring and summer. So
far, the MCP system has not affected this seasonality.
However, producers know that this problem exists and some
are beginning to analyze it. Perhaps ‘with. time, the
seasonality of protein production will be reduced and the
consistency of milk enhanced as a result of this MCP
system. If this is the case, macro coordination would be
improved as a result of a more consistent, higher
yielding, product which would improve manufacturing plant
productivity.

5.3 Cooperative B
5.3.1 Structure of the MCP System

Cooperative B began its MCP system in October of
1983. When first introduced, this system paid 10 cents a
hundredweight for each .1 percent SNF above 8.75 percent.
Currently, the SNF threshold is 8.65 percent. The premium
level currently varies seasonally depending on the SNF
level. The premium varies from 7 to 10 cents. The reason
it varies is so that the cost of cooperative B's SNF system
is approximately equal to the protein systems that are also
administered in this region.

There are also several quality premiums and

deductions that are administered independently of the SNF

87
system. Table 13 lists cooperative B's various quality

premiums and deductions.

Table 13: COOPERATIVE B'S QUALITY PREMIUMS AND DEDUCTIONS

Premiums
Plate Loop Somatic Cell
Bremigm Bacteria Count Count
50,000 300,000 to
6 cents or less and 400,000
25,000 200,000 to
12 cents or less and 300,000
10,000 and less than
24 cents or less 200,000
Deductions
Plate Loop Somatic Cell
Deggeeien gee§eria Count Count
6 percent of greater than greater than
milk check 500,000 or - 1,000,000
20 percent of greater than
milk check 1,000,000

These are fairly standard quality premiums and deductions.
It should also be noted that if a producer's bacteria
count tests 1,000,000 or more five times within a twelve
month period the cooperative drops him.

This cooperative operates in a highly
competitive market. Many cooperatives and proprietary
firms administer MCP systems. The bulk of cooperative B's
membership is based in Wisconsin, Minnesota, and the

Dakotas. Most of its membership operates in areas that

88

are dominated by SNF systems, although there are also many
protein systems in the area. The primary reason why the
cooperative instituted the system, was to meet the
competition, to offer members the same type of pricing
system that other cooperatives and proprietary firms offer.
5.3.2 Micro - Micro Coordination

This cooperative had little lead time before it
instituted its MCP system. Pmoducers's SNF, somatic cell
counts, and bacteria counts were not tested before the
cooperative instituted the system. The cooperative
decided to institute the system in June of 1983 and it took
effect that October. The primary method of communication
between the cooperative's management and its member
producers was through member meetings in the months of
September and October.

There are some current issues with the system.
Some members are interested in a protein rather than an SNF
system. Cooperative B set its SNF threshold at 8.65
percent because it is approximately equal to 3.2 percent
protein: the most common level for protein based MCP
systems. Another issue with the system is that net
premiums paid to producers are greater than deductions.
The program does not pay for itself. Some money is
deducted from the pool or blend to make up the difference.
This is due to the fact that there are many organizations

that administer MCP systems and if deductions were

89
increased then producers would leave the cooperative.

Cooperative B was somewhat late in establishing
an MCP system. These programs are quite popular with
producers. Cooperative B did not lose any members after
instituting the system but was losing some membership
before it was instituted because it did not have an MCP
system. This system is based on competitive forces, not
to obtain any measure of efficiency.

However, there have been some changes in
production patterns as a result of the system. There has
been more of an emphasis on the quality aspect of the
system. and somatic cell and. bacteria counts have been
reduced. Currently, 83 percent of cooperative B's
producers qualify for quality premiums. This has led to
increased cheese yields from the lower somatic cell count
milk. However, it is not possible to determine the
increased profitability of the cheese plants resulting from
lower somatic cell counts in milk. It is difficult, if not
impossible, for producers to affect the SNF level of their
milk and therefore cooperative B has not noticed any change
in the SNF level of producer milk.

5.3.3 Micro Coordination

This cooperative is also vertically integrated
which make analysis of the response of manufacturers
difficult. However, this cooperative believes that there

has not been much of a response from manufacturers to the

90

MCP system. This is apparently due to the fact that
neither the cost of milk, nor its composition in terms of
SNF or protein, has been changed as a result of the MCP
system. Fluid handlers have also shown no interest. This
is due to the fact that high SNF milk does not sell at a
premium at the retail level. There is no reward for
bottling milk that exceeds FDA minimum requirements.

Furthermore, there has been no shifting of
supplies as a result of this program. This is probably
because much of the milk supply is already using some type
of MCP system. Another reason is that manufacturers and
fluid handlers do not want to lose their milk supply.
There has not been any real change in operating procedures
at the manufacturing or fluid level as a result of this
system.

Cooperatives in this market area do not appear to
be uniquely qualified to administer an MCP system.
Proprietary firms which test milk could also administer
such a system. However, it was mentioned in passing that
cooperatives that were strictly' bargaining associations
would have more difficulty administering an MCP system.
This is because they do not have the manufacturing
facilities nor the testing facilities that vertically

integrated cooperatives have.

91
5.3.4 Macro Coordination

There has not been a disruption of the fluid
market as a result of cooperative B's, MCP system. This
cooperative analyzed the potential for changing hauling
routes in order toI give fluid. handlers low‘ SNF, high
somatic cell, and high bacteria milk, but the increased
cost of transportation was greater than the potential gains
from manufacturing plants. Fluid handlers are receiving
the same product as before with the exception that somatic
cell and bacteria counts are lower as a result of the
producer response to the system.

Currently, there is little incentive for fluid
handlers and manufacturers to pay for the increased
quality of the milk supply. However, this cooperative
feels that there ‘may’ be potential interest as quality
standards become more stringent. Fluid handlers have
become more particular, but there will be no incentive to
pay a premium for high quality milk as long as milk exceeds
minimum. standards. It is :more difficult to determine
manufacturers response to quality because little, if any,
of cooperative B's milk goes to proprietary manufacturers.

This cooperative is in favor of raising the
fluid standards. There are several reasons for their
position. The primary reason is that the uniformity and
consistency of milk would improve. The seasonality of

fluid milk's SNF composition would be reduced if the

92
standards were raised. A secondary reason is that the
fluid market and the manufacturing market would be treated
the same. This cooperative is not in favor of raising the
standard to the California SNF level, but to the average
SNF level of milk at the farm gate.

Closely allied with cooperative B's views on
fluid standards is its position favoring amending the
Marketing Order to include an MCP system. The two major
reasons it supports amending the Marketing Orders is that
the cooperative feels that it would increase uniformity of
the MCP systems, and insure the integrity of the program.
All participants would be treated the same. Also, if the
solid standards were raised, all milk in the market would
be treated the same which would also make uniformity of the
MCP systems more important. Also, if the Orders were
amended to include an MCP system then it would be easier to
make deductions on low SNF or high somatic cell and
bacteria count producers. Currently, given the competitive
environment cooperative B operates in, it is not possible
to equate premiums and deductions. Regulation, through the
Marketing Order, can achieve this.

There are other issues that need to be
addressed. The premiums and deductions are determined
competitively. The levels are set so that cooperative B's
system is comparable to other systems in the area. This

ensures that producers do not leave the cooperative because

93
of the MCP system. In addition, because it is difficult,
if not impossible, to change the SNF level of milk, the
seasonality of SNF production has not changed.
5.4 Cooperative C
5.4.1 Structure of the MCP System

Cooperative C's MCP system took effect on April
1, 1985. For the first 6 months of the program a premium
was paid to producers whose milk tested above 9.0 percent
SNF, and a penalty was paid by producers whose milk tested
below 8.4 percent. Producers whose milk tested between 8.4
and 9.0 percent SNF were not affected. On October 1, 1985,
the neutral range was narrowed to milk testing between 8.6
and 9.0 percent SNF. Currently, the neutral range is
between 8.4 and 9.0 percent in the months of April through
September, and between 8.6 and 9.0 percent October through
March. This takes into account the seasonality of SNF
production. The neutral range makes this MCP system an
interesting case study. All producers whose milk test
below the lower level now pay a penalty. The premium and
penalty are both 10 cents per .1 percent SNF.

There is also a penalty for producers whose milk
has a high somatic cell count regardless of SNF level. If
the somatic cell count is between 700,000 and 1,000,000 per
milliliter a producer's milk check is deducted 10 cents a
hundredweight: if the somatic cell count is over 1,000,000

a milliliter then the producer's milk check is deducted 20

94
cents a hundredweight. Table 14 summarizes cooperative C's

MCP system.

Table 14: COOPERATIVE C'S PREMIUMS AND DEDUCTIONS

SNF Leve ggemium or Deduction
(percent)

10 cents for each .1
greater than percent above 9.0
9.0 percent SNF
8.4 to 9.0 April through September no premiums
8.6 to 9.0 October through March or deductions

10 cents for each .1
less than percent below 8.4 or 8.6
8.4 April through September percent SNF depending on
8.6 October through March time of year
Wm Eduction
700,000 to 1,000,000 10 cents

greater than -
1,000,000 20 cents

This program differs from most others in several
ways. This is the dominant cooperative in the market, and
it administers one of the two MCP systems in the area. The
primary rationale for the system is that it increases
equity to members, those who produce high SNF milk get paid
more because their milk yields more manufactured product.
This cooperative's system also differs from most others in
that it is a zero sum game. Deductions are approximately
equal to premiums paid. There has not been any effect on

net producer income. It should also be noted that

95
cooperative C processes the vast majority of its
membership's milk that is not sold to fluid handlers.
5.4.2 Micro - Micro Coordination

This system has not been a major issue with the
membership. In the fall of 1984, cooperative C began
testing the SNF content of its membership's milk. In
January and February of 1985, the cooperative obtained
member feedback and discussed application of the system
through local member meetings with producers. In March of
1985, the program was voted in by the membership. Since
its inception, the MCP system has not been a major issue
with the membership. A.rough estimate is that only about
two tenths of one percent of the membership left the
cooperative as a result of the system.

This may be due to several reasons. Over 70
percent of the producers fall within the neutral range.
The MCP system has not altered the paycheck of the
majority of producers. Furthermore, the lower boundary of
the neutral range varies seasonally which reduces the
number of producers that would face deductions if the lower
level was held fixed at 8.6 percent SNF throughout the
year. Also, the cooperative's management was responsive to
member concerns, management was willing to let producers
adjust the program in addition to letting them vote for the
program. This makes the program less controversial with

the membership.

96

There has been a dramatic decrease in the somatic
cell counts for the average member farm. This has been the
greatest change in milk composition as a result of the
system. When the somatic cell count program was first
instituted, the average somatic cell count per member was
450,000. That has fallen to below 300,000. Currently, the
average somatic cell count is approximately 100,000 less
than the previous year. This cooperative does not have a
bacteria deduction or premium and therefore it cannot be
determined what effect, if any, tHere has been on bacteria
levels. As is the case with cooperative B, there has been
no change in the SNF content of the membership's milk.
5.4.3 Micro Coordination

Cooperative C's MCP system has also had little
effect on micro coordination. This system is funded
internally and the cooperative manufactures all the milk
that it doesn't sell to fluid handlers. However, this
cooperative has entered into a joint venture with a large
cheese manufacturer and is going to subject the
manufacturer to the MCP system. The manufacturer will pay
the cooperative extra for milk that contains more than 9.0
percent SNF, and the cooperative will charge less for milk
that contains less than the threshold of either 8.4 or 8.6
percent SNF depending on the time of year. The
manufacturer will pay less for milk that yields a

comparatively low amount of cheese. Its net profitability

97

is not likely to be affected as a result of this system.

There are other micro coordination issues that
need to be considered. Manufacturers and fluid handlers
have not gone to outside sources of milk. Cooperative C
manufactures its own milk and does not discriminate against
fluid handlers. Also, if a proprietary handler so decided,
it could administer an MCP system. In fact, this
cooperative feels that it may be easier for a proprietary
plant to administer an MCP system because it is less
responsive to producer concerns. However, it should again
be stated that cooperative C is one of only two
organizations in the market area that administers an MCP
system.
5. 4 . 4 Macro Coordination

Cooperative C's MCP system has not affected the
fluid market. The cooperative has not changed its pricing
practices towards fluid handlers. Also, it would be too
expensive to change the cooperative's shipping schedule so
that fluid handlers would receive low SNF or high somatic
cell count milk. If anything, the quality of milk fluid
handlers receive has been improved as a result of
producers reducing the number of somatic cells in their
milk. However, fluid handlers have not been interested in
milk which exceeds FDA requirements and are not
particularly interested in paying for high quality milk.

Manufacturers's response is more difficult to determine

98
because cooperative C processes its own milk.

The cooperative strongly supports raising the
solid standards for fluid milk. This would mean that fluid
handlers would either have to purchase milk powder and
other milk constituents to raise the standards or directly
purchase high SNF milk from the farm itself. Should this
occur, cooperative C will eliminate the neutral range and
treat SNF in exactly the same way butterfat is treated now.
However, this cooperative believes that the solid standards
will not be adjusted anytime in the near future.

Raising the standards will have effects. Prices
will rise, but the cooperative believes that consumers will
not notice the difference and there will be little, if any,
change in consumption. Implicit in this argument is the
belief that the demand for fluid milk ~is extremely
inelastic, perhaps to the point that the demand curve is
vertical. More likely there will be a small, but
noticeable, decrease in the quantity demanded if the solids
standards are raised and if consumers do not value milk
with a high SNF content more than milk with a
comparatively low SNF content. It should be noted that
raising the standards creates a potential market for milk
powder, and should consumption decline as a result of the
higher price, the cooperative feels that demand can be
increased through advertising and promotion.

It follows that should the standards be raised,

99

then the Marketing Order should be amended to allow for an
MCP system. Cooperative C is one of two market
participants in its operating area administering an MCP
system, and equity would be enhanced if it were made part
of the Order. If an MCP system were made part of the
Marketing Order uniformity in the market would be improved.

There were two reasonS* why the premium and
deduction levels for SNF were chosen. The first is that
10 cents per .1 percent SNF is an easy figure for producers
to understand. Since it is easy for members to understand,
micro - micro coordination is not adversely affected.
Also, 10 cents per .1 percent SNF is an average return:
the value of high SNF in fluid milk is zero but the value
of high SNF milk is more than 10 cents per .1 percent SNF
in manufactured products. It should be noted that the
seasonality of SNF production has not been affected by the
system.

5.5 Findings

The effects of MCP systems on the vertical
coordination of the dairy subsector has been minimal.
Hypothesis I holds in that producers have adjusted to the
altered price signal and the quality of the milk supply has
improved which has increased the technical efficiency of
manufacturing plants. More manufactured product,
especially' cheese, can now’ be produced because of the

altered nature of the milk supply. However, as a general

100
rule, these systems were not instituted as an attempt to
meet the shift in consumption towards cheese, but as a
response to the interest of dairy producers. Micro - micro
coordination is improved.

These programs are very popular with producers.
The testing that occurs on a regular basis improves
information flows between the cooperative's management and
membership which enhances micro - micro coordination.
Producers have responded to these systems by reducing the
level of bacteria and somatic cells in their milk. This
program has increased the membership of cooperative A and
is not an issue with the membership.

Cooperative B's system was basically instituted
because other cooperatives and processors have MCP systems.
It was instituted to meet competition. Although there was
little direct membership education and feedback there have
not been any serious membership problems. This may be due
to the fact that MCP systems have been in existence in
this area for some time and producers were probably already
aware of them.

Contrary to cooperatives A and B, cooperative
C's system did not receive a great deal of member support.
However, it has never been a major issue with producers.
Cooperative C did give the membership several months to
analyze the program and to determine their SNF content and

somatic cell count levels before the system was

r

101
instituted. This likely helped ensure member acceptance of
the system. Most of cooperative C's membership fall within
the neutral range and the somatic cell counts for most
producers are below the penalty levels. Unlike the other
systems, cooperative C's MCP system is close to a zero sum
game with deductions and premiums being almost equal.

The reason that the program was instituted was
so that producers whose milk had a high SNF content
received more than those whose milk had a low SNF content.
The management of this cooperative believes that using an
MCP system is a more equitable method of determining a
member's net price. Since this cooperative is the dominant
one in the market, it has apparently been able to
administer its MCP system with a minimum of controversy or
disruption.

Cooperatives A and B operate in markets with a
high Class III utilization and a low Class I utilization.
Manufacturers have not been adversely affected by the
program. They reap benefits from the MCP systems in this
market. The quality of the milk supply has improved which
has led to some increase in the per hundredweight
productivity of processing plants. Fluid milk is still
the most profitable outlet for milk and it is too expensive
to differentiate high and low quality milk and ship the low
quality milk to fluid handlers. MCP systems have not

developed into a problem for fluid handlers.

102

, Some cooperatives are in favor of amending the
Orders and increasing the solids standards for fluid milk.
If the fluid standards were raised, and the Marketing Order
amended, several things would happen. All the milk in the
market would be treated the same way: uniformity would be
enhanced because there would be only one MCP system that
would affect all market participants. Product uniformity
would also be improved if the solid standards were raised.
The uniformity would prevent MCP systems from becoming a
pricing gimmick used by cooperatives to increase or
maintain its membership. Currently, in many areas, this is
the case. Furthermore, if an MCP system is made part of
the Federal Milk Marketing Order, premiums and deductions
would be equalized; pool funds would no longer be needed to
help pay for the system. Currently, competitive pressures
in cooperative A and B's markets do not allow this to
happen.

Cooperatives have been leaders in administering
these systems. Hewever, all three case studies feel that
cooperatives are not the only participants which could
administer an MCP system. Nonetheless, because of their
unique relationship with producers, cooperative systems
may be more responsive and administered with more integrity

than MCP systems administered by other market participants.

103
5.6 Summary

This chapter analyzed the effects of MCP systems
administered by dairy cooperatives on the vertical
coordination of the subsector. Three case studies were
selected and the relevant personnel were interviewed to
obtain the information needed to test the hypothesis. MCP
systems do not have a great effect on the subsector. The
improved quality of the milk has improved the technical
efficiency of manufacturing plants. More product can be
produced from the same amount of raw milk. This improves
the welfare of those who operate manufacturing facilities.

It appears that hypothesis I does hold. The
primary reason these programs were instituted was to
appease the cooperative's membership. Enhanced
coordination at the micro and macro levels as a goal per se
is less important to the cooperative. As a general rule,
the push for an MCP system came primarily from producers.
This has enhanced micro - micro coordination. MCP systems
have not changed SNF or protein levels to meet current
demand conditions. Currently, this is not technically
possible. The added costs of changing breeding and feeding
practices are not offset by the protein or SNF premiums.

