The Market for Organic Dairy

The Market for Organic Dairy

prepared for

The Indiana Dairy Conference

January 19, 2005

Indianapolis, IN

Joseph Balagtas

and

Corinne Alexander

Department of Agricultural Economics

Purdue University

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The Market for Organic Dairy

The last decade has seen rapid growth in organic dairy farming in the United States. Growth in the organic dairy market has been driven in part by increased demand for organic foods, fueled by a complex mix of consumer concerns of food safety, nutrition, concern for the environment, and other factors. On the supply side, growth in organic dairy farming has been fueled, in part, by the promise of higher returns relative to conventional dairy farming, as well as environmental concerns on the part of producers. Although organic dairies account for less than 1 percent of total milk production in the United States, the organic model holds promise as a potentially profitable alternative to conventional. This paper provides some basic information that will be useful for farmers who are considering entering the organic market. In addition to explaining some of the key components of the organic conversion process, we also discuss some economic factors affecting organic dairy markets.

Organic Standards and Organic Dairy Certification

Since 2002, the USDA’s National Organic Program (NOP) has established national standards for the production and handling of organic products. Compliance with the NOP must be certified by a USDA Accredited Certifying Agent. Only products certified to be in compliance with the NOP can be labeled “organic”.[1]

The NOP for organic dairy farms requires that cows be under “continuous organic management” for one year before their milk can be sold as organic. The NOP standards touch on all aspects of animal management. Key aspects of the organic management of dairy cows include diet, health care, and record-keeping requirements. Below we outline the NOP requirements in each of these areas, and discuss some of the challenges faced by producers.

Feed and Forage

Any feed must be certified organic. In addition, cows must have access to organic pasture. The NOP standards for organic crops requires, among other things, that the feed must be produced on land on which chemical fertilizers, pesticides, and herbicides have not been used for at least 36 months. Organic pasture is also subject to the prohibition on these chemical inputs. (See the NOP web site for a list of banned and prohibited substances).

The organic feed requirement is a challenge for those dairy farmers who grow their own feed, and who have not previously grown organic crops. Conversion to organic soil management, in particular, requires that both for the farm manager and the soil adjust to new management practices. The NOP defines the substances and practices that are prohibited, but does not provide a guide to organic production practices. However, useful information is available (for example, http://extension.agron.iastate.edu/organicag/ , http://www.nodpa.com/grazing.html , www.attra.ncat.org and www.mosesorganic.org/factsheets/dairychecklist.pdf ).

The organic feed requirement has also posed a challenge in areas where organic feed is not widely available. Organic dairy farms in the Northeast, in particular, have had to pay high premiums because of the small supply of local organic feed.

The NOP does not specify how much pasture is required. This question is currently being debated in the industry, with some groups arguing that some certified farms are breaking the intent, if not the letter, of the law by providing little or no pasture. Some organic processors have set specific quantitative standards for their suppliers (e.g., 30% of dry matter intake and 120 days). Proposals have been made to change the NOP specify a minimum quantity of pasture, but no changes have been made thus far.

Medicine and Health

The NOP prohibits use of rbST and breeding hormones in the dairy herd. The NOP specifically requires therapeutic use of antibiotics, but milk from cows so treated must be permanently handled separately and not sold as organic. Certified organic vitamins and minerals are admissible, as is artificial insemination.

Record Keeping

Documentation of compliance with organic standards is required. A requirement of organic certification is that a farm develops an Organic Plan that details the NOP-compliant management practices. In annual certification renewals, the farm must be able to document that the Organic Plan has been followed, including verification of organic inputs (feed, pasture, vitamins) and NOP-compliant management of herd health. Our discussions with certifiers suggest that the record-keeping requirements can be burdensome, especially for smaller operations.

Economic Factors Affecting the Returns to Conversion to Organic Milk Production

Conversion to organic milk production can be analyzed as an investment with costs and benefits. Potential costs of conversion include the effort and financial costs of adjusting to a new production system. Potential benefits of conversion include premiums for organic milk, reduced input costs, as well as “lifestyle” benefits associated with organic production methods. Here we outline some key factors that influence these costs and benefits of organic milk production, and discuss how these may change in the future.

Trends in Organic Dairy Markets

Available public data, as well as data collected by private marketing firms and organic groups, have shown rapid growth in organic food sales. Retail sales of organic dairy products has experienced 20-percent annual growth in recent years, reaching $1.4 billion in 2003, approximately 13 percent of total organic food sales according to the Organic Trade Association’s 2004 Manufacturers Survey.

Growth in demand for organic products has been fueled by a complex mix of consumer concerns over food safety, nutrition, the environment, and other factors. While a very small percentage of U.S. consumers are frequent consumers of organic products, a large portion of consumers have tried organic foods. Statistical analysis of consumer surveys have found that consumers of organic products are willing to pay an additional $1.50/gallon over the conventional milk price for milk labeled “rbST-free”, and an additional $1.50/gallon premium for “organic” (Foltz and Dhar). These studies have also found that consumers of organic products are relatively unresponsive to price changes, suggesting that the perceived benefits listed above are more important than price for these consumers.

Industry reports suggest that growth in organic production has lagged growth in demand (Organic Consumers Association). Retailers have reported difficulties in keeping the organic dairy case stocked, and processors are looking to source more organic milk. Organic milk production is still less than 1-percent of total milk production in the United States.

Returns to Organic Milk Production

Rapid growth in demand combined with relatively slow growth in supply has resulted in large premiums to organic dairy farmers. Farm-gate premiums for organic milk have been as high as 50 percent in recent years. A recent study of the organic milk market in Vermont and Maine found farm prices of $22.97/cwt, a premium of $4.90 over the price received by conventional farms in the same region (Dalton et al.). This same study found that milk production per cow was similar across organic and conventional farms, so that revenue from milk sales on organic farms was higher than that on conventional farms.

