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Silverton-area dairy sour on proposed changes

Mallorie's is worried that new pricing rules will hurt business

Michael Rose
Statesman Journal - Salem, Oregon
June 5, 2005

Mallorie's Dairy Inc. tends a herd of 1,900 cows and operates a milk-bottling plant near Silverton. Its two businesses would seem to go together as well as milk and chocolate brownies.

But in the U.S. dairy industry, which relies on government regulated orders to determine prices paid to farmers, nothing could be that simple.

The company's business model has become the focus of a raging industry battle about whether Mallorie's and similar all-in-one dairy operations have an unfair advantage in pricing their products. Now, the U.S. Department of Agriculture is poised to change 70-year-old regulations that have allowed operations such as Mallorie's to prosper.

From Mallorie's perspective, it's a power play by other dairy interests to eliminate competitors.

"This is not really about farmers as much as it is about big entities that process and control milk," said Charlie Flanagan, business manager for Mallorie's.

The proposed change threatens to undermine the family-owned business, which employs 86 people and generates an annual payroll of $2.4 million, he said.

Mallorie's has mounted a public-relations campaign, urging consumers to send comments to the USDA opposing the rule change. Fliers distributed by Mallorie's to Roth's customers warn that consumers are facing higher prices and fewer choices unless the rule change is overturned. At least 5,000 consumers have responded with e-mails to the USDA, Mallorie's officials said.

Dairy operations that milk cows and package milk in-house have long rankled some prominent dairy cooperatives and milk processors. The cooperatives say that the operations, known as producer-handlers, are exempt from the government pricing system that applies to all others in the industry. As a result, the producer-handlers can undercut the prices charged by other companies.

The USDA has recently sided with the cooperatives and milk processors. It's crafted an interim decision that would require producer-handlers selling about 350,000 gallons of milk per month, or more, to be part of a regulated milk pool.

The proposed change would apply only to producers in the Northwest and parts of Arizona.

In Oregon and Washington, three producer-handlers are large enough to be affected: Smith Brothers Farms in Kent, Wash., Edaleen Dairy in Lynden, Wash., and Mallorie's.

Dairy operators in these areas would have to vote to approve the changes, but people pushing to remove the exemption for producer-handlers say they are confident the rule will be approved. Most dairy farmers are part of cooperatives.

In making its interim decision, the USDA stated that the rule change might harm some producer-handlers but "the impact is offset by the benefit to other small businesses."

If the federal regulation is approved, Mallorie's likely would pay a monthly surcharge of $83,000 to maintain its production of 520,000 gallons per month. It could avoid the surcharge by slashing production below the 350,000 gallon threshold.

Neither choice is palatable for Mallorie's.

"It's unlikely we could survive under those conditions," Flanagan said.

In all, the surcharge could take about $1 million per year out of the company's budget, he said. Reducing production to avoid the charges, he said, is no better because Mallorie's would have to drop customers.

Dairy Farmers of America, a cooperative that markets and processes 34 percent of the nation's milk supply, is a leading proponent of ending the exemption for producer-handlers. Dairy Farmers of America's operations include a joint venture with Wilcox Dairy in Salem.

Elvin Hollin, director of economic analysis for Dairy Farmers of America, said other milk producers are paid based on a "blended price" regulated by the government. It's formulated based on the price of fluid milk packaged in bottles and cartons and milk used for other dairy products that has a lower market value.

The intent of such marketing orders are to ensure that dairy farmers are paid uniform prices for the product. In essence, it's a minimum wage for dairy producers within a given geographic region.

But those regulations currently don't apply to producer-handlers. In recent years, producer-handlers have been able to sell their milk about 11 to 33 cents per gallon cheaper than farmers in cooperatives, Hollin said.

"It all boils down to 'I want to keep my unfair advantage,'" Hollin said of the arguments by producer-handlers.

The producer-handlers, among the largest dairy farmers in the business, would not have a price difference to exploit if not for the government's intervention in the milk market, he said.

Years ago, many producer-handlers were small-time operations. Any price advantage the producer-handlers might have had wasn't viewed as significant. Now, some producer-handlers have grown large enough to raise concerns about disruptions in the milk market, Hollin said.

Industry officials say that one large producer-handler in Arizona, Sarah Farms, has cost other milk producers about $11.5 million in lost revenue over a three-year period because they are exempt from the government's pricing rules.

A representative of Kroger Co., one of the nation's largest grocers, told USDA officials that it was in favor of the rule change. Kroger officials maintained that producer-handlers had a competitive advantages over other milk producers, who "have been forced to respond to competitive situations," according to USDA documents.

Mallorie's Flanagan said his company is a long way from dominating the milk market, even though with 1,900 cows, it's one of the larger dairies in Oregon. It routinely faces price competition from other milk bottlers, he said.

Mallorie's has carved out a niche market suppling independent stores, such as Roth's, and a few food processors. None of the producer-handlers in the Northwest are big enough to supply the large grocery chains, he said.

"It's a different business model and that makes people nervous," Flanagan said of Mallorie's. Although some people have worried that large producer-handlers would start up in Oregon, the number of the operations has been declining for the past 20 years.

Mallorie's has met with representatives of U.S. Rep. Darlene Hooley's office and the Oregon Department of Agriculture and asked for help in overturning the proposed USDA regulations.

Brent Searle, a special assistant to the director of the Oregon Department of Agriculture, said the state agriculture department is drafting a letter to the USDA on behalf of Mallorie's.

The Silverton dairy is "hardly a blip on the screen" compared to the many of the cooperatives, and the argument that producer-handlers could disrupt the milk market is overstated, Searle said. Agriculture experts have for years encouraged value-added processing on farms, the very type of activity that Mallorie's is doing at its milk bottling plant, he added.

Still, Searle said, it's looking like the USDA will establish some type of cap on producer-handlers. The question is whether Mallorie's will be able to function under the new rules, he said.