However, micro and to a lesser extent, macro
coordination has been enhanced because the quality of the
milk supply has improved. Manufacturers are getting a

higher yielding product and others along the marketing

104
chain are getting a higher quality product. Coordination
would be improved if these systems were made part of the

Federal Orders.

CHAPTER 6: COOPERATIVES, COORDINATION, AND SUPPLY

MANAGEMENT

6.1 Introduction

This chapter analyzes the impacts on vertical
coordination at the micro - micro and macro levels of
supply management programs administered by dairy
cooperatives. At the micro - micro level, the issues of
member education and feedback are addressed. Transfers of
base, or allotment are also considered. The critical
micro - micro coordination issue analyzed is whether or not
the cooperative lost or limited its membership and the
effects of the program on nonmember production.

The research also addresses a number of macro
coordination issues. It analyzes the effectiveness of the
programs in reducing price and output fluctuations as well
as determining whether or not the overbase or
overallocation price is, or was, low enough to discourage
production. Each program is also examined to see if it
was flexible to changing market conditions, especially
changes in demand. The research also analyzes the
potential for amending the Orders to include a supply
management program. The question of whether or not the
cooperative had enough control over the market to

105

106
effectively administer its program is also addressed.

This chapter discusses each of the three case
study cooperatives in turn. The structure of the programs
and their effects on coordination at the micro - micro and
macro levels are analyzed. Research findings are also
included.

6.2 Cooperative D
6.2.1 Structure of the Program

Cooperative D began its supply management program
January 1, 1987. The primary goal of this cooperative's
program is to control production increases in order to
prevent the construction of additional plant capacity whose
only potential buyer is the CCC. Given the uncertainty of
future government policies, cooperative D has decided to
control production.

This cooperative's market is separated from other
sources of milk by mountains (Johnson, p.1), which gives
this cooperative a considerable degree of control over the
market. It is also the dominant source of milk in the
area. The cooperative, whose members are based in
Washington and Oregon, assigns a monthly allocation to each
producer. The allocation is the highest weighted average
month of production from May through October of 1985, but
if a month from the period of November of 1984 through
April of 1985 was the highest production month then that

became the producer's monthly allocation. This rule

107

attempts to account for the seasonality of production. It
was later determined by the cooperative's management that
each producer's allocation be increased 10 percent. The
allocation is not transferable and has no value. However,
transfers of allocation can occur if the entire operation
is transferred to a family member or if the farm is sold to
another cooperative member producer.

This program was first considered before the DTP
was instituted. This cooperative's volume was reduced 13
to 14 percent as a result of the DTP: this fact led to
several changes in the mechanics of the program. The
overallocation price was increased from 3 dollars a
hundredweight to 1 dollar below the price for milk produced
within the producer's allocation. Also, as noted, the
cooperative increased each producer's allocation 10
percent.

There are other aspects of the program worth
noting. The assessment for overallocation milk applies
only in the months of April through August. New producers
can be allowed to join the cooperative if it increases the
cooperative's market share or if the added production does
not lead to production greater than the total output
ceiling set by‘ cooperative D. Finally, an Allocation
Review Committee has been established to handle member
issues and problems, including recalculation of allotments.

This is a good case study because it is a recent

108

supply management program and it is interesting to discover
some of the problems and issues the cooperative is facing.
Furthermore, it is one of only two allocation or quota
programs currently operating in the country. Also, it is
one of the few supply management programs ever that does
not allow the buying and selling of production allotments
or quotas.

6.2.2 Micro - Micro Coordination

This cooperative spent a considerable amount of
time obtaining member opinion and educating the membership
about the program. Before the DTP, the cooperative
believed that overproduction would be a problem. It sent a
survey to the membership, the results of which indicated
that given their future plans for production, surpluses
would result. In reaction to this, cooperative D conducted
member meetings which laid out the allocation program. The
cooperative also heLd a nonbinding advisory vote in which
75 percent of the producers voted in favor of the program.
The membership also helped develop the program, they were
instrumental in the organization and implementation of the
program.

The member - management feedback encouraged the
implementation of the program. The communication flows
between the management and producers led to the same point
of view concerning supply management. Also, this

cooperative lost few,‘if any, producers as a result of this

109
program. This program has not adversely affected
management - producer relations.

This cooperative's market share has yet to be
reduced as a result of the program. There has been little,
if any, increase in nonmember production since the program
was instituted. Cooperative D is also willing to accept
new members. This has the advantage of reducing the
incentive of new producers not to join the cooperative and
helps the cooperative maintain its market position.

An interesting aspect of this program which has
definite micro - micro coordination impacts is the Member
Allocation Review Board which is composed of member
producers. The committee hears producer petitions
concerning allocations and is flexible enough to meet
member needs. The Board is popular with producers; it
gives individual producers a 'voice in the program and
allows them to appeal their allocation levels. The Board
is another way that member issues can be addressed and is
another form of feedback. It also supplies a mechanism
that reduces the possibility of the farm structure of the
membership becoming fixed.

An unique aspect of this program is that the
allocations are not transferable, and therefore they have
no value. There are several reasons why the cooperative's
management is strongly opposed to making the allocations

transferable. The first reason is that if allocations were

110

transferable they would become an asset with value. This
would make the program difficult to modify, any change in
the program would change the value. of the asset, and
therefore any modification of the program would meet with
member resistance. The cooperative would also face the
problem of members selling their allocation and marketing
their milk to other cooperatives or handlers. Supplies
would increase, and the cooperative would lose some of its
market control. 7 This would defeat the purpose of the
supply management program.

Also, if the allocations became transferable it
would be difficult for new producers to join the
cooperative. The only way a new dairyman could join would
be to purchase allocation. This would create a barrier to
entry. More likely, new producers would 'not join the
cooperative which would reduce the cooperative's control
over the market.

Most of the membership supports the
nontransferability of allocations. Currently, all
allocation reverts back to the cooperative when a producer
stops marketing milk. However, the cooperative is very
generous with giving the allocation to a family member in
cases of death or retirement. However, there are some
producers who favor making the allocations transferable

because it would create a valuable asset.

111
6.2.3 Macro Coordination

Cooperative D's overallocation price is only one
dollar less than the allocation price and this assessment
is only in effect from April through August. The
overallocation price is currently not low enough to
completely eliminate the incentive to increase production
ibut the flexibility Of the program does discourage
increased production. There is always the risk that the
assessment for overallocation milk may increase. This
serves as a disincentive for producers to make investments
in more dairy livestock, plant, and equipment, and keeps
increases in total production at a minimum. Again, the DTP
reduced the need for a high overallocation assessment
because much of this cooperative's membership stopped
producing milk.

This cooperative currently believes that it has
sufficient control over the market to successfully
administer its supply management program. This market is
geographically separated from other sources of milk. Also,
this cooperative pays its producers Ihigher' prices than
other market participants. Its control is enhanced
because if a member left the cooperative his profitability
would probably be reduced. 'There are also few other
cooperatives in the area, there are few alternative outlets
for milk besides this cooperative. Cooperative D also

attempted to get other cooperatives to become part of a

112
supply management program but it was unsuccessful, there
was too ‘much resistance from. other cooperatives. The
cooperative also realizes that it would be more difficult
for its supply management program to be successful if its
market share were smaller.

Cooperative D does favor making supply management
part of the Federal Order. The primary reason the
cooperative supports making supply management part of the
Federal Order is it would provide a "level playing field":
this would prevent cooperative D's producers from being the
only group committed to managing supplies. It would
prevent those producers who don't belong to cooperative D
from increasing their profitability and market share at the
expense of the cooperative's producers. There is also some
interest by some in the cooperative in a national supply
management program. The total national allocation would
be based on total plant capacity and aggregate demand.

There has been little effect on prices or output
as a result of this program. This is likely due to the
fact that this program has only been in existence since
January of 1987. There has been a decline in production
but it is difficult to determine the cause for this. The
allocation program has likely curtailed any potential
future supply increase, while the program hasn't stopped
some dairymen from increasing production, it has slowed it

down.

113

The cooperative has not had time to study the
possible effects the program may have on seasonality of
production. However, at the current time, there is no
penalty for producing more than one's allocation in the
fall and winter. This ,aspect of the program will likely
lead to reduced seasonality of production.

One of the overriding aspects of this program is
its flexibility. The cooperative would match any increase
in demand by increasing its allocation to producers. This
cooperative would also decrease producer allocations if
market conditions warrant it. The cooperative's management
is also aware of potential member problems if allocations
are reduced, producers are less likely to protest an
increase in their allocation than a decrease. Cooperative
D would adjust individual allocations on a‘ case by case
basis. It is felt that there would be too much wasted or
unused allocation if it were increased to each producer at
a flat rate.

The cooperative is also aware of the pitfalls of
flexibility. The program could be changed in a manner that
reduces the effectiveness of the supply management system.
Examples of this would be: increases in allocations beyond
that dictated by market conditions, subjective changes in
individual allotments, or refusing to increase allotment in
times of increasing demand. These problems would make

supply management a less effective tool of macro

114
coordination.
6. 3 Cooperative E
6.3.1 Structure of the Program

This cooperative attempted to control surpluses
through the use of a Class I plan. This program was
instituted when the cooperative came into existence as a
result of several mergers. Their program was supported by
Mid American Dairymen, Inc. which is a very large regional
cooperative. This program commenced in 1968 (Riley,
Childs, and Blakley, p.2), and was discontinued after a
producer referendum in 1978.

A producer's Class I base was determined by using
the following method. The higher of the twelve monthly
production figures of 1966 or 1967 was determined. This
amount was divided by 365 in order to‘ determine a
dairyman's daily production. This amount, in turn, was
reduced by the approximate Class I utilization rate (Riley,
Childs, and Blakley, p.2)._ This amount became the
producer's daily Class I base. If a dairyman's production
history was not as long, a shorter time period was used
(Riley, Childs, and Blakley, p.2).

Obviously, this program attempted to match
marketings to Class I utilization. The goals of this
program were to control production growth and therefore
maintain a high Class I price. Another goal was producer

equity, if one producer decided to increase production,

115

other producers retained their Class I share. Also, this
program attempted to reduce the seasonality of production.
Production within the base received the Class I price and
any excess production received the manufacturing grade
price. The bases assigned varied from division to division
depending on the Class I utilization within that particular
area.

This program was successful in stabilizing the
market because those producers who operated under the
program reduced their marketings (Phillips and Babb, p.26).
However, many new producers elected not to enter the
program (Phillips and Babb, p.26). The cooperative could
not force producers to join. Over time, the cooperative
lost market share which made it more difficult for the
program to be effective.

The bases were transferable. This allowed
producers under the program to increase their operations by
purchasing base (Phillips and Babb, p.26). There was also
a base committee which was given the authority to transfer
or increase bases in instances where bases were not being
utilized or if a producer warranted an increase in his base
as a result of some type of hardship (Blakley, p.6).

Cooperative E's program was an example of a Class
I plan instead of a quota. Why it no longer exists makes a
good case study. This is also a relatively recent and rare

example of a cooperative's attempt to administer a supply

116

management program to reduce chronic surpluses east of the
Rockies.
6.3.2 Micro - Micro Coordination

This cooperative instituted its supply management
program when it was created as a result of several mergers
in the market area. Many of the producers had previously
operated under some type of supply management program
before the mergers occurred. Many producers understood how
these types of programs operated. The primary mechanism of
educating and informing the producers about the Class I
program was through member meetings. Less important
methods of education and sources of information were member
publications and individual producer contact with fieldmen.

When the program was first instituted several
problems had to be solved. At the time the program was
instituted there was a great deal of producer apprehension,
although the great majority of producers accepted the plan.
A divisive issue within the cooperative was how the bases
were divided amongst producers and within geographic
divisions in the cooperative's various market areas.
Another issue was hardship cases : the cooperative allowed
individual producers to appeal their base allocation and
when the appeals board agreed, his base was increased.
Other problems were member relations, administering base
transfers, and various personality problems that were a

natural result of the mergers. These problems were

117

evidently solved because member acceptance of the program
improved after the program came into existence. It can be
deduced from the issues listed above that there was
sufficient member feedback to address various member
concerns.

Over time, the cooperative's control over the
market declined. Some members left the cooperative as a
result of the program, for the most part these producers
did not join another cooperative but became independent.
These producers could obtain a higher income for producing
as much as they wanted outside of the cooperative's
program. They received the blend price for all their milk
outside of the cooperative. Also, due to the fact that the
bases had value, new producers did not join the
cooperative. The cost of purchasing base created a barrier
to entry. In order to increase the number of producers in
the cooperative, it offered plans to make it easier for new
producers to join the cooperative. While some new
producers did join the cooperative, some of the
effectiveness of the program was lost as a result. Also,
new producers were allowed to build base. Despite these
incentives, the cooperative feels that it did not get the
new production it would have otherwise obtained.

Another reason why cooperative E's market share
declined was the fact that nonmembers increased production

faster than member producers. There was no penalty for

118
increasing production, nonmembers continued to receive the
blend price. The burden of keeping surpluses at a minimum
fell on the members of the cooperative. Nonmember
producers gained more from the cooperative's program than
members.

Increased nonmember production led to an increase
in the amount of milk outside the control of the
cooperative. It appears that nonmember producers were free
riders. They benefitted from the cooperative's attempt to
reduce the surplus but they faced no penalty for
increasing production. This loss of control varied from
division to division. For example, in one division the
cooperative's market share declined from 80 percent when
the program was introduced, to 50 percent when the program
was eliminated.

Bases were transferable between members, the
cooperative had little control. Both the buyer and seller
signed an agreement and submitted it to division
headquarters. Bases could not be transferred between
divisions: for example, a Kansas producer could not sell to
a Texas producer. The base price varied from division to
division, it basically varied with the Class I
differentials. As a general rule, the price of base varied
from 5 to 15 dollars a pound. The program apparently did
not serve as an incentive for high cost producers to leave

the market. Technical efficiency was neither enhanced nor

119
inhibited as a result of the program.

When a producer sold base and quit the
cooperative he was not allowed to continue marketing milk
independently. There was a 5 year noncompete clause. This
clause was tested in court several times and the
cooperative was successful in preventing producers from
selling base and marketing milk independently as a
nonmember producer. However, the cooperative believes that
it was far from completely able to force producers who sold
their base from leaving the market.

6.3.3 Macro Coordination

The cooperative's overbase price was not low
enough to completely discourage overproduction. The
overbase price of milk was basically the M-W. The
effectiveness of this price being low enough to discourage
surpluses varied from division to division, in some areas
it did provide a sufficient incentive to curb production,
in other areas it was not. Also, had the overbase price
been any lower it would have encouraged producers to leave
the cooperative. Cooperative E lacked sufficient control
to ensure that the overbase price of milk would be low
enough to completely eliminate surpluses.

The cooperative feels that the program was
successful in adding stability to the market. A
producer's daily base was not seasonally adjusted.

Producers reacted to this by changing their breeding habits

120

so that cows freshened at a more uniform rate. Seasonal
fluctuations were reduced. If a producer did not produce
equal to his base in the fall he could not make it up. If
he produced in excess of his base in the spring then he
received a lower price for the excess production. This
provided the incentive to produce at a uniform level
throughout the year.

The cooperative feels that the Marketing Order is
not the tool to use in instituting a supply management
program. This is because too much milk, such as Grade B
milk and all the milk produced in California, is not under
the Federal Milk Marketing Order system. In order to have
sufficient control, a supply management program must be
nationwide in scope. However, the Orders could be used for
the administration of the program, perhaps under the
auspices of a federal bureaucracy such as the ASCS. This
cooperative is in favor of a national supply management
pregram.

This program was too flexible. Cooperative E
increased producer bases at a faster rate than fluid milk
demand. This is also a reflection of the lack of market
control the cooperative faced. If the cooperative had
sufficient control, it would have increased the total
producer base to exactly meet increases in demand.
Increasing member prices was not the goal of this program.

This cooperative probably crippled its chance to

121

effectively support a supply management program at its
inception. When the cooperative was created, it
established a 50 cents a hundredweight over - order
premium on Class I milk in an attempt to be compensated for
balancing and other marketwide services. This over - order
premium encouraged processors and fluid handlers to obtain
other sources of milk. This combination of processors and
fluid handlers looking for another source of supply and the
increase in nonmember production destroyed whatever ability
the cooperative may have had in managing supply.

This lack of control was the downfall of the
program. Due to production outside of the cooperative's
control, and processor and fluid handler unwillingness to
pay the over - order premium, the cooperative was unable to
administer the program. The continual deterioration of
market share led to a reduction in the value of bases and
made the elimination of the program via a producer
referendum simple. However, while this program was in
existence it did serve to reduce surpluses.

6.4 Cooperative F
6.4.1 Structure of the Program

This cooperative's supply management program was
different from the other two in that its goal was to reduce
seasonal fluctuations in supply. The basic rationale for
this program was to reduce costs. In order to handle the

seasonal surplus, the cooperative had to lease a

122
manufacturing plant from another cooperative: the cost of
transporting and manufacturing this excess milk was 1.60
dollars a hundredweight. The cooperative decided to save
costs by instituting a base - excess plan to reduce the
seasonal surplus which would eliminate the need for leasing
the manufacturing plant.

This cooperative was formed in 1980 and it
approved its base - excess plan in 1981. The winter of
1981 was the first base forming year and the spring of 1982
was the first excess year. The program itself began in
1983 and the results were startling. The difference
between March through June, the flush production period,
and August through November, the short production period,
was 11.3 percent in 1981 and it was only 5.5 percent in
1983. The Diversion and the DTP programs make analysis of
1984 and 1985 difficult, but the seasonal fluctuations were
still less than before the program was instituted. As a
result of the Diversion and the DTP, supplies tightened and
the cooperative decided to end the program in the spring of
1987.

This cooperative operates in an interesting
market area. Other cooperatives in this area also operate
independent base - excess plans and there is a "Louisville
plan" in the Federal Order. The base price tended to be 10
to 12 cents a hundredweight above the blend price and the

price of excess milk was usually 1.10 dollars below the

123
blend price, although it sometimes was as much as 2 dollars
below the blend price depending on market conditions. The
bases had no value because a producer formed a new base
every year.

This cooperative makes a good case study for a
number of reasons. It attempted to improve vertical
coordination by making production more uniform throughout
the year. Membership issues make this an interesting case
study as well. Also, this cooperative lacks the market
power to administer any type of quota or allotment program
even if it so desired.

