white gold

Last month, CSD offered astory about Fast Phil’s, a retailerin North Carolina that consistentlygoes head-to-head with supermarkets on its bread, milk and egg prices. The12-store chain still maintains its price war,but with the recent rise in milk prices, it’shaving a tough time of it.

“We are still trying to keep our prices aslow as possible. On gallons, we’re underthe supermarket prices, but we’re taking ahit on margins,” said Walter Herring, vicepresident and general manager of FastPhil’s. Herring said the chain’s milk pricesare under $4, but he’s hearing the rumorsthere will be another spike in Septemberand October.

Milk prices in the U.S. hit a record inJuly with consumers paying an average$3.80 a gallon, up about 50 cents fromJanuary, according to the U.S. Departmentof Agriculture (USDA). Texas tolled thehighest recorded prices—a gallon ofBorden’s sold for $4.99 at Corpus Christi-area H-E-B grocery stores and $5.49 atStripes convenience stores—while NewOrleans is the only major American city where milk prices averaged more than$4 a gallon in August. In New York, theprice of a gallon of whole milk now variesfrom $3.68 a gallon in Brooklyn to $3.95a gallon on Staten Island—and could rise accordingly to $4.21 and $4.48 a gallon,experts predict. And the USDA forecastsprices will remain high throughout the year.

Why the rise?
Dairy is a big piece of the businessat Stewart’s Shops, a 325-store chainbased in Saratoga Springs, N.Y. Stewart’sProcessing Corp. manufactures and exclusively supplies all of its fluid white andflavored milks, a line of juices and teas and40 flavors of ice cream, which the company offers in packaged form or throughan old-fashioned soda fountain.

Stewart’s is not immune to the priceincreases with milk, although its completevertical integration—handling product allthe way from the cow to the consumer—has put it more in control of its owndestiny than retailers who purchase milkfrom co-ops.

“We’ve had to increase fluid dairy andice cream prices against increased ingredient costs,” said Gary Warren, vicepresident of Stewart’s Processing Corp.”However, New York has a threshold lawthat sets the maximum allowable retailprice and we’re well below that threshold.We want to offer the best diary value inall the markets we serve and our strengthhas been our ability to do that consistentlyover time.”

A lot of factors have led to the current dairy situation. Most are quick topoint to the diversion of corn from farmsfor the production of ethanol-based fuels, which is part of it, but that’s not the whole story.

Dairy processors and experts considerit a “perfect storm,” where a number offactors all came into play simultaneously,resulting in the present situation.

The two primary causes to the pastyear’s increases are relatively unique,according to the New York State DairyFoods Association (NYSDFA). First is theexporting of Class IV powder products,which are used for manufacturing cheese, ice cream and butter. These products arebeing shipped overseas to the Middle East,China and other countries that have moremoney to spend on their populations.

“The U.S. hasn’t typically been a bigexporter of these products. Australia,New Zealand and Europe have been, butcircumstances, such as drought, haveprevented those areas from being ableto supply the demand worldwide,” saidBruce Krupke, executive vice president ofthe NYSDFA. “The U.S. was poised andready with supply and, ironically, becauseof the devaluation of the dollar, were lessexpensive. So when the domestic supplyof Class IV products was reduced thatdramatically, prices paid to diary farmersincreased.”

This part of the equation started backin 2004, which was the last record year forprices dairy farmers received for raw milksent to processing. The next year was thesecond highest price, what’s called uniform or average price for raw milk.

“Traditionally, when prices go up, dairyfarmers respond and start producing moremilk. It makes sense that they do so; theywant to take advantage of higher pricesand make more money,” said Krupke.

Although, when dairy farmers startproducing more, at a point when production gets to be too much—usually three tosix months later—the prices they receivestart falling. In May 2006, for example,prices bottomed out and in July of 2006,they started the current trend of increasing.By August 2007 the industry hit all-timehighs for Class I milk and will again be anall-time high for the prices dairy farmerswill receive.

Fuel factor
Now ethanol comes into play. One ofthe biggest costs of running a farm (couldbe as much as 50%, according to Krupke)is feed for animals—cows included—andcorn is one of the biggest components.

“When one of your biggest costs of running a business doubles, any business,farmers included, will either cut back onthat cost or they can use less-effectivealternatives,” Krupke said. “Alternativefeeds don’t allow cows to produce asmuch and this sets in motion less-than-normal production.”

Another factor that comes into playis that 2006 was a difficult year for farmattrition. While the farmers that persevered stood to gain the most, the loss offarms impacts the amount of milk available to market.

“Farmers have been terribly squeezedon profit margins with costly feed andrule, which has led to attrition in the farmcommunity,” said Warren. “It ultimatelyaffects supply and demand. Less supplywith consistent demand equals higherdairy prices. Higher exports folded inwith the ‘ethanol factor’—the planetshave lined up and we’re looking at recorddairy pricing to the consumer.”

With fewer dairy farms in the country,it seems to take a little longer for them tostart producing faster or to slow down production to work in line with demand. Butwith the unusual circumstances, Krupkefeels traditional production swings don’tmatter as much.

“A lot depends on the export demand forClass IV products,” he said. “Dependingon weather overseas and the dollar value,the U.S. can anticipate exports stayingstrong for at least six more months.”

End in sight
For the domestic production toincrease fast enough to offset the exportdemand, dairy farmers need 18 to 24months to start breeding new heifers andhaving calves to start up the U.S. milk production machine.

“The U.S. is at about 14 months now, sowe’re getting close to having the ability toincrease production where it will affectprices,” Krupke said. “I estimate priceswill fall off a little in the latter quarterof 2007. But real relief isn’t on the horizon until late next spring when we getwhat we call ‘the spring flush of milk.’ by consumers.”

The final factor to take into accountis consumption. Are consumers slowingdown their purchases of milk, cheese andice cream? Should that happen somewhatquickly, Krupke feels it may back up themilk pipeline and, in turn, have a bigger,more immediate impact on prices. USDAwill start releasing the second quarter statistics on sales and consumption by theend of September, he said.

In the meantime, for the four dairyclasses, prices have gone up 80% over thelast 12 months. Stewart’s has kept its stores’price hikes under 40%, but even with theircontrols it’s had to accept tighter marginsin the interest of continuing strong sales.The company reports its dairy sales arestill up percentage points compared tolast year and the current retails have notdecreased consumption.

“It doesn’t mean we won’t at somelevel,” said Warren. “We try to be a destination store for dairy products—morein line with a grocery store than a convenience store. We try to offer the best dairyvalue to our customers.”

And for Fast Phil’s?

“The company will take as much as a25 to 50 cent hit before raising its prices,”said an undeterred Herring. “It’s still ourcommitment to be lower than the supermarkets on our prices.”

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