Monday, February 1, 2016

Why would a firm sign this long term contract?

Interesting story from China where lower raw milk prices are actually hurting a Mengniu Dairy (a processing firm that should ordinarily benefit from lower input prices).  Instead, it has to support its upstream suppliers with continued purchases in the face of very low demand.

In the West, this kind of long term contract would be signed to encourage the upstream dairy to make relationship-specific investments necessary for trade.  But it is difficult to see the value of such investments with a good like raw milk.

I am curious, does any one know why dairies would sign contracts like this?  Is it custom, or some kind of mandate in a country where the state has a very big interest in full employment.

HT: WJ

1 comment:

  1. Dairies and farmers enter into such marketing contracts for several different reasons. I don’t know if the Chinese government is involved in the diary business in the same way as the United States government, but in the U.S., the United States Department of Agriculture (USDA), through the Agricultural Marketing Agreement Act, authorizes Federal Milk Marketing Orders (FMMOs), which establish specified provisions in which dairy processors purchase fresh milk from dairy farmers in designated marketing areas, including quantity requirements, subsidies, and price controls. Most dairy farmers are members of dairy cooperatives through contracts known as marketing agreements. These marketing agreements basically guarantee a market for milk produced that meets quality standards. In addition to this guaranteed market, the FMMOs also guarantee dairy farmers a reasonable minimum price for their milk and ensures that there is an adequate supply of fresh milk to meet consumers’ needs, as well as preventing fluctuations in price during fluctuations in milk production and processing. (http://www.ams.usda.gov/rules-regulations/moa/dairy)
    Dairy cooperatives across the country have faced large swings in demand for milk in both the national and international markets causing over-supply. Milk sales were high in 2014, but have since declined to the point where surplus milk is dumped by the tractor-trailer tanker load on a monthly basis. As prices increase, consumer demand for fresh milk, and other dairy products declines. Additionally In the global market, China has dramatically reduced import of U.S. milk due to their own surplus, and in 2015 Russia imposed sanctions against the U.S., stopping trade. (http://www.dailyfinance.com/2015/01/17/food-farm-dairy-woes-milk-price/)
    What exactly does all of this mean for dairy farmers and milk consumers? Farmers receive a guaranteed minimum price for their milk production, consumers are guaranteed an adequate supply of fresh milk at a somewhat stable price, and processors agree to purchase a set amount of milk at an agreed upon price for use in processing various dairy products such as yogurt and cheese, in addition to fresh milk. Unfortunately, as long as supply and demand remain out of balance, the over-supply of fresh milk is wasted through dumping, and farmers continue to receive very low prices, negatively impacting the income necessary to maintain their farms.
    Posted by rmariGoogle)

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