6.4.2 Micro - Micro Coordination

As a general rule, there was member support and
acceptance of the program. The membership realized that
they bore the cost of leasing the plant and transporting
milk. This provided a strong incentive to institute a
base - excess plan. The membership was educated through
member meetings and through the cooperative's member
publication.

However, there were some problems with the
program. Those producers whose milk production exhibited
the greatest seasonality- tended to be opposed to the
program. These producers tended to be located in the
northern part of the cooperative's area which led to some
regional difficulties. Also, those producers who had a

relatively constant level of production throughout the

124

year did not particularly favor the program's elimination.

Producers were given the opportunity to comment
on the program. The cooperative's annual producer meetings
provided a forum for member feedback. This cooperative
also conducted a member survey in an attempt to discover
producer opinions about the program. Another way members
were able to interact with the cooperative's management was
through their representatives who are elected by the
‘membership. It appears that although there 'were some
producer issues, the relations between the membership and
management were not adversely affected by either the
program's initiation or elimination. Good communication
probably enhanced the membership's support of the program.

However, some producers did leave the cooperative
because of the program, although there were no effects on
nonmember producers. Cooperative F did not lose membership
to other cooperatives because they also administer base-
excess plans. Instead, it lost some membership to
proprietary firms. Those producers who left the
cooperative tended to have the highest seasonality of
production. One of the major reasons why the cooperative
ended its program was that it was in danger of losing more
producers to proprietary firms because supplies had
tightened as a result of the DTP. This program, because it
is a weak form of supply management, had no effect on the

production patterns of nonmember producers.

125
6.4.3 Macro Coordination

The price of excess milk tended to be a little
over a dollar less than the blend price. This apparently
was low' enough ‘to reduce the seasonal fluctuations in
production. This cooperative believes that the program
likely worked on perception rather than actual financial
effects: in the minds of producers, the lower price for
excess milk provided an incentive to reduce production in
the spring which was the goal of the program. Producer
adjustment depended on their seasonality, the greater the
seasonal fluctuation before the program came into existence
the greater the reduction in the seasonality of production
after the program came into existence.

When the cooperative administered the program it
felt that it did have sufficient control to effectively
reduce seasonal supply fluctuations. However, as supplies
were curtailed due to other factors such as the DTP, other
markets became available, there were alternatives. Also,
there was increased plant capacity available which made
handling spring production less expensive. Had the
cooperative not eliminated the program, it would have lost
members and control would have been reduced. Cooperative F
was adaptable to changing conditions and it eliminated the
program when it was no longer needed.

The purpose of the program was to match seasonal

supply with seasonal demand. It was successful in reducing

126
seasonal supply fluctuations. There was no effect on price
fluctuations. Other base - excess plans in this market
area have also reduced seasonal supply fluctuations. In
this respect the plans have enhanced macro coordination.

The cooperative is in favor of making a base-
excess plan part of the Federal Order. Currently, there is
a ”Louisville plan" in this market but it is felt by the
cooperative that a base - excess plan is more effective
because the effects of the program are directly evident in
a producer's milk check. Some cooperatives are in favor of
having this type of plan in the Order, other cooperatives
are opposed. The largest cooperatives, which administer
their own base - excess plans, favor amending the Order.
This would likely add uniformity to the market, and ensure
that all producers would be affected by seasonal
fluctuations in milk production.

Cooperative F faced a number of other issues.
Originally, the base forming months were from September
through December. However, market analysis showed that
August through November was a better time period because of
milk needs in August and because of the holiday season in
December. A compromise of August through December was
finally reached. Another issue was the price of excess
milk. Originally the price of excess milk was the M-W, it
was later adjusted upward because of zone differences

within the order. A disproportionate cost was borne by

127
those producers who were located close to the major milk
markets, therefore the price of excess milk was increased.
6.5 Findings

Coordination can be enhanced by supply management
programs administered by cooperatives, they can reduce
both seasonal and chronic surpluses. Hypothesis II holds
if the cooperative has sufficient control of the market.
Technical efficiency is enhanced because fewer resources
are devoted to manufacturing plants needed to process
excess milk. Macro coordination is also improved through
the enhanced stability that results from the reduced
seasonality of production. Also, these programs directly
enhance macro coordination by effectively matching supply
with demand. A great deal of control is needed to
administer a program designed to curb chronic surpluses.

These programs had the support of the membership.
In one instance, the cooperative spent a great deal of time
educating and interacting with the membership. The other
two cooperatives spent less time interacting with the
membership because producers had some understanding of
these types of programs. Cooperatives D and E provided
producers a method to increase the amount of milk they were
allowed to market through an appeal process.

Micro - micro coordination was enhanced through
these programs. The management of the cooperatives

listened to producer concerns and adjusted their programs.

128
Communication flows were sound. Cooperative E was
particularly responsive to the concerns of its membership.
This was partially due to the fact that producers had
alternative outlets for their milk.

A micro - micro coordination issue is the
transferability of bases or allotments. Some producers are
in favor of creating a valuable asset by making bases or
allotments transferable. However, this creates a barrier
to entry and makes it less likely that new producers will
join the cooperative. If bases or allotments are
transferable the cooperative administering the program will
lose market control over time.

These programs were successful in meeting their
goals. Cooperative D has not been forced to build
manufacturing plants to process their membership's milk.
Cooperative F did not have to lease processing plant to
handle their membership's seasonal flush. The surpluses in
cooperative E's market area were curbed as a result of its
Class I program. Macro coordination was enhanced by the
case study cooperatives's achieving their goals.

Another aspect of these programs was their
flexibility. Cooperatives E and F eliminated their
programs. Cooperative E because their market position was
eroding and cooperative F because the DTP tightened
supplies in its operating area. .All the cooperatives

showed the ability to adjust their programs to meet

129
changing supply and demand conditions. This flexibility
also leads to enhanced macro coordination.

The critical condition that must be met in order
for a supply management program to be effective is market
control. Less control is needed to effectively administer
a seasonal program. A great deal of market control is
needed if a cooperative is to curb chronic surpluses. A
cooperative must be the dominant source of milk in a
geographically separated market to administer a quota,
allocation, or Class I program. A cooperative cannot curb
chronic surpluses east of the Rockies. If it attempts to
do so, nonmember producers will increase production, they
will benefit from the cooperative's program without having
to reduce their production. The cooperative will lose
market share as a result.

This fact has policy consequences. Base - excess
plans are part of many Federal Orders to reduce seasonal
supply fluctuations. All of the cooperatives are in favor
of making supply management part of the structure of the
dairy subsector. It appears that the only way chronic
surpluses can be reduced is through some type of national
program, the Federal Orders are too limited in scope to be
the effective institution to manage supplies on an
interyear basis. Cooperatives could be given the authority
to administer the program. Whether or not dairy surpluses

should be reduced through a supply management program is a

130
decision society as a whole must make.
6.6 Summary

This chapter focused on _dairy cooperatives's
experiences in administering supply management) programs.
Information was gathered through interviews with various
officers of the case study cooperatives. These programs
have, or at one time had, a positive influence on vertical
coordination.

Hypothesis II holds. Cooperatives can enhance
coordination via supply management programs. As a result
of these programs, surpluses, both seasonal and chronic,
were reduced. Stability was also enhanced through reduced
seasonal fluctuations in supply. This directly enhanced
macro coordination. Furthermore, fewer resources were
needed to operate manufacturing facilities to process the
excess milk. This enhanced technical efficiency.

At the time they were instituted, these programs
were popular with the membership. Two cooperatives have, or
did have, a review board to deal with producer problems.
One cooperative conducted an intensive education program
and received a great deal of member feedback. The other
cooperatives spent less time educating and informing their
membership because producers were aware of how these
programs worked. However, communication between producers
and management was important in all three cases.

There are two important issues involving these

131
programs. These programs were very flexible, the
cooperatives adjusted these programs in order to meet
changing supply and demand conditions. In two instances
they eliminated the program. This flexibility, as a
general rule, enhanced coordination. The other issue is
control. A cooperative needs a Igreat deal of market
control in order to curb chronic surpluses. Less control
is needed. ‘to administer' a seasonal supply’ management
program. No cooperative east of the Rockies possesses this
degree of control in its market, there is not sufficient
isolation from other sources of :milku National dairy
policy must be amended if surpluses are to be reduced
through a supply management program. Either a nationwide
quota, Class I, or allotment program is necessary to curb

chronic surpluses.

CHAPTER 7: COOPERATIVES, COORDINATION, AND MARKETWIDE

SERVICES

7.1 Introduction

This chapter analyzes the four case study
cooperatives's experiences with providing the marketwide
services of seasonal balancing and marketwide information.
The effects of these services on micro - micro, micro, and
macro coordination are studied. The first part of this
chapter deals with seasonal balancing, the second part of
this chapter analyzes marketwide information.

There are several micro - micro coordination
aspects of these services that. need. to Zbe considered.
Since these services have public good characteristics, the
cooperatives may need the support of the membership in
order to perform them. The cost of these services to the
membership is discussed. Also, various producer free
rider problems are addressed. Another question that this
chapter analyzes is the various ways that marketwide
information improves the decisionmaking abilities of
producers.

There are several micro coordination aspects of
seasonal balancing and marketwide information that are
analyzed. The question of the effects on the subsector if

132

133

the cooperative stopped providing these services is
addressed. Another issue faced by cooperatives that
perform these services is the potential for proprietary
firms to be free riders, to benefit from the activities
pursued by the cooperative without sharing the cost. An
example is the potential enhanced decisionmaking abilities
of proprietary firms which result from the marketwide
information services provided by the cooperatives without
the proprietary firms sharing the cost.

Compensation issues dominate macro coordination.
Questions concerning how cooperatives should be compensated
are addressed. Possible changes in behavior as a result of
changes in the way cooperatives are compensated for these
services are discussed. The question of marketwide
information's role in improving the match between aggregate
supply and demand is also analyzed. Research results are
also included in this chapter.

7.2 Seasonal Balancing

7.2.1 Cooperative G
7.2.1 a Background

This cooperative has attempted to be compensated
for the marketwide service of seasonal balancing.
Cooperative G tried to amend seven Marketing Orders in the
Southeast to allow for hauling credits to meet excess fluid
demand or dispose of excess supply (USDA, News Division,

pp.4-5) . This cooperative undertakes several balancing

134

activities. In the fall, it brings in milk from areas
where it doesn't have members. The cooperative brings in
milk from the Midwest, Southwest, Pennsylvania, and
Maryland to meet the needs in its market. Cooperative G
has to pay to obtain this milk; from July 20, 1987 to the
middle of October of 1987 the net cost to the cooperative
of obtaining this milk was 1.2 million dollars.

Cooperative G also undertakes balancing
activities in the spring. This cooperative handles more
than its pro rata share of the seasonal flush: it operates
butter, powder, and. cheese plants. Since 1983, these
plants have been closed from July until March and operate
at near full capacity from March through June. The fixed
costs that are not covered when these plants are idled is a
major cost of balancing that cooperative G bears.
7.2.1 b Micro - Micro Coordination

There is membership support for seasonal
balancing. There have not been many members who have left
the cooperative as a direct result of this service, but
there is a free rider problem. According to cooperative G,
the price their members receive is less than others in the
market because their members bear a disproportionate share
of the cost of the service (USDA, News Division, p.26).
Furthermore, testimony at the Federal Order' hearing' by
former members of the cooperative indicated that they left

the cooperative to obtain a higher price (USDA, News

135

Division, p.27) . Nonmember producers benefit from the
cooperative's seasonal balancing activities but do not bear
the cost. The proposed amendments to the Marketing Orders
were cooperative G's attempt to eliminate the free rider
problem (USDA, News Division, p.26). Free riders will
continue to be a problem as long as the cooperative is
placed at a competitive disadvantage because of the
marketwide services it pursues. They will be a problem as
long as those who do not belong to the cooperative receive
a higher price than those who do.

This cooperative bears much of the cost of
seasonal balancing. It was estimated that all cooperatives
in the market bear 90 percent of the costs of providing all
marketwide services, and cooperative G bears 60 percent of
the total in this market area. As noted, this places the
cooperative at a competitive disadvantage compared to other
market participants.

To offset the costs of balancing this market,
cooperative G attempted to obtain a hauling credit for
bringing in supplemental milk supplies: it tried to obtain
a credit of 3.3 cents a hundredweight per 10 miles distance
between shipping and receiving plants (USDA, News Division,
pp.4-5). This credit was based on actual costs borne by
the cooperative. The cooperative also tried to have the
Orders amended so that it was compensated for operating

plants that process seasonal reserves. The payment this

136
cooperative tried to receive for this service varied from
62 to 94 cents per hundredweight depending on the Order
(USDA, News Division, p.5). This was an attempt by the
cooperative to cover the fixed costs of the plants when
they are not in use.

There was widespread membership support for
having the Orders amended. The members of the cooperative
are aware of the fact that they bear a disproportionate
share of the cost of these services, and as a result, their
net price is less than nonmembers. The reason this
cooperative tried to amend the Orders was to address the
free rider problem. The primary opposition to these
proposed amendments came from processors and fluid
handlers who were afraid that cooperative G would gain
market share. The fact that the cooperative was not able
to get the Orders amended will affect both micro and macro
coordination.

7.2.1 c Micro Coordination

If the cooperative stopped its seasonal balancing
activities it feels that several things would happen.
Prices would rise in the fall and there would also be
seasonal price fluctuations. The price level would also
fall toward the order minimum. The over - order premiums
would be reduced because the cooperative would not have to
be compensated for the service. Another result would be

the inefficiencies that would occur from milk moving in an

137
unstable manner.

This cooperative believes that there would also
be market disruptions because all handlers and
manufacturers would have to obtain outside sources of milk
during the fall and winter, and obtain an outlet for excess
milk in the spring and summer. Seasonal balancing
insulates processors and fluid handlers from the potential
instability and uncertainty and reduces the potential for
over or underinvestment in the dairy subsector. In this
part of the country where there are so few firms, poor
investment decisions could cause serious market
disruptions. There are also economies of scale from having
only one or a few organizations performing the activity of
seasonal balancing.

There is a free rider problem at the micro level
as well as the micro - micro level of coordination.
Limited service cooperatives as ‘well. as jprocessors. and
fluid handlers benefit from the balancing activities this
cooperative undertakes without paying for them. This
cooperative does not possess sufficient market control to
be completely compensated for these services through over-
order premiums. It currently charges proprietary firms
for balancing but cannot completely offset the total cost
of this service due to the level of competition in the

market.

138
7.2.1 d Macro Coordination

Cooperative G attempted to have the Marketing
Orders in the area it operates in amended: their effort was
unsuccessful. This cooperative has tried to Ihave the
Orders amended since 1971, the primary rationale for
amending the Orders was to eliminate the free rider
problem. How this cooperative will change its operating
procedures as a result of the decision will have effects on
macro coordination.

If a cooperative is not able to obtain sufficient
compensation for the service, it is less likely to provide
it. A cooperative may not ship milk from outside sources
and it may be less willing to give up milk for the fluid
market. Alternatively, a cooperative could increase the
price it charges its customers. However, if the
cooperative does not possess the control over the market to
enforce a price level that covers the cost of balancing it
will lose customers. If this is the case, the cooperative
will likely cut back on its balancing activities.

This would adversely affect coordination. This
would likely lead to fluctuations in supplies and prices,
and could lead to over or underinvestment in this market
area. Macro coordination will be adversely affected if a
cooperative does not possess the market power to force
processors and fluid handlers to bear some of the costs of

balancing.

139
7.2.2 Cooperative H
7.2.2 a Background

Cooperative H is another cooperative that
provides the marketwide service of seasonal balancing. In
this market, seasonality of production varies by a
difference of 10 percent between the highest and lowest
months of production. Due to this, and the fact that the
demand for fluid milk also varies seasonally, the
cooperative balances the seasonal surplus.

This cooperative makes milk available for fluid
consumption in the fall and winter by idling manufacturing
plant and equipment. During these months plant utilization
is approximately 70 percent of capacity and therefore some
fixed costs are not covered. This is the cooperative's
major balancing expense which the membership partially
bears. This cooperative usually does not have to transport
milk to seasonally balance the market.

7.2.2 b Micro - Micro Coordination

There is membership support for providing this
service. However, there is also strong support from the
membership to pay their "fair" share for these services and
no more. This cooperative is well aware of the fact that,
due to the public good characteristics of these services,
other market participants benefit from marketwide services
without bearing any of the costs. As a result of the fact

that the cooperative's membership is adversely affected by

140
this situation, some producers have left the cooperative;
competition amongst handlers has led to a reduction in the
cooperative's membership. The free rider problem is an
issue in this market.

The cooperative estimates that the cost of
providing the marketwide services of seasonal balancing and
marketwide information is 19 cents a hundredweight. The
over - order premium helps offset this cost but it does not
address the free rider problem. All producers, whether or
not they belong to the cooperative, receive the same blend
price. The incentive to free ride on the cooperative's
activities still exists in the presence of over - order
premiums.

This cooperative is not unique in providing this
service. There is another cooperative. that balances
supplies in this area. Also, any processor has the ability
to give milk to the fluid market in the short season if it
elected to do so. However, cooperatives are the only
market participants actually balancing supplies.

7.2.2 c Micro Coordination

Cooperative H believes that micro coordination
would also be adversely affected if this cooperative
stopped providing the marketwide service of seasonal
balancing. The primary result would be increased market
volatility. Fluid handlers would have to operate

manufacturing plants or have to pay the cost of

141

transportation in order to handle milk in excess of their
fluid needs. Technical efficiency is likely enhanced by
having one or two organizations balance supplies in this
market: there are apparently economies of scale in
performing seasonal balancing activities. In this market,
there are two cooperatives that currently balance seasonal
supplies. This is less costly than having each
proprietary firm balance its own seasonal supplies. In
summary, due to the fact that the cooperative balances
seasonal supplies, net costs to market participants are
lower than they otherwise would be, and market stability is
enhanced.

There is also a free rider problem at the micro
level as well as the micro - micro level. Processors and
fluid handlers are insulated from fluctuations in supply
and demand without having to pay for this insurance. This
fact reduces the cooperative's ability to provide this
service and the cooperative's membership suffers because
they bear the cost of providing the service. Also, other
cooperatives that do not provide seasonal balancing
services benefit from the increased market stability that
results from cooperative H's balancing activities without
paying for the service.

