In many regions of the United States, Grade A milk is priced by means of a somewhat complex process that mixes market forces with government influence. Grade A milk represents milk that meets stringent quality standards and can be sold as fluid milk to consumers.

In simplified terms, there are three players whose input of labor and resources is reflected in the price consumers pay for milk at the grocery store. These players include: dairy farmers, who produce unfinished (“unprocessed” or “raw”) milk; dairy processors (which buy raw milk from dairy farmers and process it into finished, packaged products); and grocery retailers (which buy finished products from processors and sell them to the public). Along this production/distribution chain, government influence on the pricing process is focused on dairy farmers. In contrast, processors and retailers function in a mostly free-market environment.

Government participation in the milk pricing process has its roots in historical experience and the nature of milk itself. Milk is highly perishable and must be moved from farm to market very quickly . Volatility in consumer demand was and still is exacerbated by volatility in supply – due to seasonal and other factors. In the past, the resulting instability in the supply-and-demand equilibrium translated into steep peaks and deep troughs in retail prices; similar roller-coaster patterns in the supply of milk; and feast-or-famine episodes in which consumers were supplied with either too much or too little milk, while dairy farmers were either profitable or going broke. Government intervention in the milk pricing process – which began in the 1930s – was intended to assist dairy farmers in the development of more stable prices and foster a dependable milk supply at reasonable cost for consumers. A secondary goal was to establish market conditions that supported dairy farmers’ long-term investment in animals, plant and equipment.

Government intervention in the milk-pricing process is accomplished by means of federal regulations known collectively as the Federal Milk Marketing Orders. Milk marketing orders are designed to facilitate the efficient marketing of milk by counter-balancing the destabilizing effects of the nature of milk, milk production and demand on market prices. Federal orders are requested by dairy farmers in a region and voted into existence by a super-majority of those whose milk is affected by the order. Each order is administered by a Market Administrator who is appointed by the U.S. Secretary of Agriculture . The orders regulate the “first buyers” of raw Grade A milk (usually processors) and apply a uniform system of classified pricing and pooling within a specified geographical region. The orders require buyers to pay a higher price for raw milk that will be processed into fluid milk (“drinking milk,” known as Class I) than for milk used to manufacture other dairy products (known as Class II, Class III or Class IV). This higher price is related to the higher costs farmers face in maintaining Grade A status and supplying the fluid or Class I market. The minimum prices for raw Grade A milk change with each month and are announced by the Market Administrator responsible for a given order region. Each month, the Market Administrator calculates a weighted average value of all milk (“the pool”) using the announced Class prices; this is the Uniform price and is the minimum processors pay to dairy farmers. In practice, the actual price paid to dairy farmers by processors typically floats somewhere above the minimum Uniform price established by the order, because processors offer higher prices to farmers for superior product quality and other desirable attributes valued by consumers and the market.

In contrast to dairy farmers, dairy processors and grocery retailers generally set their prices according to their assessment of “what the market will bear,” taking into account competitive and other market conditions as well as their costs. Among dairy processors, competition for the business of retailers and other dairy product end-users (such as school districts) tends to be fierce – keeping profit margins in check. Exact amounts are difficult to determine due to processor reticence. In earlier decades grocery retailers often used milk as a “loss-leader” – that is, a product which they sold at a price that yielded little or no profit but which brought larger numbers of consumers into the stores, where they would buy other, more profitable products. This strategy explains why the dairy case is typically located at the back of any grocery store – requiring consumers to walk past many other products en route. In recent years, the “loss-leader” strategy has faded from near-universal use due mainly to the consolidation of grocery retailing among a relatively small number of nationwide firms. These firms have typically shifted to an alternative strategy that requires every product in their stores to constitute a “profit center.” Accordingly, dairy product retail prices have trended upward for a number of years – but at a slower pace than the Consumer Price Index (CPI) for other foods. Despite the upward pressure on dairy prices, they remain a good value for their retail cost due to their versatility and nutrient-dense composition.

The pricing mechanism for milk in the U.S. is efficient; but it was never intended to completely eliminate the ups and downs of supply-and-demand. Neither has it always yielded prices that were satisfactory to all participants in the farm-to-table continuum. For dairy farmers, the skyrocketing costs of operating a dairy – land, water, plant, equipment, animals, feed, veterinary care, environmental compliance, taxes, fees, labor, fuel – have greatly increased the break-even point at which the farm clears its cost-of-production and begins to realize a profit. In the Pacific Northwest Milk Marketing Order (which includes Washington), the “break-even” cost of production is currently about $17 to $18 per 100 lbs. of milk. By way of comparison, at the bottom of the latest “crash” in farm-level milk prices (in March 2009), Washington’s announced Class I price stood at $11.33 per 100 lbs – that is, about 35% below a typical dairy’s cost-of-production. For any dairy, then, controlling costs plays a critical role in farm survival, with the order system encouraging efficiency in milk production and marketing.

Farm-level price crashes like that of 2008-09 have fuelled interest in developing alternative systems for establishing farm-level prices for milk. Many of these alternative systems attempt to rectify two conditions that distinguish dairy farms from almost every other type of business in the U.S. economy: dairy farms have difficulty in setting the price for milk due to its perishability and cannot easily pass along their increased costs-of-production to processors. Regardless of how milk is priced, an underlying challenge for dairy farmers is likely to remain: in the dairy product production continuum, it is dairy processors and dairy retailers that contribute much of the “added value” to the dairy farmer’s raw milk (by flavoring it, reducing or eliminating its fat, adding protein or probiotics, turning it into cheese or yogurt and in many other ways tailoring it to meet changing consumer tastes; and by marketing it in ways that enhance its perceived value among consumers). Not surprisingly, it is these players in the dairy production process that are rewarded with the lion’s share of a product’s enhanced value. Today, U.S. dairy farmers pocket – on average – only about 29% of what consumers pay for milk in a grocery store. The balance is shared by processors and retailers.