Living Economics

Milked to Order
Milk price support has discouraged vertical integration in the milk industry that might have led to cheaper milk for and lower tax on milk consumers.

Hein Hettinga is a maverick dairy farmer who brings consumers cheap milk. One Sam’s Club store in Yuma, Arizona, sells two gallons of Hettinga’s whole milk for $3.99, the same price as a single gallon of whole milk in Chicago.

From a humble beginning in 1974 when he ran his first dairy farm, Hettinga’s Sarah Farms has now expanded to 15 dairy farms stretching from California to west Texas. Hettinga’s success started from a $160,000 milk bottling plant that he built in Yuma to process his own milk. Because the bottling plant does not have to pay elevated subsidized milk prices like other milk processors, he can undersell his rival processors in the booming discount supermarket sector. He now supplies more than 10% of the bottled milk in Arizona.

Hettinga owes his everyday-low-price success to Depression-era federal regulations governing the marketing of raw milk and the highly fragmented industrial structure in the milk business. In the milk industry, milk farmers are separate from milk processors. Milk processors must pay at least the USDA-set minimum prices for raw milk to ensure that the milk farmers are not exploited by the bigger and more concentrated milk processors. But milk producers who also process their own milk are exempt from such set prices.

The exemption was intended to take care of small dairy farmers who might bottle the little milk they produce and sell to their neighbors. Hettinga’s exploitation of this loophole has thus enraged both the dairy farmers and the milk processors. The farmers are enraged because their income is reduced by the amount that Hettinga’s bottling plants are exempt from paying into the regional milk marketing pool. The milk processors are enraged because the lower milk cost of the Hettinga’s plants gives them a cost advantage.

Regulating the orderly marketing of milk might have been expedient in the Depression era to protect small milk farmers with a highly perishable product from more organized milk producers. But these outdated regulations have inadvertently prevented the rationalization of the dairy industry. In the chicken industry, vertical integration from the hatching of eggs to the packaging of chicken parts has lowered the prices and raised the quality of the end products. Milk price support, on the other hand, has prevented vertical integration in the dairy industry. If the milk processors must continue to pay elevated supported milk prices after integrating milk farming, there is no net cost savings to pass on to shareholders or to consumers. High supported prices have also encouraged over-production because the surplus milk will be purchased by the government as the buyer of last resort. If the market were allowed to work without outdated regulations, bumper milk output would have led to lower retail milk prices and fewer and more efficient milk farmers. As things stand, we have instead higher retail milk prices and higher taxes to support too many milk farmers.

The days of cheap milk in Arizona will soon be over. Milk processors and major dairy cooperatives have successfully lobbied federal regulators to write new rules that would eliminate the price-support loophole. And a bill is working its way through Congress to address the same issue.

Note:
  1. Update: In March 2006, Congress passed a law reshaping the Western milk market and essentially ending Hettinga's experiment -- all without a single congressional hearing. (Washington Post 12/10/2006. "Dairy Industry Crushed Innovator Who Bested Price-Control System.")
  2. Update: In March 2006, Congress passed a law reshaping the Western milk market and essentially ending Hettinga's experiment -- all without a single congressional hearing. (Washington Post 12/10/2006. "Dairy Industry Crushed Innovator Who Bested Price-Control System.")
References:
  • Chicago Tribune. 2/19/2006. “He sells milk for half the price you pay. The feds want to stop him. Why?”
  • WSJ. 2/2/2006. “Small dairyman shakes up milk industry.”
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