7.2.2 d Macro Coordination
As noted above, coordination is enhanced through

the increased technical efficiency cooperative H provides

y 142

by performing the service of seasonal balancing. If the
Order is amended, there would not be an effect on the price
level. The over - order premiums would not be affected.
Instead, pool funds would be reallocated so that
cooperative H's producers would receive more than they
currently do. Total farm income would remain the same but
the members of cooperative H and other market participants
who perform the service of seasonal balancing would no
longer bear a disproportionate share of the cost. The free
rider problem would be alleviated by amending the Order.

The critical problem this cooperative faces in
balancing seasonal supplies is the free rider as outlined
in the micro - micro and micro sections of this chapter.
In order for basic market performance goals to be met this
service needs to be offered, and over time, the cooperative
has performed this taskn The cooperative 'may’ not be
uniquely qualified to balance seasonal supplies but it is
one of the few participants actually willing to provide
this service. Macro coordination would be adversely
affected because per hundredweight balancing costs would
be higher and the market would be less stable if the
cooperative stopped balancing supplies. Currently, the
cooperative is at a competitive disadvantage because it
bears a disproportionate share of the cost. Cooperative H

could offset some of this cost if the Orders were amended.

143
7.2.3 Cooperative I
7.2.3 a Background

This cooperative is very active in seasonal
balancing. Cooperative I is part of the Chicago Milk
Producers Cooperative (CMPC), a cooperative federation
that operates in the Chicago market. Cooperative I
balances seasonal supplies in two ways. In the fall and
winter, it takes milk out of its manufacturing plants to
meet fluid demand. In the spring, when the milk supply is
greatest, this cooperative opens up its excess capacity to
handle this milk. Furthermore, it transports milk to near
and distant markets.

Also, through the CMPC, the market is split so
that all cooperatives share in the burden of balancing
supplies. While much of the burden of balancing falls on
cooperative I, other cooperatives also participate in
balancing activities. The major cost of balancing is the
foregone profit of the manufacturing plants in the fall.
Average costs rise when the plants are not operated at full
capacity. However, cost estimates are difficult or
impossible to obtain.

7.2.3 b Micro - Micro Coordination

Cooperative :membership, although. more informed
than nonmember producers, may not be totally aware of the
function of seasonal balancing. The primary effect of

balancing on coordination is primarily at the macro level,

144
and secondarily at the micro level. However, stability
both to members and nonmembers, is improved because price
fluctuations are reduced as a result of the balancing
activities of operating manufacturing plants and
transporting milk.

However, the service is somewhat of an issue with
the membership. Some of the membership is aware of the
fact that the cooperative is bearing a disproportionate
share of the cost of balancing. It was estimated that this
cooperative bears approximately 80 percent of the cost of
balancing and that the share of the cost borne by this
large cooperative rises in the cooperative's southern
region which is not part of the CMPC. This is reflected in
the fact that the price received by the membership is a few
cents less than nonmember producers. Some members have
left due to the fact that the price for members is somewhat
lower and others may not have joined the cooperative for
the same reason. However, actual numbers are not possible
to obtain. Producers may not realize that they are free
riders, they do not intentionally take advantage of the
cooperative, but apparently react to the net price they
receive.

7.2.3 c Micro Coordination

Cooperative I believes that seasonal balancing

has several effects on micro coordination in this market.

It adds stability and enhances technical efficiency. It

145

enhances stability by reducing seasonal price fluctuations.
It reduces "boom - bust" cycles that would result in the
absence of seasonal balancing. It ensures a healthy dairy
industry in the flush spring period which allows it to meet
fluid demands in the short fall season. This activity
allows processors and handlers to know in advance the price
they will pay for Class I and Class II milk.

Technical efficiency is enhanced as a result of
one organization, the CMPC, balancing supplies. If
cooperatives did not balance supplies, the burden would
fall on individual fluid handlers and processors. Since
there appears to be economies of scale in manufacturing
plants (Ling 1983, pp.10, 18, 21), the total cost of
balancing seasonal supplies would probably increase if
cooperatives, such as cooperative I, did not undertake this
activity.

There is also a free rider problem at the micro
level in this market. As noted, seasonal balancing is a
high exclusion cost good. This fact makes seasonal
balancing more difficult. Processors, fluid handlers, and
small cooperatives benefit at the expense of large
cooperatives, such as cooperative I, which bear the brunt
of’ the cost of seasonal balancing. Performance would
likely be improved if these costs could be shared. The

CMPC is an attempt to share these costs.

146
7.2.3 d Macro Coordination

It is difficult to imagine how the market
cooperative I operates in would continue to function in an
orderly fashion without the seasonal balancing activities
cooperative I in 'particular, and the CMPC in general,
undertake. Cooperatives are uniquely qualified to
undertake seasonal balancing activities. Not only is
stability and technical efficiency enhanced but price wars,
as well as shortages and surpluses are reduced. Without
cooperative involvement, uncertainty would increase,
decisionmaking would be more difficult, and there would be
disruptions of the fluid market. Price fluctuations would
be a result.

Furthermore, cooperative I argues that without
the CMPC, cooperatives would also engage in price wars and
would be unwilling to supply fluid needs in the fall. The
CMPC allows cooperatives to act together instead of
competing in a way that would destabilize the market. An
interesting aspect of the CMPC's activities is the
committed supply credit, a type of contractual agreement in
which fluid handlers and cooperatives agree to commit
themselves to handle or meet supplies on a 365 day basis.
This adds stability, reduces uncertainty, and helps match
supply with demand. This insures that supplies will be
available in the fall.

One problem currently faced in this market is

147

cooperatives's willingness to take cheap milk in the
spring and summer and their reluctance to give up milk in
the fall and winter. Committed supplies, and the power of
the CMPC, reduces this problem and improves macro
coordination or at least prevents macro coordination from
being adversely affected. Without the CMPC, those
cooperatives that balance supplies would bear an even
greater share of the cost.

It is obvious that coordination of this market at
both the micro and macro levels would be difficult without
the CMPC. This cooperative federation shares the costs of
various services and presents a unified voice in
negotiations with proprietary firms. It prevents predatory
pricing in this highly competitive market and gives
cooperatives such as cooperative I sufficient control over
the market to undertake these activities without loss of
profitability or market share. Without the CMPC and the
control it gives member cooperatives, marketwide services
such as seasonal balancing' may not exist. No single
cooperative has enough control over the market to undertake
various marketwide services.

There is a free rider problem in this market.
There are some processors, fluid handlers, producers, and
limited service cooperatives that benefit from the seasonal
balancing services cooperative I and the CMPC provide but

do not pay for the service. This is due to the fact that

148

seasonal balancing is a high exclusion cost service. The
CMPC helps maintain the market power needed to insure that
those cooperatives that balance supplies do obtain some
payment through the over - order premiums for providing
this service. Cooperative I, which actively balances
seasonal supplies, benefits from the over - order premiums.

Cooperative I and the CMPC are in favor of being
compensated for these services through over - order
premiums. This allows flexibility in charging for these
services. The cooperative feels that obtaining accurate
cost estimates for most of these services is difficult and
the over - order premium provides an umbrella payment for
all marketwide services. However, it should be noted that
cooperatives may not have an incentive for obtaining cost
estimates for these services. If the .total cost of
providing the service was less than the over' - order
premium, it would be argued that cooperatives are earning
excess profits. It may be the case that the over - order
premium does represent charges for marketwide services and
profit.

Cooperative I is in favor of amending the Federal
Order to obtain credit for transportation. Of all
marketwide services transportation is amongst the easiest
to understand and the cost estimates of transportation are
amongst the easiest to obtain. Cooperative I, in

conjunction with the CMPC, amended the Order. Neither

149
cooperative I nor the CMPC are attempting to receive direct
compensation through the Federal Order for seasonal
balancing.
7.2.4 Cooperative J

There is membership support for this service. In
the past, the cooperative has received 1 cent a
hundredweight for operating balancing facilities. This
cooperative is also currently able to charge handlers for
seasonal balancing, and the reduced output due to the DTP
has made seasonal surpluses less of an issue. Also, this
cooperative has not transported milk in the past to balance
supplies. For these reasons seasonal balancing is not
currently much of a coordination issue.

However, balancing could conceivably be an issue
in the future. This cooperative does possess the means to
balance supplies. Also, this cooperative is attempting to
institute a base - excess plan in the Order to reduce
seasonal supply fluctuations. Should there once again be
an increase in production, the cooperative will find itself
in a position to perform the service of seasonal balancing.
If this occurs, problems such as the free rider and the
cooperative membership's share of the cost will become

coordination issues.

150
7.3 Marketwide Information

7.3.1 Cooperative G
7.3.1 a Background

Cooperative G supplies several types of
marketwide information. Ilt provides market analysis, and
current market information. It also provides policy
evaluations, particularly in respect to national programs:
this includes lobbying. Furthermore, it provides
information on amendments to Federal Milk Marketing Orders.

Cooperative G also provides marketwide
information on technical developments, an example of this
being information concerning bovine growth hormone. It
provides information to all producers on quality and
production, such as methods to reduce somatic cell counts
and proper milk parlor maintenance. This cooperative also
provides field services and demonstrations for all
producers.

Cooperative G also attempted, to amend the same
Orders to allow for payment for marketwide information as
it did for seasonal balancing. Under its proposal, a
cooperative would have received 3 cents a hundredweight
from the producer settlement fund for providing this
service. However, cooperative G defined a qualified
cooperative in such a way that it would usually be the only

cooperative eligible for the payment (USDA, News Division,

pp.6-8).

151
7.3.1 b Micro - Micro Coordination

There is widespread support amongst the
membership for the marketwide yinformation services
cooperative G provides. There is also somewhat of a free
rider problem with marketwide information as well as
seasonal balancing. In fact, one of the information
services this cooperative provided was to inform producers
about the concept of the free rider and the problems that
they cause. Due to the free rider problem there was strong
support from the cooperative's membership to have the
Orders amended. Cooperative G also works with other
cooperatives in providing information to their membership.
This cooperative also bears much of the cost of supplying
marketwide information.

It was estimated cooperative G bore 60 percent of
the cost of providing marketwide information. In order to
offset this cost, the cooperative attempted to amend
several Federal Milk Marketing Orders in its operating
area. This cooperative tried to obtain a 3 cents a
hundredweight assessment for providing marketwide
information (USDA, News Division, pp.6-7). This was based
on actual cost estimates. It was intended to cover the
costs of salaries, travel expenses, and publications.
Determining the costs of marketwide information was
somewhat more difficult than estimating the costs of

seasonal balancing. _ Nonetheless, it is the member

152
producers who bear the cost of the service through lower
net prices.

Producers derive many, benefits from the
information services this cooperative provides. Knowledge
of policy and marketing information helps producers plan
for the future. This adds stability and reduces the
possibility of producers over or underinvesting in fixed
assets. Also, through various information services, the
cooperative helps producers make decisions concerning feed
costs and whether or not they should grow their own feed.
This also affects producer planning for the future.

7.3.1 c Micro Coordination

This cooperative asserts that the marketwide
information it provides also benefits manufacturers and
fluid handlers. This market area's milk supply was
unusually short this fall: on July 1, 1987 cooperative G
met ‘with. manufacturers and fluid. handlers in order to
determine how to meet their needs. Efforts like this allow
processors and fluid handlers to plan ahead and make price
decisions. The information services cooperative G provides
allows fluid handlers to improve their decisionmaking
abilities concerning long term commitments and to decide
whether or not to obtain new producers. It helps them
determine and analyze current and future market
fundamentals. Through the cooperative's market analysis

processors are able to adjust their labor requirements,

153
output mix, and to make other management decisions. These
services reduce uncertainty at the micro level of
coordination. If the cooperative stopped providing
marketwide information, the planning just outlined would
be more difficult and the level of uncertainty would
increase.

There is also a free rider problem at the micro
level. Limited service cooperatives as well as processors
and fluid handlers benefit from the marketwide services
cooperative G provides but does not pay for them.
Furthermore, manufacturers and fluid handlers were opposed
to having the Orders amended. They were afraid that this
cooperative would gain market power.

7.3.1 d Macro Coordination

There are other organizations besides
cooperatives which could provide marketwide information.
University extension services, and government agencies
such as the ACS, or the Agricultural Marketing Service
(AMS), could also provide some of these information
services. These two entities also serve as a source of
data for the cooperative. However, given current budget
limitations, the future role of public organizations in
providing information is in question. Government budget
reductions may make the cooperative's marketwide
information services even more important, less information

available to all market participants will increase

154
uncertainty.

Some of the marketwide information services
cooperative G provides directly help match total supply
with total demand. One example of this is through the
information the cooperative provided dairymen which showed
them that increasing production in the Southeast would not
lead to lower prices. In fact, net producer income would
be increased because dairymen would not have to bear any of
the cost of transporting milk from outside areas. In this
high Class I utilization market, increased production would
not lead to lower prices.

There are other types of marketwide information
that enhance macro coordination. This cooperative
provides projections and estimates as well as price
information to all market participants. This cooperative
also provides analysis of legislative issues and acts as a
lobbyist. Furthermore, it works with other organizations
in providing national dairy advertising. These marketwide
information activities are all the more important given the
asset fixity problem in the dairy subsector. These
activities help ensure that there is a market for the
products these assets produce.

Cooperative G attempted to have several Marketing
Orders amended so that it could be compensated for
providing marketwide information but it was unsuccessful.

This cooperative is currently studying its options in light

155

of this fact. It is too early to state exactly how it will
change its operating procedures with respect to the
activity of providing marketwide information. Given the
fact that this cooperative lacks the means to be fully
compensated for providing‘ marketwide information it is
likely that it will reduce the level of marketwide
services it provides. Furthermore, had the Orders been
amended, performance measures would have been explicitly
stated and for any cooperative to be compensated it would
have been forced to meet these criteria.
7.3.2 Cooperative H
7.3.2 a Background

Cooperative H also provides a number of
marketwide information services. Its monthly member
publication is also distributed to proprietary firms and
the land grant university in the state where its members
produce milk. Furthermore, it provides and sponsors
leadership conferences, member meetings, and marketing
seminars which tend to be more member oriented. The
cooperative's management is a source of expert knowledge to
the media and elected officials. This type of information
reaches any market participant who has access to the media.

Cooperative H is also active in providing policy
information. Cooperative H is active in the Federal Milk
Marketing Orders. It provides testimony in support or

opposition to amendments to the Order in addition to

156

formulating its own amendments to the Order. Cooperative H
is also part of the National Milk Producers Federation
(NMPF), which is an organization comprised of cooperatives;
this organization analyzes dairy subsector issues and
interacts with policymakers at the national level.
Nonmember producers, as well as the cooperative's
membership, benefit from the information services this
cooperative provides.
7.3.2 b Micro - Micro Coordination

There are several types of information services
this cooperative provides that improves a producer's
decisionmaking abilities and therefore enhances
coordination. Situation and outlook information keep
producers abreast of :market conditions. This type of
information helps producers plan for the future. This adds
stability and reduces the possibility of over or
underinvestment in dairy production. Also, producers are
given information on dairy policy issues at the national
level through the NMPF. This also helps producers plan
for the future and gives them a voice in making policy.

Cooperative H also provides information on farm
management issues. An example is the potential utilization
of bovine growth hormone. The cooperative also works with
the extension services and the Dairy Herd Improvement
Association in providing information services to producers.

An interesting aspect of some information

157

services is that it provides feedback between the
cooperative's management and its member producers. This
helps the cooperative's management meet membership needs,
and gives producers a voice in policy issues and other
areas of interest to the membership. The decisionmaking
capabilities of the cooperative's management is improved.
The major form of feedback is the annual local producer
meetings which provide a forum for the membership to air
their concerns. Communication is two way, and through this
feedback, the ties between management and membership are
strengthened.

As noted in the discussion of seasonal balancing,
there is a free rider problem. The over - order premium
helps offset this cost but it does not address the free
rider problem. Other cooperatives which provide marketwide
information in this area face the same problem.

7.3.2 c Micro Coordination

Cooperative H provides processors and fluid
handlers with information that improves their
decisionmaking abilities. The cooperative provides
processors and fluid handlers with projections of future
supplies and prices. This improves their ability to plan
for the future and to adjust their labor requirements. It
also allows processors and fluid handlers to make
adjustments in their manufacturing capacity or make

improvements in existing plants with more confidence about

158

the future. This reduces the probability of proprietary
firms over or underinvesting in plant and equipment and
also enhances stability. Cooperative H has also given
proprietary firms information concerning some of the issues
that the dairy subsector faces if the CCC purchases more
than 5 billion pounds of milk in 1987. This also helps
processors and fluid handlers plan for the future.

Cooperative H also offers other types of
information to processors and fluid handlers. It provides
fluid handlers with information concerning fluid supplies,
this helps fluid handlers meet their commitments. This is
less of a problem in this market because the cooperative
has made the effort and will continue to make the effort to
meet the demands of fluid handlers. This cooperative does
not offer much information concerning demand fundamentals,
processors and fluid handlers do this themselves.

If this cooperative stopped providing marketwide
information several things would occur. To a great extent,
information is part of the overall package cooperatives
offer proprietary firms as a part of supplying their needs.
The free rider problem is more of an issue with nonmember
producers than with proprietary firms. However, if the
cooperative stopped providing marketwide information, it
feels that other sources besides ‘the: cooperative ‘would
become more important. Examples of these alternative

sources of information ‘would be 'the «extension service,

159
private industry, or government agencies.
7.3.2 d Macro Coordination

The cooperative provides several types of
information that aid in matching aggregate supply and
demand in this market. Cooperative H provides information
concerning Marketing Orders, and through the NMPF provides
policy information. This improves the decisionmaking
abilities of those who formulate and carry out policy. The
cooperative also provides information concerning the level
of CCC purchases to market participants. The cooperative
has also stressed the importance of discretion in analyzing
potential production increases and helps farmers analyze
their cash flow. These information services reduces the
potential for overinvestment in dairy production and the
surpluses that this overinvestment would cause. This
directly enhances macro coordination.

Cooperative H provides a wide range of
information on a number of other issues. In the past, it
has provided information on the DTP that helped producers
determine their bid. It is currently working on ways to
increase the diversification and market development of
dairy products. Also, the cooperative is analyzing the
future competitiveness of the dairy industry in this area
as compared to other parts of the country. This also
improves the decisionmaking abilities of a wide range of

market participants.

160

The cooperative is not currently attempting to
amend the Federal Order to be compensated for providing
marketwide information, nor does it appear that it will
attempt to do so in the near future.

