Milk Production | What Really Drives the Price of Milk?

More milk, fewer farmers and a sinking demand: So why has the price of milk been falling? And, why are we still producing more milk each year?

In 2019, the global milk industry was worth a staggering 570 billion euros.¹ With more than 172 million tonnes of raw milk produced in 2018, the EU is collectively responsible for around a fifth of global milk production.^2,3

Although the number of cows and milk-producing farms have been decreasing in recent years, we are still seeing an overproduction of raw milk. In the last three decades alone, worldwide milk production has increased by more than 59%, from 530 million tonnes in 1988 to 843 million tonnes in 2018. Consumer demand, however, did not increase at the same rate - instead, milk consumption in major consuming nations like the US alone fell by 4% since 1975. But if we’re already producing too much milk, why are we still producing even more each year?

Setting the Context: Milk Farmer Income 

To address this question, we need to first understand the issue surrounding milk farmers and their income. But who is it that actually keeps the profits in the milk industry? Take the price of 1L of milk produced in Germany as an example: 15% stays with the milk processors, 6% goes to storage and transport, 14% to packaging and disposal, and 17% stays with the supermarkets. But while farmers retain the biggest cut - keeping 43% of the revenue - they also have to carry most of the costs.  

Farmers often claim that the money they earn from selling their milk does not cover their costs: things like electricity, veterinary bills, credits or other financial loans, their own cost of living and - most of all - food for the animals. While one kilo of German milk sold for just over 50 cents in 2018/19, it actually costs an average of 64 cents to produce -  meaning any revenues made barely cover 79% of the farmer’s costs.⁴ 

Another issue lies between producers and those further down the chain: retailers. Retailers, who are competing to offer the cheapest products to their consumers, hold the most negotiating power and will pressure farmers to sell their products for an overly cheap price, while retaining most of the revenue from sales in their own shops - sometimes up to half the product price paid by consumers.⁵

Why Dairy Farmers Produce Too Much Milk

Then, how do lower revenues lead to an overproduction of raw milk? To keep producers afloat, milk processors might offer milk farmers financial loans. However, these loans and their interest rate often pressure milk farmers to produce more milk to make a profit – sometimes even more milk than the market demands. While more raw milk production benefits milk processors, this is in many ways a problem rather than a solution. Pressure to increase milk production creates an overstock of milk flooding the market, resulting in a lower gate price for milk farmers. It’s basic economics: if there’s too much milk supply and too little demand, you end up with lower prices.

The Issue With Government Subsidies

Simultaneously, national governments and the EU have been providing agricultural subsidies for milk farmers. Income support for farmers was launched back in the 1950s, when the EU initiated a series of market interventions like the Common Agricultural Policy (CAP) to boost agricultural production. Under CAP, EU countries started subsidizing dairy products, which meant that farmers had a portion of their production costs covered. 

Learn more about the Common Agricultural Policy

In addition to subsidizing milk farmers to keep milk prices from rising too high, the EU also buys surplus milk to keep milk prices from falling too low. Historically, the EU purchased surplus agricultural goods to minimise impacts on retail prices. In 1986, for example, the EU bought 1.23 million tonnes of unwanted butter, then exported it at cheap prices.⁶ 

And they still continue with this practice today: starting in 2014, the EU bought 400.000 tonnes of milk powder and stored them. Most of it has been sold with a financial loss estimated to 24 million euros. Where the milk powder ended up, is not clear.¹⁰

Incentivized Up-scaling

But staying afloat as a farmer still seems to be challenging. As it stands, the subsidies issued under CAP incentivises larger milk farms. Put simply, farmers receive Direct Payments (income support) for every hectare of land they own. With a sinking milk price and lower profit margins, small scale farmers are pressured to grow, literally - increasing the size of their land so they can receive more income support. 

However, growing is hard to do, as many milk farmers have buckled under the pressure and are inevitably swallowed up by bigger milk farms that have been enjoying higher subsidisation from the EU. In fact, all European countries have seen a decrease in numbers of existing individual farms since 2005.¹⁰ This, in part, may be because small milk farms are usually less profitable than big milk farms. A sample taken from the US showed the smallest farms had two times higher production costs than larger milk farms.⁷ Where labour costs are concerned, however, small-scale milk producers in the EU often have similar labour costs to those of large-scale dairy farms, as small-scale producers tend to rely on family labour.⁹ Furthermore, large milk farms are able to operate more cost-effectively and can flood the markets with cheap milk, putting even more pressure on small milk farmers who can’t afford to sell milk for such low prices. 

How are smaller milk farmers coping today?

Right now, there’s a trend amongst milk farmers to move into niches to maintain their livelihood - for example, producing organic or grass-fed milk (“Heumilch”), a type of milk for which animals have been fed only with fresh natural fodder, like hay. In comparison to conventional milk, organic, grass-fed, or organic grass-fed milk is then sold for a higher price – and many customers seem to be willing to pay it. 

Another way to cope involves shortening the milk chain and selling dairy products directly to locals with milk vending machines or farm-gate milk. By avoiding a split in revenues with milk processors and supermarkets, smaller milk farmers are able to retain a higher profit.

The question, however, still remains, why are we subsidizing an industry with a lack of demand? The answer is not so straightforward, particularly because different countries have different needs. While we often have an oversupply of raw milk, some countries are even experiencing shortages of other dairy products like butter, as suggested by Andreas Eder, researcher at the University of Natural Resources and Life Sciences Vienna. Whether switching completely to consuming and producing more plant-based alternatives, is really the best solution to this dilemma, remains a disputed question. However, a shift to a more balanced system with environmental and social issues in mind seems like a reasonable and inevitable first step.

Do you think that dairy should be subsidized? Let us know in the comments below!