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Developing a multiple component pricing system for milk : a hedonic approach to component valuation

University of British Columbia

The dairy industry in British Columbia (B.C.) and elsewhere is facing a change in consumer demand for many milk products. In particular, demand is shifting away from products with high butterfat content and towards those with high protein content. Yet the present system of determining the price of milk in B.C. is based solely on butterfat content. The increase in consumption of low-fat fluid dairy products in B.C. has caused substantial excess butterfat supplies on the fluid side of the market that has required diversion to the industrial milk market, a situation known in the trade as "skim-off. It therefore appears desirable to modify the current milk pricing system from one driven by butterfat alone to a broader, more market-oriented system that values the range of components in milk and conveys changes in consumer preferences to farm producers and processors more directly. Such a system is called a multiple component pricing (MCP) system. Given that component levels can be affected in farm production, shifting to a system where milk is priced by its components could be a "win-win" situation in which there are efficiency gains throughout the milk sector. The empirical model used in this thesis employs a pooled cross-section time-series data set and involves the econometric method of generalized least squares. A hedonic market approach is used to determine component values from wholesale product prices across a range of retail milk products. It reveals that the current butterfat differential pricing system does not succeed in providing the true market values of the multiple milk constituents produced and demanded in the B.C. market. The results indicate a positive value for each of milk protein, butterfat and the remaining solids including lactose and minerals. Protein is estimated to have a higher shadow value than butterfat in almost all regressions in both the aggregated (fluid and industrial milk) market model, and in the industrial model. The value of "other solids" is, with few exceptions, estimated to be more valuable than butterfat in the aggregated model. This research indicates that hedonic pricing models are effective in determining market valuations of the individual components and can be done with provincial data. It also indicates that the importance of both protein and other non-fat solids in milk pricing in B.C. has been largely ignored and undervalued. Generalizing from the evidence in this study, we find that in choosing component values, the protein component should be priced no less, per kilogram, than butterfat, and the other non-fat solids should be priced similarly. Because these results are derived from B.C. data, extensions of the quantitative results to other regions should be preceded by further empirical testing with data for those regions.

Thesis/Dissertation

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2009-04-30

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http://hdl.handle.net/2429/7734

Agricultural Economics

University of British Columbia

UBCV

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