7.3.3 Cooperative I
7.3.3 a Background

Cooperative I undertakes several marketwide
information activities. The cooperative publishes a
membership magazine which has a limited readership. For
the most part, only the cooperative's membership reads it,
but there are some marketwide information aspects of the
publication. Also, there are meetings with the board of
directors. These meetings inform the board, and the
members of the board disseminate this information via word
of mouth throughout the market area. Again, the membership
is most likely to be the greatest direct beneficiary of
this type of information. Cooperative I also conducts
several meetings of various size throughout the states
where the cooperative has members. There are also some
marketwide aspects of this type of information.

The management and leadership of cooperative I
are also a source of information. Radio and print media
use this resource for expert information and their
knowledge is disseminated throughout the market area.
Another major activity this cooperative undertakes is its

political actions. These activities provide information to

161
policymakers at the federal and state levels. Cooperative
I also provides information and. interacts ‘with.'various
bureaucracies, in particular the AMS, that has effects on
coordination.

There are some infermation activities that
primarily affect processors and fluid handlers.
Cooperative I and the CMPC exchange information with
processors and fluid handlers that deals with various
market conditions that these market participants face.
Also, cooperative I provides information on a weekly basis
that gives the total butterfat and protein levels in the
milk supply.

7.3.3 b Micro - Micro Coordination

Cooperative I is actively involved in providing
marketwide information, much of which benefits its
membership. The cooperative disseminates information
through its member publication. Some of this is repackaged
in a form that is easier for producers to use from raw data
and information from such sources as university extension,
the National Dairy Board, or the NMPF. USDA data is also
used. The cooperative also provides expert knowledge for
the local press which benefits all producers and other
market participants.

The cooperative also provides information on
policy issues as well as farm management information. This

improves the decisionmaking abilities of producers in

162

analyzing both policy and production problems. An informed
producer is better able to deal with changing conditions in
the marketplace. Cooperative I is able to inform producers
whether or not a processor is financially able to meet his
commitments, whether or not he can pay the producer. This
information helps aid the decisionmaking abilities of
producers.

There are other forms of marketwide information
that affect micro - micro coordination. Cooperative
management interacts with its membership through board
meetings, delegate sessions and smaller meetings throughout
the area where the cooperative has members. Some of the
information disseminated through these meetings is spread
throughout the market area via word of mouth.

This cooperative feels that providing information
to members is a very important activity. Information the
cooperative provides and the feedback it gets from its
membership adds cohesion to the cooperative. It gives the
members of the cooperative a sense of common purpose and
unity as well as a sense of belonging amongst those
involved with the cooperative. This interaction also
allows the membership to be involved in policy issues. The
cooperative is the voice of the membership at the state and
federal levels. Furthermore, this information gives the
cooperative a higher profile among nonmembers and can be

seen as good public relations for cooperative I.

163

Membership information services are crucial for the
cooperative to keep the membership informed and involved in
the cooperative's activities. The cooperative could not
exist as such without membership information services.

These information activities make the membership
more aware of what services, marketwide and other, the
cooperative performs. This has made the membership aware
of the fact that they are bearing a disproportionate share
of the cost of providing the service. A. very rough
estimate is that 60 percent of the cost of providing
marketwide information is borne by the cooperative. Net
pay prices are lower than nonmember pay prices and this
acts as an incentive for producers to leave the cooperative
or not join the cooperative. However, it cannot be
determined how many producers have quit or have not decided
to join cooperative I because of this fact. There is a
free rider problem but it is difficult to quantify or
analyze in any depth.
7.3.3 c Micro Coordination

Cooperative I provides processors information
concerning the quality of milk. Cooperatives test their
membership's milk, and processors and fluid handlers are
given information concerning the composition of the milk
supply. The cooperative gives processors and fluid
handlers information concerning butterfat and protein

content.

164

In addition to information about the composition
and quality of milk, the cooperative also provides
proprietary firms with information concerning market
conditions. Cooperative I provides manufacturers and fluid
processors with information concerning prices, terms of
trade, and other market conditions. This enhances
stability in the market and improves competition.
Marketwide information increases processors and handlers
knowledge of market conditions and this leads to a
reduction in price disruptions (Stigler, p.214).
Processors and handlers as well as consumers may be
unwilling or unable to make the requisite investment in
information, therefore the marketwide information services
provided by the cooperative reduce price dispersion and
reduce instability (Stigler, p.220). These information
activities also enhance the technical efficiency of
processors and fluid handlers. Daily interaction between
the cooperative, processors, and fluid handlers allow
proprietary firms to alter their bottling and manufacturing
schedules and reduce per unit costs.

More information helps ensure that all market
participants are treated equitably. The cooperative feels
that if it did not provide these marketwide information
services this information would likely become proprietary.
Market participants in the dairy subsector are of different

size and possess different degrees of market power, the

165

marketwide information cooperatives provide help maintain a
"level playing field" (Bonnen, p.16), a market in which all
participants are treated equitably, and enhances
competition in the dairy subsector. Without the marketwide
information services provided by the cooperative, the
market power and profits of proprietary firms would likely
increase.

7.3.3 d Macro Coordination

Macro coordination is improved in this market
through the information that is exchanged between the
cooperative and processors and fluid handlers. Through
this flow of information the decisionmaking abilities of
the market participants is improved. There is less market
disruption and instability as a result of these services
and there is less overpayment or underpayment for dairy
products as a result of this service.

Cooperative I also provides information to
policymakers at various levels. It discusses policy issues
with elected officials. This helps their decisionmaking
process. Cooperative I also works with various government
agencies such as the AMS to analyze and discuss market
conditions. These activities also help match aggregate
supply with demand and gives dairy producers a voice in
dairy policy issues.

This cooperative is not attempting to amend the

Order to be compensated for marketwide information.

166

However, it is not possible for the cooperative to be
compensated voluntarily for these services due to the free
rider problem. If some market participants did compensate
the cooperative and others did not, those that did would be
placed at a competitive disadvantage. The cooperative does
receive indirect payment for marketwide information through
the over - order premium set by the CMPC. Over - order
premiums give cooperatives, as well as other market
participants, greater flexibility than would the Orders if
they were amended to include payment for marketwide
information.

7.3.4 Cooperative J

7.3.4 a Background

This New York cooperative already receives an
assessment for both seasonal balancing and marketwide
information. These payments are part of the New York - New
Jersey Marketing Order. This Order is unique in that it
allows cooperatives to be paid for providing marketwide
information.

In order for cooperative J to be compensated it
must meet certain conditions. It must analyze milk
marketing problems and possible solutions, and prepare
relevant statistical data. It must also analyze and
prepare amendments to the Federal Milk Marketing Order and
participate in Order amendment proceedings. The

cooperative must also participate in meetings called by the

167

Market Administrator and present data at such meetings.

Also, a qualifying cooperative must conduct a
comprehensive education program for all producers, not just
the cooperative's members. This includes issuing
publications and conducting educational meetings (Market
Administrator, p.23). These conditions must be met for a
cooperative to be compensated for marketwide information.
7.3.4 b Micro - Micro Coordination

The basic conditions that this cooperative must
meet to obtain a payment from pool funds have been
outlined. In order to meet these requirements, the
cooperative provides several types of information
services. This cooperative makes its member publication
available to all producers in the market at a subscription
rate of one dollar per year. This publication provides
information to producers concerning marketing, policy, and
a range of farm management issues. Cooperative J also
provides press releases through the director of public
relations and provides the local media with expert
personnel. These types of information are available to all
market participants and provides information on market
conditions and various policy issues.

Another very important marketwide information
activity this cooperative provides are educational meetings
with producers. In order to qualify for payment these

meetings must be open to all producers, members and

168

nonmembers alike. This cooperative, and another
cooperative that operates in this market, undertake these
meetings in a joint venture in order to reduce costs and
eliminate repetition. The emphasis of these meetings is on
price and marketing issues: producers receive a great deal
of situation and outlook information at these meetings.
These meetings cannot be held more than 50 miles away from
any one producer.

These services do improve the decisionmaking
abilities of producers. Some of the dairy farm management
information has improved milk quality through lower somatic
cell counts. However, the meetings focus on marketing and
policy. This information helps producers plan for the
future, dairymen make future production decisions using the
information on prices and supplies .based on the
information the cooperative provides. It also provides
forecasts based on possible changes in the support price
which also aids dairymen's decisionmaking abilities
concerning the future.

The cooperative receives 3 cents a hundredweight
for providing the marketwide service of marketwide
information, but these information services cost the
cooperative 12 cents a hundredweight. The Order payments
to the cooperatives that provide these services have not
increased since 1954. Currently, it does not appear to be

politically feasible to have the payments increased. This

169
leads to some serious problems. While the existing
membership supports providing the service, they are placed
at a competitive disadvantage because they make up the
difference between the cost of providing the service and
the payment the cooperative receives.

This ‘market is 'unique in that only about 50
percent of the producers are members of a cooperative.
Furthermore, cooperative J has lost members and others
have refused to join the cooperative because the
cooperative bears the cost of providing the services. It
is felt that if the cooperative received more for providing
the services more producers would join the cooperative.
Nonmember producers who free ride on' this cooperative's
information services are a critical issue in this market.
7.3.4 c Micro Coordination

This cooperative actively interacts with
processors and fluid handlers. Information flows between
the cooperative and proprietary firms allow them to
interact with each other and give both the cooperative and
the proprietary firms the opportunity to discuss each
other's needs and problems. The information flows help
meet the supply and demand needs of each of the
participants and enhances micro and macro coordination.

An example of this is the cooperative's working
with proprietary firms in analyzing the Marketing Order.

In the fall of 1987, the IMarket .Administrator’ had to

170
institute a call provision in order to insure that the
demand for fluid milk was met. The cooperative helped
processors and fluid handlers understand how the call
provision worked and its effects.

If the cooperative stopped providing marketwide
information services several things would happen. Over
time, the Marketing Order would fall into disrepair,
changes in the Order would not be as responsive to changes
in marketing conditions as they currently are. According
to the cooperative, the Orders would become obsolete and
chaos in the entire market would result. Analysis of the
potential of consolidating the Orders in this area or the
possible increase in Class I prices would not have occurred
without the cooperative's involvement, either directly or
through the NMPF.

The free rider is an issue. It would not be
possible for individual producers to supply this type of
information. They lack the background and the resources to
provide information on Marketing Orders and other types of
marketing information. Apparently there are economies of
scale in providing marketwide information as well as
seasonal balancing. Furthermore, independent producers who
benefit from the cooperative's services without paying for
them is the biggest problem the cooperative faces. The
free rider is less of an issue with processors and

handlers. A great deal of the information flows are part

171
of the cooperative's natural milk marketing operation.
7.3.4 d Macro Coordination

As noted, this cooperative operates in an unique
market area. This cooperative is compensated for providing
the marketwide service of marketwide information. However,
this cooperative's costs are not fully covered.
Cooperative J has yet to decide whether or not it will
attempt to amend the Order so that its payments from the
pool will increase. If more of the cooperative's costs
were covered, performance would likely be improved.

If the cooperative received more from pool funds
it would be able to provide more and improved information
services if it so desired. The services could be more
sophisticated and the presentation of information could be
‘improved. Currently, the cooperative's information
services are at the minimum level to meet the conditions
for payment under the order, it might possibly do more if a
greater proportion of its costs were covered.

If the cooperative were paid more for providing
the service, prices would likely increase. The position of
the cooperative's membership would improve because they
would bear less of the cost of the service. This, in turn,
would make membership in the cooperative more attractive.
Processors and fluid handlers would then have to raise the
prices they pay their producers in order to keep them from

joining the cooperative, proprietary firm profits would

172
fall as a result. This would likely occur because so few
producers are members of a cooperative in this market. In
this manner, prices paid to producers would increase if the
cooperative were paid more for providing marketwide
information.

The cooperative's marketwide information services
primarily enhance macro coordination through its services
to producers. The cooperative feels that the primary
supply and demand balancing mechanism is the support price.
However, through the producer meetings, the cooperative
provides outlook and situation information that allows
producers to plan for the future and adjust their
production patterns. It is through this type of marketwide
information that total supply in the market is affected to
match demand more closely.

Another form of marketwide information that
affects macro coordination is through the cooperative's
activities with the NMPF. This allows dairy cooperatives
to provide information to policymakers that improves their
decisionmaking capabilities concerning Marketing Orders and
other dairy policy issues. This cooperative is also active
in providing information and amendments to the Marketing
(Irders which improve the performance of this institution.

7.4 Findings
Both seasonal balancing and marketwide

illformation enhance the vertical coordination of the

173

subsector: hypothesis III holds. Seasonal balancing
enhances coordination by reducing market instability and
directly matching supply and demand in different markets.
This is particularly true in the Chicago market. All
market participants benefit from the cooperatives's
seasonal balancing activities. Seasonal balancing exhibits
economies of scale. The cost of seasonally balancing a
market is lower if one or a few organizations carry out
this activity. Technical efficiency is enhanced by having
a few market participants carry out this activity.
Cooperatives appear to be the only market participant
willing and able to undertake this activity.

Marketwide information also enhances vertical
coordination at all levels. Cooperatives offer a wide
range of marketwide information services.- The information
services enhance the decisionmaking abilities of producers,
proprietary firms, government officials, and other
subsector participants. This reduces the possibility of
over or underinvestment in the subsector. Stability is
also improved as a result of the marketwide information
services supplied by cooperatives. Much of this
information improves communication flows between the
cooperative and other subsector participants. This is
particularly ‘true. for information. flows and. interaction
between the cooperative's management and membership.

Micro - micro coordination in particular, is enhanced as a

174
result of some of the.:marketwide information. services.
This adds cohesion to the cooperative and gives it a sense
of unity.

As a general rule, cooperatives are placed at a
competitive disadvantage with respect to other subsector
participants as a result of performing marketwide services.
They bear a disproportionate share of the cost of providing
these services which benefit other subsector participants
as 'well. Free riders, especially' nonmember' producers,
place the cooperative at a disadvantage and likely reduce
the cooperative's ability or desire to pursue these
activities.

If cooperatives do not receive sufficient
remuneration for providing these services several things
are likely to happen. The cooperative is less likely to
provide these services at the level they would if they did
receive compensation. This will adversely affect
coordination: in particular, markets will become less
stable. Also, cooperatives are more likely to turn to the
Orders or form cooperative federations to address this
issue. Federations could give cooperatives enough market
control to receive adequate compensation for providing
marketwide services.

Cooperatives have two means at their disposal to
receive compensation for providing' marketwide services.

They could amend the Orders, which is becoming more common:

175

or they can charge over - order premiums, obtaining prices
above the minimum Class I price set by the Orders, which is
quite common in some areas. The major problem with over-
order premiums is that they do not eliminate the free
rider, there is still an incentive for producers to leave
the cooperative and nonmembers to stay out of the
cooperative that performs marketwide services. Also,

over - order premiums do not explicitly state the costs of
marketwide services.

Most of these problems would be eliminated if
compensation for marketwide services were made part of the
Federal Order. Cost and performance criteria would be
explicitly stated. Furthermore, all market participants
would share the costs of these services: the free rider
,problem would be eliminated. The major problem with
amending the Orders is loss of flexibility. Cooperatives
would be constrained by the regulations when faced with
changing market conditions. Despite this fact,
cooperatives are increasingly looking to the Marketing
Orders as a way to perform marketwide services without
being placed at a disadvantage.

7.5 Summary

Four' case study' cooperatives *were selected ‘to
test hypothesis III. Relevant personnel were interviewed
in order to collect the information needed to test the

hypothesis. It was determined that the marketwide services

176
of seasonal balancing and marketwide information enhance
coordination in a number of ways.

Cooperatives are essential_in balancing seasonal
supply and demand fluctuations. This entails
transportation of milk and/or operating manufacturing
plants to handle the seasonal surplus. Seasonal balancing
adds stability, and helps match supply with demand. This
service also exhibits economies of scale. Technical
efficiency is improved if only a few participants provide
this service. Cooperatives appear to be the only
subsector participant willing and able to undertake this
activity. Coordination at the micro - micro, micro and
macro levels is improved as a result of these
cooperatives's seasonal balancing activities.

Coordination is also improved as a result of the
cooperatives's marketwide information activities.
Marketwide information improves the decisionmaking
abilities of all subsector participants and therefore
enhances coordination at the micro - micro, micro, and
macro levels. The potential for over or underinvestment is
reduced, and stability is improved as a result of the
information services provided by cooperatives.

The provision of these services often place the
cooperative at a competitive disadvantage. Free riders are
a particular problem. If this continues, the ability and

desire of cooperatives to perform these services will

177
decline. In order to receive some compensation for
providing marketwide services, cooperatives have charged
over - order premiums. Also, cooperatives are turning to
the Federal Orders to receive compensation for providing

these services.

CHAPTER 8: FURTHER ASPECTS OF COOPERATIVES AND VERTICAL

COORDINATION

8.1 Introduction

The last three chapters have analyzed three
activities cooperatives undertake. The effects of these
activities on vertical coordination at the micro - micro,
micro, and macro levels have been discussed. This chapter
is an attempt to synthesize the previous chapters and to
state and analyze four conditions or issues that impact the
cooperative's ability to affect vertical coordination. It
is an attempt to draw generalizations from the experiences
of the case study cooperatives.

There appear to be two conditions needed for a
cooperative to be able to enhance coordination at various
levels. The first is member support and the second is a
degree of control over the market. Furthermore, if
cooperatives lack sufficient control they can turn to
various types of regulations and policies. Some conditions
and issues are more important at some levels of
coordination than others. This makes generalizations
difficult. There are also certain aspects of cooperatives
that are unique. This uniqueness also affects
coordination, particularly at the micro - micro level.

178

179
8.2 Micro - Micro Coordination
8.2.1 Member Support

In order for a cooperative to be successful in
carrying out coordinating activities it must have the
support of its membership. This is a critical aspect of
micro - micro coordination. Cooperatives are an unique
form of organization in that they are controlled by the
membership. Dairy cooperatives are successful only when
the membership contributes actively to the cooperative:
those associated with the cooperative share one or more
common goals such as profit maximization; and when
communication among those associated with the cooperative
is present (Helmberger and Hoos, p.277). In order for a
cooperative to be successful micro - micro coordination
must be sound.

It was stated by several of those interviewed
that the primary goal of the cooperative was to maximize
the profits of its member producers. If the cooperative is
successful in maintaining prices that are higher than, or
equal to, the rest of the market, it will not have a
problem in keeping its membership or maintaining its market
position. Micro - micro coordination will remain sound.
However, if a cooperative is placed at a competitive
disadvantage because of the coordinating activities it
pursues it will face problems. Producers will leave the

cooperative, which will lead to a reduction in the control

180

a cooperative has in the market and a loss of support.
Examples in this research of this fact are the marketwide
services case studies of cooperatives G and J, as well as
the supply management case studies of cooperative E, and to
a lesser extent, cooperative F. Cooperatives need the
support of their membership to undertake coordinating
activities.

