Cost of Production Records: The First Key to Marketing Management

Ernie Oelker 
Trumbull County, Extension Agent

Total economic cost of production is a very important number that all dairy farmers should carefully monitor. According to Dr. Cameron Thraen, Dairy Marketing Specialist, Agricultural, Environmental and Development Economics, Ohio State University, without knowing your costs of production, there is no way you can answer this question: What is a good milk price? Having a sound working knowledge of your farms total economic cost (cash and non-cash) of producing a hundredweight of milk is key to formulating a good marketing risk management program.

Cost of production includes physical capital (facilities and equipment), labor, energy, livestock, feed costs and all other costs incurred in producing the total output of the dairy farm. The total economic cost includes all opportunity costs of land ownership, foregone interest on your equity, and the opportunity cost of unpaid owner and family labor. Proper costing treats the dairying activity as a separate enterprise and does not commingle costs from other farming operations such as crop or forage production, heifer raising, etc. Only the actual costs of producing milk should be included.

In today's agricultural environment, dairy farmers face substantial risks which arise from many different sources. The USDA's Risk Management Education program identifies five primary sources of risk: 1) production risk, 2) financial risk, 3) legal risk, 4) human resource risk, and 5) marketing risk. Marketing risk is the risk associated with unexpected changes in input and output prices. It is the risk associated with not having a marketing plan and with not knowing your costs of production of milk.

I have been privileged to be part of a team of Extension professionals which planned and conducted a series of meetings on dairy farm risk management. We presented information on dairy farm risk assessment and put participants through a series of exercises designed to help them work with dairy farmers to complete dairy farm risk assessments. The participants in these workshops (about 50 in total) represent agricultural credit organizations, farm service and supply industry, and veterinarians. They were quite serious in their participation in the risk assessment workshops. They seemed to be in agreement that risk assessment on dairy farms is a serious challenge and that more needs to be done to help dairy farm management teams deal with the issue of risk, especially price risk.

Marketing or price risk is one of the most important areas your management team should address. Since market forces (not government policy) control the prices you will receive for your milk, you need to learn how to protect your business against price fluctuations, because these fluctuations are a fact of life. Understanding the milk pricing system will help you to understand the monthly fluctuations in your milk check. But, understanding is not enough! You need to know your costs of production and use the milk marketing tools available to you to lock in a profit margin, or at least cover production costs during times of low prices.

I suggest that you work with your cooperative field representative or your local Extension agent to find out more about dairy futures options. Become familiar with the terminology of milk marketing; basis, hedging, margin accounts, etc., and begin to explore the alternatives available. Next, try some on paper transactions to see how these tools could work for you. As you learn about the new milk pricing system and the marketing tools available, get a system in place to help you determine your total actual costs of production per cwt. Information is power. Collect it and use it to improve your profitability.