Dairy cows and calves raised under organic management from the last trimester of gestation can be sold as organic beef animals. This is a potential source of additional revenue for organic dairy farms. However, little information is available on the market for organic dairy cows and calves sold for slaughter.

The NOP requirements for organic dairy farms (highlighted above) affect costs of production. Organic feed costs have been the biggest difference between costs of production between organic and conventional dairies. The Maine study found that additional cost of organic feed was equal to 54% of the price differential received for organic milk (Dalton et al.). However, availability of organic feed, and thus organic feed prices, differs regionally. Greater availability of organic feed, and less reliance on purchased feed, may reduce these additional feed costs in the Eastern Corn Belt.

Of course, organic farms have lower costs on prohibited inputs in crop production, such as chemical fertilizer, pesticides, and herbicides. Similarly, NOP restrictions on medicines and other health supplies also reduce costs of animal health management on organic farms. The Maine study found that reduced fertilizer costs amounted to a 4-percent cost savings, and reduced health supplies an additional 4-percent cost savings. These cost-savings must be weighed against the cost of NOP-approved methods of soil management, pest control, and herd health, as well as potential differences in cropland and dairy cow productivity due to the different management practices.

The benefits and costs listed above need to be weighed to quantify the profitability of organic dairy farming. The Maine study found that costs exceeded revenue on organic dairy farms, generating a negative (-2.9-percent) return to farm assets on organic dairies, compared to a +4.1-percent return to farm assets on conventional farms. Thus, based on a sample of 30 farms and 2004 market conditions, organic dairy farming was on average not profitable in the Vermont and Maine. These results must be viewed with caution before extrapolating to other years and other regions. Milk prices and costs vary over time and across regions. Importantly, the main additional cost component for organic dairy farms, organic feed costs, is likely to be smaller in regions where organic feed is more readily available and dairy farms are less reliant on purchased feed. Because of this, proponents of organic dairy farming believe that the Eastern Corn Belt may be ideally situated for organic production.

The Costs of Conversion to Organic

Caution is also required for interpreting the results from the Maine study because it considers only the ongoing costs of existing organic farms. However, under NOP requirements, it takes several years to transition to organic milk production. It takes three years to convert cropland to organic if it previously has been farmed under conventional soil management practices. In addition, all milking cows must be under organic management for a full year before the milk can be sold as organic. Thus, during these transition years, producers incur the costs of compliance even though they are unable to benefit from organic milk prices.

Some organic dairy processors have made efforts to ease the financial burden of the transition years by offering premiums to producers still in the transition process.

Uncertainty in the Organic Market

As is the case with any investment, producers considering organic production must take into account not only present market conditions, but also forecast costs and prices out over several years. The difficulty associated with forecasting in an established market environment is compounded by the fact that the organic market is new and continues to develop. The NOP standards for organic milk and dairy products have existed only since 2002 and may continue to evolve. Many organic farmers and manufacturers are continuing to adjust to organic production methods. At the same time, consumer perception of organics continues to evolve. Here we outline questions that producers will want to consider before entering the organic market.

· How fast will demand for organic dairy products grow, and what will be the effect on prices? The organic dairy industry has projected that organic food sales will continue to grow at an impressive rate. Strong growth in demand will help support large retail premiums for organic dairy products.

· How fast will production of organic milk and dairy products grow? How responsive will the industry be to growing demand? Growth in production of organic dairy products and organic milk will reduce the premiums paid for these products. Stricter NOP standards that the restrict entry will tend to limit supply and increase the organic premiums.

· How will premiums at the retail level translate to premiums at the farm gate? Thus far, farm-gate premiums for organic milk have reflected retail premiums for organic dairy products. However, the pass-through of premiums from the retail level to farmers depends on competitiveness along the supply chain.

· What will be the availability/prices of organic inputs? Prices of organic feed, pasture, heifers, etc., will affect the costs of production on organic dairy farms. As organic inputs become more available, prices of these inputs could fall.

· What will be the prices of corollary outputs? Organic dairy farmers that can command premiums for surplus organic crops and organic cows and calves for slaughter will increase returns to organic farming.

References and Sources for Further Information

Bowman, Cissy, Indiana Certified Organic (Accredited Certifying Agent), Phone 317.539.4317, e-mail: .

Dalton, T.J., L.A. Bragg, R. Kersbergen, R. Parsons, G. Rogers, D. Kauppila, Q. Wang. 2005. “Costs and Returns to Organic Dairy Farming in Maine and Vermont for 2004,” University of Maine Department of Resource Economics and Policy Staff Paper #555 (November).

Dhar, Tirtha and Foltz, Jeremy, The Market for rBST-free and Organic Milk, University of Wisconsin-Madison, 2003. http://www.pats.wisc.edu/pdf%20documents/fact18x.pdf

Organic Consumers Association, “Demand for Organic Dairy Products in USA Exceeds Supply--New Farmers Needed”, May 20, 2005, http://www.organicconsumers.org/organic/cheese052705.cfm

Organic Trade Association, “The OTA 2004 Manufacturer Survey Overview” http://www.ota.com/pics/documents/2004SurveyOverview.pdf

Rheinheimer, Lowell, CROPP/Organic Valley (organic dairy processor), Phone 574.642.3759, e-mail .

USDA, Agricultural Marketing Service. National Organic Plan, http://www.ams.usda.gov/nop/indexNet.htm.

USDA, Economic Research Service. Organic Farming and Marketing Briefing Room, http://www.ers.usda.gov/Briefing/Organic/.

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[1] The official website of the NOP is: http://www.ams.usda.gov/nop/indexNet.htm.