8.2.2 Education

The management of the cooperatives are aware of
this fact. This is why cooperatives offer education
programs and conduct. member' meetings. The case study
cooperatives undertake a wide range of education activities
that inform the membership about the various functions the
cooperative performs. These educational activities also
address some of the problems and issues that the
cooperative faces.

Information flows from the management to the
membership and vice versa. Cooperatives allow producers to
state their concerns and to assist in formulating and
implementing cooperative policies. This happens at member
meetings, when the cooperative conducts member surveys, and
whenever a vote on a cooperative's policy is held. These
are common practices among dairy cooperatives. These forms
of communication allow the membership to influence or
determine the policies of the cooperative. Information

flows help management and membership identify and meet

181
cooperative goals and enhance micro - micro coordination.

8.2.3 Micro - Micro and Other
Levels of Coordination

Dairy cooperatives will adjust their practices in
order to gain member approval. In this study, cooperatives
were particularly responsive to the questions raised by the
membership in regards to multiple component pricing and
supply management. Sometimes, in order to be responsive to
members, the cooperative may alter its practices in a way
that reduces the cooperative's ability to enhance
coordination at the micro and macro levels.

The case studies provide examples of this.
Cooperatives A and B, due to the level of competition in
the market area,.and membership concerns, have used their
MCP systems as a gimmick and not as a method to enhance
coordination. Cooperative C has developed its system in a
way that reduces member controversy. Cooperative F
eliminated its supply management program. when supplies
tightened and it appeared that it would lose membership if
it continued its base - excess plan. Cooperative E's Class
I plan became less popular with its membership with the
passage of time and its program was also eliminated.
Cooperatives that provide marketwide services may alter
their practices because their members are bearing a
disproportionate share of the cost of providing these

services.

182
8 . 3 Micro Coordination

8.3.1 The Uniqueness of
Cooperatives

The previous discussion pointed out the
importance of membership support in undertaking
coordinating activities; this fact affects micro
coordination. Cooperatives give producers the opportunity
to express themselves and allow them to negotiate with
proprietary firms in a unified manner. This gives
producers a degree of power or strength that varies from
market to market. Cooperatives allow producers to pool
their resources in a way that concentrates milk supplies.

Cooperatives also appear to act as a "missing
hero" in undertaking some coordinating activities. They
perform functions that enhance coordination at all levels
that no other participant is willing or able to undertake.
An excellent example of this is the marketwide services
cooperatives provide. Proprietary firms benefit from some
of these activities. This can cause problems if the
cooperative is placed at a competitive disadvantage as a
result of performing these coordinating functions.
Membership concerns will arise. Again, a classic example
of these conditions is marketwide services. Cooperatives
are also uniquely qualified to perform some coordinating

activities for other reasons.

183
8.3.2 Economies of Scale

The size and scope of the dairy cooperative's
role in the subsector was outlined in the first chapter.
This size allows the cooperative to undertake some
coordinating activities at the lowest possible cost.
Cooperatives can undertake some coordinating activities
that improve the coordination of the subsector at a lower
cost per hundredweight than other subsector participants,
especially processors and fluid handlers. They exhibit
economies of scale that other participants cannot match.
An example of this is the marketwide service of seasonal.
balancing.

Technical efficiency is enhanced when
cooperatives take advantage of these economies of scale.
This improves coordination at the micro and macro levels.
Coordination is also improved when cooperatives use this
unique characteristic to enhance the stability of a market.
Cooperatives are also uniquely qualified to help manage the
flow of product because most of the milk in a given market
is controlled by them. Examples are seasonal balancing and
supply management.

8.3.3 Control and Competition

Cooperatives can be constrained in enhancing
coordination at the micro level by competitive pressures.
If, for example, they cannot pass on some of the cost of

providing marketwide services through over - order premiums

184

performance is likely to decline. There are free rider
problems that cooperatives face when they undertake some
coordinating activities. The effects of nonmember
producers can also adversely affect a cooperative's
program. An example of this was the effect of nonmember
dairymen's response to cooperative E's supply management
program.

A cooperative needs some level of control to
pursue micro coordination activities. One way to obtain
control is through cooperative federations. A cooperative
federation is an organization comprised of cooperatives in
an attempt to pool resources, work towards common goals and
achieve a degree of market control that an individual
cooperative cannot obtain. Cooperative federations are a
type of horizontal integration. However, there are few
examples of successful federations.

One of the best known federations in the dairy
subsector is the CMPC, which has already been discussed in
some detail. The CMPC operates in an area of the country
where there are many cooperatives and the vast majority of
producers belong to cooperatives. The market area the CMPC
operates in also produces more milk than any other part of
the country. If the cooperatives did not work together
through the CMPC, predatory pricing would likely result.
This would adversely affect micro coordination by

destabilizing the market. An individual cooperative in

185
this market does not have the ability to enhance
coordination at the micro or macro level on its own, it
would be too small. Other actors would take advantage of
an individual cooperative. The CMPC addresses these
potential problems.

Another cooperative federation is the Regional
Cooperative Marketing Agency (RCMA) which is based in the
Northeast. This federation is relatively strong in the New
England states and is trying to extend its influence into
the New York - New Jersey area. The RCMA does not have
the control over the market the CMPC has. In New York,
only about 50 percent of the producers belong to
cooperatives. The RCMA is currently not as effective as
the CMPC, but there appears to be growing interest in the
federation. A major goal of both the RCMA and the CMPC is
to increase the profitability of dairymen. Again, the
importance of improving the welfare of member producers is
the overriding reason for a cooperative activity or
institution.

8.4 Macro Coordination

8.4.1 The Importance of
Control

In order for a cooperative to successfully match
supply with demand for an entire market, some degree of
market power or control is needed. Sometimes, as is the
case with supply management, control is essential. Control

reduces the risk cooperatives face when they undertake

186

macro coordination activities. It also gives the
cooperative the ability' to reduce the chance of being
placed at a competitive disadvantage as a result of the
coordinating activities it undertakes. An example is a
cooperative that possesses enough control to be able to
offset the cost of providing marketwide services through
over - order premiums.

The level of control needed to pursue
coordinating activities varies. For some activities, such
as administering a supply management program, a cooperative
must dominate the market. Cooperative D may be in such a
position, cooperative E was not. Cooperatives G and J
lack the market power to receive adequate compensation for
providing marketwide services. This may adversely affect
macro coordination. Cooperatives H and I,.which are in a
stronger market position, are able to obtain higher over-
order premiums. Also, a cooperative has to be a certain
size in order to capture economies of scale.

It is difficult for cooperatives to dominate a
market. This is why federations are formed. Milk, in its
raw state, is basically a homogenous product. A
cooperative's ability to dominate a market is limited by
even a minor alternative source for processors and fluid
handlers of this homogenous product. Milk is also a
perishable commodity, a cooperative cannot store or hoard

the product in its raw state to bid up the price.

187
8.4.2 Membership Issues

However, the biggest reason why a cooperative
cannot dictate the terms of sale is that it cannot control
supplies unless it operates in a geographically separated
market, and the membership agrees to curb production.
Cooperative D may be in such a position, but east of the
Rockies controlling supplies via the use of a quota, Class
I, or allocation program is impossible. Alternative
supplies are too easily available.

If a cooperative is successful in obtaining
higher prices, member producers will increase production
which will have a depressing influence on future prices.
Cooperatives cannot control the output levels of the member
producers and therefore are constrained by the fundamental
supply and demand conditions in the- market area.
Cooperatives, because they are responsive to the needs of
their membership, must find a market for their milk.

8.4.3 Regulation

Cooperatives, because they generally lack
control, have turned to regulation. Macro coordination may
be improved either through changes in Marketing Orders, or
through alterations in national policy. A major reason why
regulation should be introduced in some instances is to
have performance criteria explicitly stated. In order for
a cooperative to be compensated for carrying out certain

activities, it would have to meet these standards. Also,

188
the cost of carrying out these activities would be
explicitly stated. Regulation would help cooperatives
that do not have sufficient control to effectively pursue
coordinating activities on their own.

However, there are disadvantages to regulation as
well. While it is true that performance criteria could be
explicitly stated and cooperatives would no longer be
placed at a competitive disadvantage, flexibility would be
lost. Taken to an extreme, if all aspects of marketing
dairy products were made part of the Federal Orders,
cooperatives and others would have to amend the Order every
time marketing conditions changed.

An interesting aspect of each of the coordinating
activities studied in this research are their policy
implications. Performance would be improved if MCP systems
became part of the Order. Uniformity would be assured and
there would be improved enforcement of the program. This
would mean that all market participants would be treated
the same. Also, premiums and deductions could be equated,
this is currently impossible in highly competitive areas
such as those where cooperatives A and B market their
milk. In addition, performance would likely be enhanced if
the fluid standards were raised. There is little reason to
raise the fluid standards to the level of those currently
imposed in California. Hewever, the consistency of fluid

milk would be improved if the standards were raised to the

189
average of raw milk currently produced.

If a supply management program designed to curb
chronic surpluses is to be instituted it will have to be
nationwide in scope. Most of the discussion has been
focused on the Federal Orders. Marketing Orders are not
the instrument for eliminating interyear surpluses.
Cooperatives, by themselves, do not have sufficient control
over the market to administer such a program unless they
operate in an isolated area. Seasonal supply management
programs such as base - excess plans could be, and have
been, part of the Federal Milk Marketing Orders.

Cooperatives could administer such a program if
they are given the authority. They have the experience to
deal with producer concerns, and administering a supply
management program would be a natural. extension of
transporting and testing milk, and writing member checks.
Currently, the vast majority of cooperatives do not possess
sufficient market control to administer a supply management
program. Forces beyond the cooperative's control would
work to make the program ineffective.

Marketing Orders should be amended to allow
cooperatives to receive payment for providing marketwide
services. Performance criteria would be explicitly stated
in the Order. For a cooperative to be eligible for
compensation it would have to meet these criteria. If the

cooperatives are compensated for performing these services

190
the free rider problem would be eliminated. Cooperatives
would no longer bear a disproportionate share of the cost
of providing these coordinating activities that have clear
public good characteristics.

8.4.4 Cooperatives and the
Public Sector

Cooperatives are also in some respects uniquely
qualified to work with the public sector. This has
definite effects on macro coordination. Cooperatives allow
producers to act together and air their concerns about
dairy policy and other issues. The NMPF is an example of
dairy cooperatives working together to inform policymakers
about dairy issues. Also, cooperatives are able to work
with land grant universities to develop extension programs
which help analyze the various aspects of the dairy
subsector and to disseminate this type of analysis.

Dairy cooperatives may also be in an unique
position to step in and provide services the public sector
is no longer able to provide. Given the budget constraints
various government agencies and land grant universities
face, these subsector participants may reduce their
coordinating activities. .An example of this would be
providing marketwide information. Cooperatives will likely
have to step in and provide these services if the public

sector reduces its role in the dairy subsector.

191
8.5 Synopsis

This research has uncovered two conditions and
two issues involving cooperatives and vertical
coordination. In order for a cooperative to be successful
in undertaking coordinating activities it must have the
support of its membership and at least some control over
the market. If it lacks this control, regulations imposed
through amendments in the Marketing Orders or changes in
national policy can allow a cooperative to pursue
coordination activities without adversely affecting the
welfare of its membership. Cooperatives are uniquely
qualified to pursue some coordinating functions.

Membership support is a necessary condition for a
cooperative to undertake coordinating activities. The
management of cooperatives are responsive to the concerns
of their membership. Education and other types of
information flows improve member - management relations.
Cooperatives are excellent coordinating institutions at the
micro - micro level. The management of cooperatives will
not hesitate to adjust their programs to ensure membership
support and approval. Without membership support,
cooperatives will not perform functions that would improve
micro or macro coordination.

Another necessary condition is the need for a
cooperative to have a certain degree of market control and

be a certain size to perform some coordinating activities.

192

This is particularly true for those activities that affect
macro coordination. The level of control necessary to
enhance coordination varies from activity to activity. If
a cooperative does not possess sufficient control it may be
placed at a competitive disadvantage if it undertakes some
coordinating activities. This will eventually reduce the
cooperative's ability and desire to pursue those
activities. Examples in this research were supply
management and the marketwide services. This may lead to
inferior performance in the subsector.

If cooperatives lack sufficient control they can,
and indeed have, turned to regulation. This regulation can
protect the cooperative when it performs coordinating
activities and can promote stability and uniformity in a
market. This would affect micro and macro coordination.
One advantage to instituting this regulation is that it
would force cooperatives to meet explicit performance
criteria. A disadvantage is that the cooperative's
flexibility to meet changing market conditions would be
reduced. The Marketing Orders should be changed to
include MCP systems, payments for marketwide services, and
base - excess plans. If society desires, a supply
management program designed to eliminate chronic surpluses
will have to be nationwide in scope.

Cooperatives are uniquely qualified to perform

some coordinating activities. This makes the role of the

193
cooperative crucial in the coordination of the subsector at
all levels. Cooperatives allow producers to work together
toward common goals and gives them the ability to interact
with other subsector participants. Also, cooperatives
pursue coordinating activities that other subsector
participants are not willing or able to pursue. Due to the
large size of some cooperatives, they are able to enhance
technical efficiency at the micro and. macro levels of
coordination by pursuing activities that exhibit economies
of scale. The role of the cooperative in the subsector may
become even more important if the role the public sector
plays is reduced in the future.

This list of issues and conditions concerning
cooperatives and vertical coordination is not exhaustive.
Rather, the conditions of membership support and market
control, and the issues of regulation and uniqueness were
common in the analysis of the coordinating activities that
were the focus of this research. Further analysis of
these, or other, coordination activities may lead to the
discovery of further conditions and issues facing dairy
cooperatives in the coordination of the subsector.

8.6 Summary

Cooperatives are unique organizations. This
uniqueness makes micro - micro coordination very important.
Dairy cooperatives put the needs and desires of their

membership first when undertaking coordinating activities.

194
This means that cooperatives place more emphasis on micro-
micro coordination than micro or macro coordination.

A necessary condition for cooperatives to pursue
coordinating activities is membership support. In order to
obtain this support, management undertakes educational
activities. There is a great deal of information that
flows between the management and membership of the
cooperative. These information flows help those involved
with the cooperative to come to decisions concerning the
goals and policies of the cooperative.

Cooperatives are uniquely qualified to perform
some micro coordination activities. They provide a
mechanism for dairymen to interact with fluid handlers and
processors. Cooperatives act as "missing heros" in
undertaking some activities that only they perform. Also,
due to the economies of scale many cooperatives possess,
they can perform some coordinating activities at a lower
cost than other market participants.

However, cooperatives can be constrained by
competitive forces. Free riders and alternative milk
markets can reduce the cooperative's ability to perform
some coordinating activities. Cooperatives are unlikely to
perform coordinating activities if their membership is
placed at a competitive disadvantage. Some cooperatives
have formed federations in an attempt to eliminate some of

these problems.

195

As a general rule, control is necessary if a
cooperative is to enhance macro coordination. Performance
of the case study cooperatives would improve if they had
more control. This is particularly true for the MCP case
studies and some of the marketwide services case studies.
Almost complete market control is needed for a strong
supply management program to be effective. Somewhat less
control is needed for a cooperative to administer a
seasonal supply management program.

Market control is difficult to obtain which has
forced cooperatives to look for alternatives, particularly
changes in the regulations. Performance would be enhanced
if multiple component pricing, payments for marketwide
services, and base - excess plans were made part of the
Federal Orders. Whether or not a supply management program
designed to eliminate chronic surpluses should be
instituted on a nationwide level is a decision society as a

whole has to make.

CHAPTER 9: CONCLUSIONS, RESEARCH RESULTS, AND TOPICS FOR

FURTHER RESEARCH

9.1 The Cooperative's Place in the Dairy Subsector

Cooperatives are major actors in the dairy
subsector. As noted in the first chapter, cooperatives
have become the primary source of fluid milk and are also
major producers of manufactured products. They have been
involved with various aspects of marketing for more than
one hundred years. The size and scope of dairy
cooperatives are important characteristics given the
coordination problems inherent in the dairy subsector.

Milk is a highly perishable and bulky product.
Furthermore, the seasonality of production and consumption
are not matched. Another very serious problem in the dairy
subsector is the fact that many assets used in the
production of dairy products are fixed, they cannot be used
for anything else. There are also biological lags in dairy
production that makes coordination difficult and planning
for the future important. Cooperatives have undertaken a
wide range of activities that address these and other

problems.

196

197
9.2 Research Methods

This research stressed vertical coordination, or
matching supply and demand, at three levels. The first
level was coordination within the cooperative, particularly
between the membership and the management: this was
referred to as micro - micro coordination. The second
level of coordination analyzed ‘was :matching' supply' and
demand between cooperatives and proprietary processors and
fluid handlers; this was referred to as micro coordination.
The final level of coordination was matching aggregate
supply with aggregate demand for a particular market; this
was referred to as macro coordination.

This framework simplified the analysis and
allowed the research to fecus on the three major nodes of
vertical coordination. Furthermore, it allowed the
researcher to identify coordinating activities and issues
and the various levels of coordination that were affected
by the activities pursued by dairy cooperatives. This was
done in the second chapter. I

As Table 4 shows, cooperatives undertake a wide
range of activities that affect the vertical coordination
of the subsector. In order to make the research manageable
three activities were selected. They’ were: 'multiple
component pricing, supply management, and the marketwide
services of seasonal balancing and marketwide information.

These, coordinating activities were selected because they

198
are issues of current interest to those involved in the
subsector. This is particularly true of supply management
and marketwide services.

The cooperatives selected were chosen for a
number of reasons. The MCP cooperatives were selected
because they had an historical record. Also, cooperatives
that administered SNF and protein programs were selected.
There are very few cooperatives that have attempted to
administer supply management programs without government
involvement of one form or another. The supply management
programs selected in this research constitute much of the
total number of cases which could have been selected.

The marketwide services cooperatives were also
selected for a number of reasons. One was selected because
it tried to have the Orders amended and. failed in its
attempt, and another was selected because it currently
receives some payment from the Order for providing the
marketwide services studied. The other cooperatives were
selected because they undertake the marketwide services of
seasonal balancing and marketwide information, and they are
large cooperatives in their market area and charge over-
order premiums.

