The modernization of the Federal Milk Marketing Order (FMMO) has been making dairy news headlines for over a year now. With debates surrounding make allowances and “higher of” Class I milk mover, the modernization effort is fraught with market lingo and regional complexities that can make it challenging to understand. Let’s revisit the basics of FMMOs to understand how the recommended changes the U.S. Department of Agriculture (USDA) has put forward could impact the dairy industry.
Introduction to FMMOs
What are FMMOs?
Federal Milk Marketing Orders (FMMOs) are government regulations that dictate the buying and selling of milk between dairy farmers and dairy processors. Authorized in 1937 by Congress as part of the Agricultural Marketing Agreement Act, they were introduced to stabilize milk prices, ensure fairness for dairy farmers and processors in the market, and encourage milk production that met consumer demand.
Why were they created?
During the Great Depression, dairy farmers faced low milk prices and limited bargaining power, as milk processors controlled the marketplace. The perishability of milk and farmers’ need to find a home for their product, left processors with an unfair advantage in the marketplace. Additionally, most milk production at the time was from farms milking a handful of cows, so there were many smaller farms selling milk to just a few milk processors. At the time, many of the farmers were producing Grade B milk and there was a limited supply of Grade A milk that could be used for bottling. This, coupled with the seasonality of milk production, created supply issues for consumers at the grocery store.
FMMOs addressed this imbalance by setting minimum prices for milk and creating rules that leveled the playing field. This ensured farmers received fair pricing for their milk while guaranteeing consumers had a consistent supply of bottled fluid milk. Over the years, FMMOs have evolved, consolidating from nearly 70 local orders to the 11 regional orders we have today. These changes reflect the growth of the national dairy market and its shift toward regional and national distribution.
How FMMOs Work
FMMOs do not set minimum retail prices for consumers, do not guarantee a profitable price is paid to farmers and do not set dairy production requirements or determine milk quality standards. Instead, the FMMO system ensures that milk pricing is fair, transparent and stable for farmers, processors and consumers. Here’s how it works:
Milk Classes
Milk is categorized into four classes in the FMMO based on its end use, with different prices assigned to each:
- Class I: Fluid milk used for drinking, including eggnog and buttermilk (typically the highest-value category)
- Class II: Soft products like cream, ice cream, yogurt and cottage cheese
- Class III: Hard cheeses, cream cheese and whey (often the largest class of milk utilization)
- Class IV: Butter and powdered milk (typically the lowest-value category)
The classification system ensures that milk intended for higher-value products provides higher returns to farmers.
Pooling and Depooling
Pooling
Pooling ensures that farmers are paid a uniform blend price regardless of whether their milk is used for fluid consumption, ice cream, cheese or butter. Monthly, dairy processors report how much milk they purchased and its end use to a regional market administrator. The total revenue from all milk sales is then totaled (or pooled) and the average price (or uniform blend price) is distributed to dairy farmers.
This system guarantees that farmers are compensated fairly, no matter where their milk ends up, and creates stability across the market. In the FMMO, adjustments, such as location differentials, account for the cost of moving milk to specific areas and encourage Grade A milk to move to areas with higher population densities, ensuring supply meets consumer demand. The location of the processing plant and its proximity to population densities determines the Class I differential charged to the plant.
Depooling
Depooling is also a part of FMMOs and is often controversial because it allows a processor to decide to temporarily remove milk from the FMMO revenue pool. While pooling ensures farmers receive a uniform blend price based on all milk sold within the market, depooling allows certain processors to bypass this system when it’s financially advantageous for them. For example, if a processor primarily produces cheese and the Class III price is expected to be significantly higher than the blend price, they may depool their milk to avoid owing additional revenue to the pool.
Depooling often lowers the blend price farmers receive, but dairy farmers who belong to cooperatives that own processing plants do not face the same disadvantages because cooperatives can also depool to remain competitive in the marketplace. Depooling is highly regulated with restrictions designed to discourage frequent depooling and maintain fairness across the system.
Minimum Pricing
Rather than establishing fixed prices for dairy products, the USDA uses a three-step approach, known as the three C’s, to calculate the minimum price for milk each month:
- Step 1: Commodity Pricing: The USDA surveys wholesale prices for key dairy commodities, including 40-pound cheddar blocks, 80% butterfat butter, nonfat dry milk and dry whey. Commodity pricing is also influenced by make allowances, which account for the production cost of converting raw milk into finished dairy products. Make allowances help processors cover operating expenses by factoring in the costs of labor, packaging and energy to manufacture the products.
- Step 2: Component Pricing: Using the commodity prices, the USDA calculates the value of milk components: protein from the cheese price, butterfat from the butter price, nonfat solids from the nonfat dry milk price, and other solids from the dry whey price. Component pricing is also influenced by yield factors, which estimate how much finished product can be produced from each component. Yield factors link milk pricing to the actual value of milk components, ensuring that minimum prices are aligned with the efficiency of dairy production. For example, if new genetics or better feed management increase the protein levels in milk, processors may extract more cheese from the same volume of milk, raising its value.
- Step 3: Class Pricing: The component prices are combined with fixed formulas to calculate the minimum prices for each milk class. Class II is set by butterfat and nonfat solids pricing; Class III is set by protein, butterfat and other solids pricing; and Class IV is set by butterfat and nonfat solids pricing; and Class I pricing is set by the Class III and Class IV pricing using the Class 1 milk mover, which will be the “higher of” Class III or Class IV for most milk after the modernization is implemented in the future. Today, the Class I milk mover is based on the “average of” Class III or Class IV.
