Organic milk demand and supply in the U.S. and implications for organic milk industry
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Organic food in the U.S. has attracted great interest from consumers since the late 1990s for health and environmental reasons. Organic dairy is the second largest organic food group after fruit and vegetables. Sales of organic dairy in the U.S. were more than 5 billion dollars in 2014, 15% of the industry. Recently, the average annual growth rate for organic milk sales has exceeded 10%. With the popularity of organic food, organic food has expanded beyond natural food stores to mainstream grocery stores. Since late 2013, organic milk has been in short supply and many stores have not been able to provide enough for their customers. One reason for this shortage has been the unwillingness of conventional dairy farmers to convert to organic operation due to lack of information about future demand. This shows that consumer demand information is crucial for dairy farmers' operational decision making. Two large organic milk processors coexist in the U.S. One of them is a cooperative and the other is an investor-owned firm. The pricing strategy for organic raw milk is very different than for conventional milk. Since 1989, the price of organic milk has steadily increased with a clear trend. However, the price of conventional milk has fluctuated from year to year, and even from month to month. Compared with conventional milk, the organic milk farm price is more stable and predictable from month to month. I hypothesize that the duopsony market structure and the cooperative play important roles in the pricing of organic raw milk and protect organic dairy farmers' profitability. The general objective of this study is to examine the organic dairy industry supply-demand coordination challenge with a specific emphasis on the consumer demand side. Specifically, my first objective is to examine consumer demand for organic and conventional milk in the U.S. and how consumer response to price and income changes. This study provides information about market conditions and how consumer demand for organic milk products affect farm milk price. The second objective is to describe participants in the organic milk industry from production to processing, to compare price and profitability for organic and conventional dairy farms, and to provide decision-making information for potential organic dairy farmers. The third objective is to examine a supply chain coordinator in the organic dairy industry, Organic Valley, and its internal decision-making challenges in balancing supply and demand, and stabilizing the price of raw milk in the organic milk value chain. The first chapter of this dissertation lays out the background, motivation and research objectives of this study. The second chapter provides a detailed theoretical framework of consumer behavior and empirical models for consumer demand studies. The third chapter surveys the literature of organic milk demand. Chapter four develops a vector error correction almost ideal model for organic and conventional fluid milk with monthly aggregate data from the U.S. This chapter considers the time series properties of the data and the endogeneity of price and expenditure. Using the parameters estimated in the model, price and expenditure elasticities are calculated, and implications for the industry are drawn. Chapter five analyzes the structure of the organic dairy industry, and the organic milk farm price. Chapter six examines the role of Organic Valley cooperative in the pricing of organic raw milk and in supply chain coordination, and the challenges organic dairy farmers and their cooperative are facing. Chapter six gives a brief summary of the dissertation and discusses policy and industry implications. The empirical study of organic milk demand shows that the time series data for organic and conventional fluid milk retail prices, expenditure, and budget shares are nonstationary and cointegrated. For this reason, the vector error correction model is the best fit for the study. In addition, the group's expenditure is found to be endogenous and income is used as an instrument for group expenditure. The estimates from the model suggest that demand for organic, conventional whole, and conventional reduced fat fluid milk is price inelastic. Demand for organic fluid milk is expenditure elastic, and demand for conventional fluid milk is close to unit-expenditure elastic. In the short run, consumers adjust their consumption of fluid milk to a long-term equilibrium. This study provides a new method for estimating consumer demand for organic and conventional fluid milk by incorporating the time series properties. The results show that increasing the prices of conventional and organic fluid milk can cause the revenue of retailers to increase due to inelastic price responses. Inelastic price demand at the consumer level can also be transmitted to the farm level. As a result, farmers can also benefit from increased prices if price transmission is occurring. Elastic expenditure demand means when income increases, possible expenditure on organic milk will also increase. Therefore, farmers can enhance their management decision making by understanding macroeconomic conditions. Under conditions of increased consumer demand and short supply, in a normal or good economic environment, farmers can achieve higher income and returns by expanding their production. This study finds that organic raw milk is priced differently from conventional raw milk due to the unique mission of the Organic Valley cooperative, which seeks to provide stable and sustainable farm prices to protect its family farmer members. The cooperative has set up a pricing standard and serves as a price leader in the organic dairy industry. The profitability per cow comparison between organic and conventional dairy farmers indicates that organic dairy farms have performed much better financially than conventional farms over the last seven years. Considering the relatively small size of organic dairy farms, the relatively higher profitability of organic dairy operations is especially important for small dairy farmers who want to maintain their size and earn a living through farming. Converting to organic operation has the potential for better profitability. Organic operation has the potential to bring economic benefit to dairy farms, especially small ones. At the same time, organic operation can reduce the use of chemicals and synthetic fertilizers, benefit the environment and promote sustainable agricultural production. For these reasons, policy makers may consider providing more economic support for organic dairy farmers and potential organic dairy farmers.