There are other characteristics of these
cooperatives which should be noted. All of the
cooperatives are vertically integrated into some

manufacturing activities, and several are involved in

199

handling fluid milk as well. Several of the cooperatives
are the dominant source of milk in the market.
Geographically, the case study cooperatives were ‘widely
dispersed, all areas of the country, with the exception of
the Rocky Mountain region and California, were represented.
.Some of these similarities were not anticipated but likely
reflect the important role dairy cooperatives now play in
the subsector.

The method used to test the hypotheses was
analysis by case study. Personal interviews with a wide
range of cooperative management were used to collect the
information to test the hypotheses. This technique allows
a researcher to gain in depth information from a wide
range of experiences on the coordinating activities
studied. Utilizing case studies is also a natural way to
conduct any type of vertical coordination research. The
theory of vertical coordination is far from complete, there
is no standard approach to vertical coordination issues.
Using case studies applied to a particular subsector adds
experience and provides information which can be used in
future research efforts. It also allows others to follow
and to either verify or reject the research results.

9.3 Research Results

9.3.1 Multiple Component
Pricing

Several conclusions regarding MCP systems can be

stated. As a result of these systems, producers have

200

reduced the somatic cell and bacteria counts of their milk.
This has improved the quality of milk produced by the
members of the case study cooperatives and has increased
the productivity of manufacturing plants. This has been
the primary improvement in coordination as a result of the
MCP systems. There has not been any change in SNF or
protein levels as a result of the programs nor has there
been any change in the seasonality of SNF or’ protein
content in milk. Currently, the expense to a dairyman of
increasing the SNF or protein level in his milk does not
justify itself.

Hypothesis I can be accepted in that coordination
at all levels has been slightly improved as a result of the
MCP systems studied. However, these systems were not
instituted in order to adapt to changes in the demand for
dairy products. Rather it was an attempt by cooperatives A
and B to provide a pricing system that member producers
wanted. Cooperative C instituted its system to improve
equity amongst its member producers. It wanted to increase
the returns of those producers whose milk yielded the most
manufactured product.

Producer support, or at least the absence of
producer antagonism, is needed for an MCP system
administered by a cooperative to be successful. MCP
systems have proven to be very popular with the membership

of cooperatives A and B. In fact, a primary reason why

201
cooperative B instituted its program was to satisfy
producers. Cooperatives A and B operate in very
competitive markets and premiums paid to producers are
greater than deductions from producers.

Cooperative C's experience is somewhat different.
The impetus for this program came from the management
rather than the membership. However, producers did have
input in the design of the program and the program has been
designed in such a way that 70 percent of the producers are
not affected by the program. In cooperative C's case,
deductions and premiums are approximately equal, and the
MCP system is not a major issue.

Control over the market is apparently not needed
to administer an MCP system. It could be argued that in
the case of cooperatives A and B the MCP systems indicate a
lack of market control. If these cooperatives had more
market control the system would likely be administered
differently. The systems were offered to please
membership, and in the case of cooperative A it led to an
increase in membership. Cooperative C is one of only two
participants in its market area that administers an MCP
system, but because there is little effect on the
membership or on processors and fluid handlers, the program
is not controversial nor has it led to market disruption.
While market control is not needed to administer an MCP

system, it is probably the case that the more control a

202
cooperative has over a market, the more effective an MCP
system is as a coordinating mechanism.

The biggest issue with .MCP systems is the
potential disruption of the fluid market: this would
adversely affect micro and macro coordination. This has
not occurred. The fluid market is still the most
profitable outlet for milk, and it is too expensive for
cooperatives to differentiate between milk going to fluid
and manufacturing plants. If anything, the quality of milk
going to fluid markets has improved as a result of the
reduced somatic cell and bacteria levels. It should also
be noted that there has been little, if any, change in
proprietary manufacturer operating procedures as a result
of these systems.

Cooperatives are not uniquely qualified to
administer these programs although there are some
advantages to having them perform this task. In some
areas, particularly Wisconsin, proprietary firms
administer some type of MCP system. However, cooperatives,
because they are responsive to member needs, may be more
likely to adjust the systems. Also, they may be more
likely to test milk more fairly than proprietary firms.

MCP systems are mostly a producer issue. In
cases where these programs are popular with producers
micro - micro coordination is improved. The primary reason

why cooperatives A and B have instituted their MCP systems

203

is to improve member relations, not to meet changing
consumer demand. This is not the case with cooperative C
which instituted its MCP system to reward producers who
produce milk with a high SNF content, which yields more
manufactured product, and those who have low somatic cell
counts. Coordination at the micro and macro levels has
been improved slightly because milk quality has improved as
a result of these systems. Somatic cell and bacteria
levels have been reduced as a result of these systems.
Government intervention through regulation of the
Marketing Orders and increasing fluid standards would
improve coordination at all levels.
9.3.2 Supply Management

Hypothesis II holds if cooperatives have
sufficient control over the market. When cooperatives are
successful in instituting supply management programs
surpluses are reduced. This is true for both seasonal
supply management programs such as base - excess plans or
more stringent supply management programs such as allotment
programs or Class I plans. This enhances technical
efficiency because the need for building manufacturing
plants to process the surplus milk is reduced or
eliminated.

These programs must meet with the approval of the
membership in order to be instituted. Cooperative D spent

a considerable amount of time educating and interacting

204

with the membership to formulate a program that met with
membership approval. Cooperatives E and F spent less time
and effort on education programs because, in their cases,
the membership was more aware of how the programs worked.

Barriers to entry is another issue confronting
these programs. If a cooperative's program creates a
disincentive for producers to join the cooperative it will
lose market share. This was the experience of cooperative
E. Cooperative D has designed its program so that it does
not create barriers to entry. Whenever bases or quotas
become transferable and obtain value, new producers are
less likely to join the cooperative that administers the
program. Also, nonmember producers may increase production
and processors and fluid handlers may look for alternative
sources of milk. Cooperative D operates in a
geographically separated area and will accept new members
into its cooperative. Cooperative F's program was
administered in such a way that bases were adjusted
annually. The effectiveness of cooperative F's program was
strengthened by the fact that other cooperatives in the
market operate similar programs. Bases did not have an
intrinsic value and there were no barriers to producers for
joining the cooperative as a result of the program.

Producers do respond to the price signals
generated by the programs. The goals of cooperatives D and

F were met by the program. The need to build or lease

205

manufacturing plants to process excess milk was eliminated.
Cooperative E's program was also successful as long as it
had sufficient market control. Over time however, this
control was lost and the cooperative was unable to manage
supplies effectively. There was too much milk from other
sources. This is a ;problem facing all producers and
cooperatives east of the Rockies. Also, while the overbase
price reduced the incentive to increase production, it did
not completely eliminate it. Surpluses in cooperative E's
market area were reduced but not eliminated.

It should be noted that the results of
cooperative D and F's programs are affected by national
policies. The Diversion and DTP reduced the potential
pressure on these programs. In fact, cooperative F
eliminated its program because of the reduced supplies that
resulted from these policies. Cooperative D also raised
its overallocation price and reduced the period that
overallocation milk is penalized because of the DTP.
Currently, producers are penalized for producing over their
allocation only in the spring.

The fact that the programs were altered as a
result of the effects of national policies point out
another aspect of these programs: they are adaptable to
changing supply and demand conditions. Flexibility in the
face of changes in supply and demand conditions also

enhance coordination especially at the macro level.

206

Cooperative D will apparently increase allotment if the
need arises. It will also change the overallocation price
of milk or perhaps reduce the amount of allotment.
Cooperative E also altered its program in a number of ways,
but these alterations were aimed more at the cooperative
keeping its market position and less in an attempt to keep
supply and demand balanced. Cooperative F showed its
adaptability by eliminating its program when it was no
longer needed.
9.3.3 Marketwide Services

Cooperatives improve the coordination of the
dairy subsector at all levels by performing the marketwide
services of seasonal balancing and marketwide information.
Hypothesis III holds. Seasonal balancing reduces supply
fluctuations and stabilizes the market. _This stability
reduces price fluctuations, and the potential for over or
underinvestment in dairy inputs by all market
participants. Cycles of over or underproduction are
reduced as a result of the cooperatives's seasonal
balancing activities. Furthermore, because seasonal
balancing exhibits economies of scale, coordination is
improved because technical efficiencies result from one, or
a few cooperatives or organizations performing this
activity.

Vertical coordination at all levels is also

enhanced as a result of the marketwide information services

207

that cooperatives perform. These services reduce
uncertainty and improve the decisionmaking abilities of all
subsector participants. This adds stability to the
subsector, and reduces price fluctuations. Planning by
subsector participants is improved and the voice of dairy
farmers is strengthened on the national level by some of
the information activities that cooperatives pursue.
Chapter' 7 deals 'with the ‘various types of information
services that the case study cooperatives provide in
greater detail.

In order for cooperatives to provide these
services, there must be member support. This is
particularly true if the cooperative is placed at a
competitive disadvantage. The membership of the
cooperatives studied in this research are fairly aware of
the issues and problems the cooperative faces when pursuing
these balancing activities.

The biggest problem the cooperative faces is the
free rider. There are three types of free riders:
nonmember producers, limited service cooperatives, and
processors and fluid handlers. Marketwide services have
the public good characteristics of being high exclusion
cost, and joint - impact goods. This makes it possible for
others to free ride on the cooperative's activities. Some
cooperatives are able to charge over - order premiums which

help compensate cooperatives for providing marketwide

208
services, but there is still an incentive for nonmember
producers not to join the cooperative, and there is also an
incentive for members to leave the cooperative.

This fact makes it difficult for cooperatives to
perform these services. Cooperative G attempted to amend
several Milk Marketing Orders but was unsuccessful: it may
curtail the services it provides as a result. Cooperative
.J is not able to be fully compensated for providing these
services. If it did, the cooperative would likely improve
its marketwide information activities. Cooperatives H and
I are the largest cooperatives in their respective markets,
the free rider is less of an issue with them. This is
particularly true for cooperative I, which is part of the
CMPC and is able to negotiate high over - order premiums
and operates in a market where the vast majority of
producers belong to cooperatives that make up the CMPC.

The cooperative's position in. providing these
services is an unique one. The fact that there are
economies of scale in performing seasonal balancing
activities has already been mentioned. If cooperatives did
not perform the marketwide information services the
information would tend to fall into the hands of
proprietary firms. Cooperatives help provide a "level
playing field" between producers and proprietary firms.
Also, the cooperative's role in providing marketwide

information may become even more important should

209
government agencies and the extension service cut back on
the information services they provide.
9.3.4 Recommendations

MCP systems have come into existence and are now
firmly established without being incorporated into the
Federal Milk Marketing Orders. However, performance would
be improved if the MCP systems became part of the Orders.
Uniformity would be improved and there would be improved
enforcement of the program. Furthermore, all market
participants would be treated the same. Also, premiums and
deductions couLd be equated. This is currently impossible
in highly competitive markets such as those in which
cooperatives A and B operate. In addition, performance
would likely be enhanced if the fluid standards were
raised. There is little reason to raise the fluid
standards to the level of ‘those currently' enforced in
California. However, the consistency of fluid milk would
be improved if the standards were raised to the average of
raw milk currently produced.

Most MCP systems have become a way to gain or
keep producers rather than a method of enhancing
coordination. Making MCP systems part of the Orders would
improve uniformity and would be a mechanism for making the
system a method to ensure that milk has the
characteristics that consumers and processors desire rather

than a pricing gimmick. Making MCP systems part of the

210
Order would eliminate this deficiency.

Whether or not supply management should become
part of the dairy subsector depends on the policy goals of
society. The program would have to be nationwide in scope
to be effective. An exception is supply management
programs in geographically separated markets. Seasonal
supply management programs such as base - excess plans
could be, and have been, part of Federal Milk Marketing
Orders, but any program that would curb chronic surpluses
will have to be nationwide. It is likely that a good
opportunity to institute a supply management program was
lost after the DTP. A quota or other type of program could
have been instituted while supply and demand were
relatively closely matched. This opportunity may not
present itself again in the near future.

Cooperatives could administer such a program if
they are given the authority. They have the experience to
deal with producer concerns, and administering a supply
management program would be a natural extension of
transporting and testing milk and writing member checks.
Currently, the vast majority of cooperatives do not possess
sufficient market control to administer a supply management
program. Forces beyond the cooperative's control would
work to make its program ineffective.

Marketing Orders should be amended to allow

cooperatives to receive payment for providing marketwide

 

211
services. A major reason is that performance criteria
would be explicitly stated in the Order. For a cooperative
to be eligible for compensation, it would have to meet
these criteria. Also, if cooperatives are compensated for
performing these services, the free rider problem would be
eliminated. Cooperatives would no longer bear a
disproportionate share of the cost of providing the
coordinating activities that have public good
characteristics.
9.4 Further Aspects of Cooperatives and Coordination

9.4.1 Micro - Micro Coordination

One of the most obvious results of this research
is the cooperative's need for member support. The
management of the cooperatives studied are sensitive to
producer concerns. Without membership support, neither the
MCP nor the supply management programs would have been
instituted. These programs were adjusted to meet with
member support. It was also the case that cooperatives
allowed the membership to vote on these programs and
received feedback from the membership on these programs.
There is also membership support for the marketwide
services the case study cooperatives perform.

Cooperatives can alter their programs to meet
with member approval. This can have an adverse effect on
coordination. This is the case with cooperatives A and B's

MCP systems. Cooperative C, in an attempt to reduce member

212

resistance, designed its program in such a way that the
majority of producers were not affected. The supply
management cooperatives were also responsive to the
concerns of the membership when their supply management
programs were instituted and also adjusted them to meet
with membership approval.

Cooperatives are a unique form of organization.
The ‘management of the cooperatives interact. with. their
membership and are very reluctant to place their membership
at a competitive disadvantage. This has effects on the
cooperatives's ability to enhance coordination of the
market. Cooperatives are likely to pursue coordination
activities with less vigor than they otherwise would if
these coordinating activities place them at a competitive
disadvantage. This was particularly true in the marketwide
services case studies, and to a degree cooperative E's
supply management program.
9.4.2 Micro Coordination

Cooperatives appear to act as "missing heros" by
performing some coordinating activities that proprietary
firms are unwilling or unable to perform. This makes the
cooperative's role in coordinating the subsector crucial in
improving performance. An example of this is providing
marketwide services which not only improve the welfare of
the membership but also fluid handlers, manufacturers, and

other subsector participants.

213

Many cooperatives are also quite large.
Cooperatives handle most of the milk produced at one level
or another and are actively involved in many manufacturing
activities. Due to this fact, cooperatives are uniquely
qualified to perform some of the coordinating activities
that exhibit economies of scale. This enhances technical
efficiency. The marketwide service of seasonal balancing
is a good example. The size of many cooperatives point out
another condition for coordination, that of market control.

Some cooperatives, in particular, those who
operate in the Chicago Milk Marketing Order region, have
formed cooperative federations in an attempt to increase
their control at the micro and macro levels of
coordination. This is a type of horizontal integration.
Due to the fact that the CMPC includes the largest
cooperatives in the market, it is able to negotiate a high
level of over - order premiums, part of which go to pay for
marketwide services. Another such federation is the RCMA.
which is based in the Northeast. This cooperative
federation is less effective in negotiating over - order
premiums because there are more nonmember producers in this
market.
9.4.3 Macro Coordination

Some degree of market control is needed for most
of the coordinating activities cooperatives perform in the

dairy subsector. This is important if cooperatives are to

214

play a role in enhancing macro coordination. One of the
reasons MCP systems are not as effective as they could be
for cooperatives A and B is that they lack this control.
The lack of sufficient control was the fundamental reason
why cooperative E's supply management program was
eliminated. Cooperative D may have sufficient market
control to effectively administer its supply management
program. Cooperative F had sufficient control to
administer its program because less control is needed to
administer seasonal programs, and because other
cooperatives in this market area also used some type of
seasonal supply management program. In order for
cooperatives to have the ability to perform many marketwide
services they must also have some degree of market power.
The free rider problem is less of an issue in markets that
are dominated by a large cooperative or a cooperative
federation.

The necessary level of control needed varies from
activity to activity. For some coordinating activities,
such as supply management, a great deal of control is
needed. For others, such as MCP systems, much less is
required.

If cooperatives lack sufficient market control
they can try to change various regulations and policies.
One finding of this research is that uniformity and

stability would be improved if the Orders were amended to

215
include MCP systems. If supply management is to be
effective, a national program ‘would likely have to be
instituted. Marketing Orders are not the proper instrument
for a strong supply management program designed to
eliminate chronic surpluses.

Of all the coordinating activities studied,
regulation would play the biggest role in marketwide
services. Making payments for marketwide services part of
the Federal Orders would reduce, or eliminate, the free
rider problem. Cooperatives would no longer be placed at a
competitive disadvantage for providing these services.
Also, making payment for providing marketwide services part
of the Orders would explicitly state the performance
criteria that the cooperative would have to meet in order
to be compensated. However, regulation. should be used
with care.

There is a tradeoff between the benefits of
regulation and flexibility. If all cooperative, or for
that matter all dairy subsector, activities were regulated
it would be difficult to adjust to changing supply and
demand conditions. Cooperatives have proved themselves to
be flexible in regards to all the activities studied and
some of this flexibility may be lost if regulation

concerning these activities is introduced.

216
9.5 Further Research Needs

There is more need of quantitative work
concerning cooperatives and vertical coordination. Much of
the work involving these areas has been descriptive in
nature. One of the benefits of this research is that the
marketwide services of seasonal balancing and marketwide
information have been thoroughly discussed and analyzed.
There needs to be some quantitative research concerning
such issues as the optimum level of marketwide services 4
provided and the payment that cooperatives should receive
from the Order pool to complement this research. Also,
perhaps some cross cultural research concerning supply
management in the U.S. vis a vis other countries would also
be useful.

Another research area that should be explored is
further research into the coordinating activities
cooperatives perform. Table 4 in Chapter 2 outlined a wide
range of activities dairy cooperatives undertake. Research
into these activities may uncover more aspects concerning
dairy cooperatives and vertical coordination. Further
research into dairy cooperatives and the various
coordinating activities they pursue would add evidence to
support or reject the conclusions this research has
reached.