Minimum pricing, along with its support from yield factors and make allowances, ensures fairness in the marketplace while stabilizing the dairy market, benefiting farmers, processors and consumers.
Why FMMOs Matter
FMMOs play a critical role in supporting the entire dairy supply chain, from farm to fridge.
- For Farmers: FMMOs provide fair compensation to farmers by setting a minimum price that processors must pay for milk, ensuring dairy farmers are not underpaid for their products. They also provide price stability by pooling revenue and stabilizing prices, protecting dairy farmers from severe price swings in the marketplace. FMMOs also establish rules for payment schedules, ensuring farmers are paid twice a month, and they oversee milk testing and weights to ensure milk is accurately measured and payments to farmers are fair.
- For Processors: Processors benefit from FMMOs because they level the playing field. Since FMMOs require all processors in the region to pay the same minimum prices for milk, it prevents unfair competition and prevents larger processors from undercutting smaller processors by negotiating lower milk prices. FMMOs also provide processors with the price they will need to pay for certain classes of milk in advance of when they purchase the milk, which allows them to more effectively plan for future expenses.
- For Consumers: Consumers benefit indirectly from FMMOs through enjoying stabilized wholesale pricing that keep retail prices reasonable, and through receiving a steady milk supply that ensures milk and other dairy products are readily available on grocery shelves.
FMMO Challenges and Recent Developments
Regional Differences
FMMOs must account for varying costs of production across regions. For example, farmers in Colorado, who import much of their cattle feed, have higher production costs than those in the Midwest, where feed is often grown within miles of the farm. It’s challenging to ensure pricing that adequately reflects these regional differences.
Debate Over “Higher Of” or “Average Of” Pricing Methods
One ongoing issue is the debate between using the “higher of” or “average of” Class III and Class IV prices to calculate the Class I base price. While the “higher of” method benefits farmers by setting prices at the most favorable level, the “average of” method simplifies long-term contracting for processors. This debate was fueled during the COVID-19 pandemic, which saw a spike in Class III pricing that was estimated to cost dairy producers over one billion dollars under the “average of” pricing system.
Modernization Efforts
Recent adjustments aim to modernize the FMMO and address outdated aspects. USDA’s recently proposed changes are focused on five key areas:
- Milk Composition Factors: Updating milk composition factors to reflect the higher protein, other solids and nonfat solids content of milk produced today.
- Surveyed Commodity Products: Removing the 500-pound cheddar cheese barrels from commodity price calculations and relying on 40-pound block cheddar cheese instead to more accurately reflect today’s commodity market.
- Make Allowances: Increasing make allowances to more accurately reflect today’s cost of production for dairy products.
- Class I Pricing Calculation: Reverting to the “higher of” pricing model for most Class I products, excluding extended shelf-life products. Excluding extended shelf-life products addresses those processors needs for long-term contracting, which the “higher of” pricing model complicates.
- Class I Location Differentials: Increasing Class I location differentials, which are added to the Class I mover to determine the full Class I price in specific U.S. counties, including those in the Great Lakes region, to better account for transportation costs to population centers with higher market demand.
These updates ensure FMMOs remain relevant and reflective of today’s dairy industry and market conditions.
The Future of FMMOs
As the dairy industry evolves, FMMOs must adapt to remain relevant to the industry. With a growing reliance on exports, FMMOs will need to integrate with global trade practices that allow American dairy products to compete internationally. In addition, with changing consumer preferences that favor ultrafiltered milk and extended shelf-life products, milk classification and pricing will need to be flexible.
Today’s modernization efforts have also proven that it’s critical that the FMMO continues to be updated in the future. Historically, FMMO reforms have been infrequent which have led to outdated policies that don’t always reflect current market realities. Despite the imperfectness of FMMOs, they continue to support a stable, fair and efficient dairy market that benefits the entire supply chain, from farm to fridge.
How will the changes to the Federal Milk Marketing Order affect dairy farmers in the Great Lakes region?
By Carl Rasch
When a milk marketing order is amended, the USDA is required to perform a regulatory economic impact analysis. It is standard practice to assess the potential effects of proposed changes for producer prices, handler costs, and consumer prices. Such an analysis was performed by the USDA’S Agricultural Marketing Service (AMS) and was published along with the final decision that producers voted on.
The AMS analysis concluded that all 11 federal order markets would have benefitted from these price formula changes during the 5-year period of 2019 – 2023 to varying degrees. The impact on an individual marketing order will depend on the utilization of producers’ milk supply in each market. Specifically, for farmers in the Federal Order #33 market, which encompasses much of the Great Lakes region, AMS has estimated an increase in the price paid to producers of $0.50/cwt.
Additionally, the dairy producers who belong to cooperatives like MMPA who own and operate production facilities should benefit from the updates to the make allowances. As owners of those production facilities, MMPA and its members will see improved operating margins at those plants due to increased make allowances. The increase in make allowances will allow our plants to retain more of the sales price of the products being produced in order to compensate for labor, utilities, packaging and maintenance costs which have increased significantly since 2006. Failure to recover all of those costs recently has negatively impacted cooperative members’ milk checks.
In total, these proposed changes better reflect current marketing costs experienced by both dairy farmers and processors. These changes are expected to increase producer revenue, ensure that milk is delivered to the Class I market when and where it is needed, and contribute to orderly market conditions.
This article was originally published in the January/February 2025 issue of the Milk Messenger. Subscribe »