There is also a very critical need for further

development of the theory of vertical coordination. There

217
has been a great. deal of applied research on ‘various
subsectors concerning vertical coordination but the concept
itself remains nebulous. Currently a researcher can
determine various degrees of "good" or "bad" coordination
based on ‘various. performance goals but the nature and
theory of vertical coordination remains very
underdeveloped. All research in areas such as those
discussed within these pages would benefit from improved
theories of vertical coordination.
9.6 Final Statement

This research focused on the dairy cooperative's
role in the vertical coordination of the subsector. It
analyzed three coordinating activities that dairy
cooperatives perform by using case studies. It was
determined that coordination at all levels is improved
somewhat via MCP systems because the quality of milk has
improved. Also, technical efficiency is improved and
surpluses can be reduced through supply management programs
administered by cooperatives. The marketwide services of
seasonal balancing and marketwide information also enhance
vertical coordination at all levels by reducing uncertainty
and adding stability to the subsector in a cost effective
manner.

This research uncovered four aspects concerning
cooperatives and vertical coordination. In order for a

cooperative to effectively enhance vertical coordination,

218.
it must have the support of the membership and at least
some degree of market control. It was determined that
cooperatives are uniquely qualified to perform some
coordinating activities. Also, in order for cooperatives
to perform some coordinating activities, especially if they
lack sufficient market control on their own, regulations
such as Marketing Orders, or national policy, have to be

changed.

 

APPENDIX

 

I‘VE.

I.

1.

2.

3.

II.

1.

2.

3.

4.

APPENDIX

MCP QUESTIONNAIRE
General Questions '
Make sure background information is correct.
Effects on net income (producers and manufacturers).
How is the system funded.
Micro - Micro
Producers education and feedback.
Is it still an issue.

Lost membership; still in market: join another coop; why
left (SNF, protein or quality).

Changed production habits (SNF, protein, or quality).

III . Micro

1.

2.

3.

4.

IV.

1.

2.

3.

4.

5.

6.

Manufacturers and fluid processor response.

Outside sources of milk (did they obtain adequate
supplies).

Other organizations and MCP (are coops uniquely
qualified).

How have manufacturers and fluid processors changed
their operating procedures as a result of the program.

macro

Has there been a disruption of the fluid market (what
has the coop done to eliminate this problem).

Have manufacturers and fluid processors been willing to
pay for the increased quality.

Should the solids standards be raised.
Should MCP be made part of the Marketing Order.
How are the premiums determined.

Has the seasonality of SNF or protein been reduced.
219

220

7. Other problems faced by the coop.

I.

1.

2.

221
SUPPLY MANAGEMENT QUESTIONNAIRE
General Questions
Rationale for the program.
Price of excess milk.
Price of quota or base.
Level of control in the market.

Qualifications of the cooperative to manage supplies.

II. Micro - Micro

1. Member education and initial response.

2. Member feedback.

3. Lost membership to other coops (new entrants not join).

4. Did nonmembers increase production (what was the
effect).

5. Did quota or base transfers encourage high cost
producers to leave the market.

6. How are bases or quotas transferred.

III. Macro

1. Is the overproduction price low enough to discourage
production.

2. Does the cooperative have enough control over the area
(including processors and fluid handlers) to manage
supply.

3. Are fluctuations in supplies and prices reduced
(evidence).

4. For supply management to be effective will the Marketing
Order have to be amended.

5. Is the program flexible to changes in demand.

6. What other problems or issues did the cooperative face.

7. Why did the cooperative eliminate the program.

222
MARKETWIDE SERVICES QUESTIONNAIRE
I. General

1. What balancing activities does the coop undertake and
what does it cost (estimates). ‘

2. What marketwide information activities does the coop
undertake and what does it cost (estimates).

3. What other organization has, or could, provide these
services.

II. Micro - Micro
1. Is there membership support for these services.
2. Have members left the coop because of these services.

3. Have producers not joined the cooperative because they
free ride.

4. How has marketwide information improved the
decisionmaking abilities of producers.

5. How much of the cost of these services is borne by the
coop.

III. Micro

1. How does marketwide information affect the
decisionmaking abilities of processors and fluid
handlers.

2. What would happen if the coop stopped providing these
services.

3. Do free riders (other coops, manufacturers and fluid
processors) reduce your ability to provide these
services.

IV. Macro

1. Is the cooperative in favor of being directly
compensated for providing these services (how would its
behavior and level of over - order premium change).

2. Is the coop going to attempt to have the Marketing Order
changed so that it is compensated (how will its behavior
change if its attempt is unsuccessful).

223

3. What forms of marketwide information help match supply
with demand.

4. What additional problems does the cooperative face when
undertaking marketwide services.

5. Why was the coop unsuccessful in getting the Order
amended.

BIBLIOGRAPHY

 

a-l

BIBLIOGRAPHY

Alexander, C. and A. Novakovic. "What are the Potential
Impacts of Component Pricing," Hoard's Dairyman.
October 25, 1985, pp. 1103, 1112.

Babb, E.M. Milk Markering Seryiees Erevided by Cooperatives

end Ereprietary Eirre, Station Bulletin No. 279.
West Lafayette: Department of Agricultural

Economics, Agricultural Experiment Station,
Purdue University, 1980.

Blakley, L. V. Clase I Base glansl Agricultural Economics
Paper No. 7611. Stillwater: Agricultural
Experiment Station, Oklahoma State University,
1976.

Bonnen, J.T. "Agriculture in the Information Age."
Presented at the Agricultural Institute of
Canada, Saskatoon, Agricultural Economics Staff
Paper No. 86-78. East Lansing: Department of
Agricultural Economics, Michigan State
University, 1986.

Boynton, R.D. e o ids tanda s ssue Cornell
Agricultural Economics Staff Paper 83-5.
Ithaca: Department of Agricultural Economics,
Cornell University, Agricultural Experiment
Station, Cornell University, 1983.

Campbell, G.R. and T.S. Clevenger. An Institutional
V 'ca 0 d'nat'on ' A r'culture
NC 117, Working Paper No. 1. Madison: College
of Agricultural and Life Sciences, University of
Wisconsin - Madison, 1975.

Carley, D. et a1. ' a e e 'ces and Class I

Allgnmenr gensiderations; A Report to the goare

s at kes - Sout nc
East Lansing: Department of Agricultural
Economics, Michigan State University, 1971.

Christensen, R.A. ghoeld Qairymeg re Paid for Milk on the
aegis e: Eretein Contenr, Study Paper 74-1.

Logan: Economics Research Institute, 1979.

224

225

Cook, H.L. et al. The Qeiry Subsecrpr of American

 

Agricpltpre: . Organizetion and Vertical
gpordiperipp, NC Project 117, Monograph 5.

Madison: College of Agricultural and Life
Sciences, University of Wisconsin - Madison,

1978.
Cooperative A. Quel PACK.
Covington, C. "Half the Nation's Milk Could be on

Component Pricing," Moerd's Dairymanll December
10 and 25, 1986, pp. 1057, 1091.

Fallert, R.F., J.J. Miller, and L.G. Sleight. a' :
fleekgrpppe for 198p Farm Legisletipp, U.S.
Department of Agriculture, Economic Research
Service, Agriculture Information Bulletin 474.
Washington: U.S. Department of Agriculture,
1984.

Graf, T.F. (1984A). "Current Implementation Of Component
Pricing Plans." Presented at the 39th Annual
Milk Marketing Conference, Columbus, 1984.

Graf, T.F. (1977A). o ' t o r s'n Bo
Mpnfet egg Eer Values ip Milk, Agricultural

Economics Staff Paper Series No. 129. Madison:
University of Wisconsin - Madison , Cooperative
Extension Programs, 1977. .

Graf, T.F. Marge; Implications of Changing Fat Content of
Milk and Dairy Products, Agricultural Economics

Staff Paper Series No. 86. Madison: University
of Wisconsin - Madison, Cooperative Extension
Programs, 1974.

 

Graf, T.F. (1984B). "Protein and Quality Premiums Take Off

in Wisconsin,"_Mperg;e_peirymepr_June 25, 1984,
p. 773.

Graf, T.F. (1977B). Irapsporration ang orher Market
Seryicee Eerrormed by Cooperatives, Agricultural

Economics Staff Paper Series No. 133. Madison:
University of Wisconsin - Madison, Cooperative
Extension Programs, 1977.

Hamm, L. and S. Nott. The Qanadian Milk Quota §ystem: An
Apelysis and Comparison to the Michigan and U.S.
Deiry ngustry, Michigan State University,

Agricultural Economics Report No. 489. East
Lansing: Michigan State University, 1986.

226

Harrington, T.M. "Multiple Component Testing and Product
Yield Pricing of Milk." East Lansing: Michigan
State University, 1984.

Helmberger, P. and S. Hoos. "Cooperative Enterprise and

Organization TheorY-" 19urnal_9f_£arm_zsgngmis§l
(May, 1962), 275-290.

Henderson, J.M. and R.E. Quandt. Microeconomig Theopy:
t ' a o ' d d' '
New York: McGraw - Hill, 1980.

Hoard's Dairyman. "AMPI N.C. Region Begins SNF Payments,"
Heardl§_nairxmanl February 10. 1984. p. 142-

Hoard's Dairyman. "Land 0' Lakes Begins SNF Payment

Program," Mgapd's pgipypap, November 25, 1983,
p. 1420.

Hoard's Dairyman. -"We Produce Under Supply Management,"

Heardl§_nairxmanllJanuary 25. 1987. pp- 62-63-

Hubbard, L.J. "The Price of Dairy Quota in England and
Wales.” Presented at the Twelfth European
Seminar of Agricultural Economists, Helsinki,
1986. '

Jesse, E.V. and A.C. Johnson, Jr. 5p Analysis of
v - F ' '1
U.S. Department of Agriculture, Economic Research
Service, Technical Bulletin No. 1708.
Washington: U.S. Department of Agriculture,
1985.

Jesse, E.V. and A.C. Johnson, Jr. Mgpkgping Cooperatives
gag Undug Epige Enhancement: A Theopetigai

Egrspectiye, NC 117, Working Paper No. 46.
Madison: College of Agricultural and Life

Sciences, University of Wisconsin - Madison,
1980.

Johnson, T.R. "Milk Marketing in Arizona - A Regional Quota
System Approach.” 1987.

Jung, G.H. "Dairymen, Inc. - Our' Role in the Dairy
Industry." Presented at the Milk Marketing
Inservice Seminar, East Lansing, 1982.

Kaiser, H.M. "Alternative Voluntary Supply Management
Policies for the Dairy Industry," in Mandatory
me t - ' ol' 0 'o .

Ithaca: Cornell University, 1986.

 

227

Keltke. M-G- and L-V- Blakley- Effigiensie§_in_sentral
gpordination of Fiuig Milk Supplies Through
Dapperative Mergers: A Case Studv of tha_

Soprhgrn Region of Associated Milk ProdugersI
{nary Bulletin No. B - 777. Stillwater:

Agricultural Experiment Station, Division of
Agriculture, Oklahoma State University, 1985.

 

Knapp, J.G. o e ' a erat've nte r'ses'
1529 - i220, Danville: The Interstate Printers
and Publishers, Inc., 1969.

Ling, K.C. A gaaarya Daiapcing Boo; py D,§, Dairy

gpppgrariyaaryU.S. Department of Agriculture,
Agricultural Cooperative Service, Research

Report No. 51. Washington: U.S. Department
of Agriculture, 1985.

Ling, K.C. Dairy Droducr Manufacturing gosts at

ggoperative Plants, U.S. Department of
Agriculture, Agricultural Cooperative Service,

Research Report No. 34. Washington: U.S.
Department of Agriculture, 1983.

Ling, K.C. Brigipg Diapg for Mapagipg Saasopai Deiiverias
Dy Dairy ggoperatives, U.S. Department of

Agriculture, Agricultural Cooperative Service,
Research Report No. 22. Washington: U.S.
Department of Agriculture, 1982..

:mJflLA gm 1:. .1 nu“

 

Lough, H.W. and R.E. Fallert. "Supply Control -- An
Extension of the Institutionalized Fluid Milk
Marketing System."

Manchester, A.C. Dairy Erige Boligy; Sarting, Droplems
Alternatives. U.S. Department of Agriculture,

Economics, Statistics and Cooperative Service,
Agricultural Economic Report No. 402.

Washington: U.S. Department of Agriculture,
1978.

Manchester, A.C. Dayipg rgr MarMepwide Saryices in Fluid
H113_M§IKQE§1 U.S. Department of Agriculture,

Economic Research Service, Agriculture
Information Bulletin No. 514. Washington: U.S.
Department of Agriculture, 1987.

Manchester, A.C. l o e ' e ai Econom :
Mhy apg flaw ggverppepra Ipparyape in the Milk

Dpaina§§r__Boulder: Westview Press, 1983.

228

Marion, B.C. t' c S
Eppd_§y§rapr__Lexington: Lexington Books, 1986.

Market Administrator, New York - New Jersey Area, Federal
Milk Marketing Order No. 2. ggppararive
Wu. 1958-

Metzqer. H. Woe.
Department of Agriculture, Bureau of

Agricultural Economics, Technical Bulletin
No. 179. Washington: U.S. Department of
Agriculture, 1930.

Michigan Milk Messenger. "Component Pricing Here,"

eril 1985 p. 7-

Mighell, R.L. and L.A. Jones. Vertical Coordination in

Agrigplrprar U.S. Department of Agriculture,
Economic Research Service, Agricultural Economics

Report No. 19. Washington: U.S. Department of
Agriculture, 1963.

National Milk Producers Federation (NMPF). "Model for
Component Pricing in Federal Milk Orders."

National Milk Producers Federation (NMPF 1986). Bapprp_pr

e e rde o a
WWW

Arlington: 1986.

Nott, S. and L. Hamm. Dpotas for U.S. Dairy Farmers: A
Rayiayr Michigan State University, Agricultural

Economics Report No. 490. East Lansing:
Michigan State University, 1986.

Ontario Milk Marketing Board (OMMB). Repgrp by the Special
ttee Mu ti om ent es n and

Eric ing at Miik ip Optarip, Ea r; 1. Ontario Milk
Marketing Board, 1975.

Phillips, J.B. and E.M. Babb. "Can a Class I Base Plan

Succeed?." W1 January 10. 1973.
p. 26.

Poulsen, P.R. ”Feasibility of Ultrafiltration for
Standardizing Protein in Milk." J u na 0

Dairx_fisiensel (June. 1978). 807-814-

229

Riley, J.B., M.D. Childs and L.V. Blakley. Q1a§§ I Miik

Daaa Iransfera, Prices apg Price Erpectations,

Qkiapopa AMP; Producers, 1272, Research Report
No. P - 677. Stillwater: Oklahoma State

University, Agricultural Experiment Station,

1973.
Schader. LoF- et al- Q992gratixe_ang_2r92rietarx_
'b ' ' om a ' o e fo an

Research Bulletin No. 982. West Lafayette:
Department of Agricultural Economics, Purdue
University, 1986.

Schmid, A. A. Erpparry. 29w ar, apg Pub 11g ghoige; Ap

Insnir2_int9_La__a_d_EggngmiQ§1 New York:
Praeger, 1978.

Secretary of Agriculture. Study or Aiterpative Methods for
Qantrollipg Earm Milk Production and Supporting

Brigaa pg Earmara for Milk and Butterfat.
Washington: Government Printing Office, 1955.

Shaffer, J.D. "Thinking About Farmer's Cooperatives,
Contracts and Economic Coordination." East
Lansing: Michigan State University, 1986.

Shaffer, J.D. and J.M. Staatz. "Potential Coordinating
Functions of Farmer Cooperatives." in Earmar
Q922erarixe§_fgr_the_figfurel_NCR 140- West
Lafayette: Department of Agricultural Economics,
Purdue University, 1986.

Stafford, T.M. and J.B. Roof. Markering Operations of Dairy

've U.S. Department of Agriculture,
Agricultural Cooperative Service, Research Report
No. 40. Washington: U.S. Department of
Agriculture, 1984.

Stigler, J.G. "The Economics of Information." Ipa_gpprpai
9f_£glitigal_222n2mxl (June. 1961). 213-225-

 

Strain, J.R. et al. e Assoc'ate Reserve Standb Pool
e v : Paat Perrormance and Future
ect . e o t S bm'tte t e 0 rd

ors he ss ' t d e e ta db Poo
999992211291 1973.

Timmer, G. "Somatic Cell Counts Don't Pay - They Cost, "
Misniga__uilk_ne§§engerl April 1985 p- 10-

230

U.S. Department of Agriculture, Agricultural Cooperative
Service. "Top 25 Dairy Coops Handle 55 Percent

of Supply: Hoard's," Farmer gogparatives, March

1987, p. 9.
U.S. Department of Agriculture, Agricultural Marketing
Service. Gre t as nd Lake Mead
t n A ea ° ecommended Decision and

Opportunity to File Writtan Objections pp
Droposed Amendments to Tentative Marketing

Agreemants apg Orders. Washington: U.S.
Department of Agriculture, 1987.

 

U.S. Department of Agriculture, Agricultural Marketing
Service. e edera ' Mark t' 0 de
Erpgrapy U.S. Department of Agriculture,
Agricultural Marketing Service, Marketing
Bulletin No. 27. Washington: U.S. Department
of Agriculture, 1981.

U. S Department of Agriculture, Economic Research Service
(1987A). ' : a o e ort
DS - 412. Washington: U.S. Department of
Agriculture, October, 1987.

U.S. Department of Agriculture, Economic Research Service
(19878) DaiI11__S1taat19n_and_gntlogk_1earbggkl
DS - 411. Washington: U.S. Department of
Agriculture, September, 1987.

U.S. Department of Agriculture, Economic Research Service

(1984A). Nationwide Adoption of the California

gaiids Stapdards for Fluid Milk Productsl Staff
Report No. AGE8840816. Washington: U.S.

Department of Agriculture, 1984.

U.S. Department of Agriculture, Economic Research Service

(1984B). view of 's ' an Al e n t've
W. staff Report No.

AGE8840121. Washington: U.S. Department of
Agriculture, 1984.

U.S. Department of Agriculture, News Division. DSDA

t s ceed'n v o t e 5 er
Federal__nilk__2rger§1 Washington: U-S-
Department of Agriculture, 1987.

Williams, S.W. et al. Or a ' t'o n Co 't'on in he
Migwaar Dairy Ipdpstries= Ames: The Iowa State

University Press, 1970.

231

Zurborg, C.E. "Raising Minimum Standards of Milk
and Milk Products; Protein or SNF Differentials,
Better Quality Control, Better Taste. The
Mississippi Valley Milk Producers Association
Experience." Presented at the 73rd Annual
Meeting of the American Dairy Science
Association, East Lansing, 1978.

 

.II‘I'II'I‘
.‘I’l‘l

It-
| 11.: ll!
0"

.I ‘
\r l

"IT'E’Tflilflfllifllflflilfl’lfilflT