As the second-largest contributor to the Canadian economy in 2012, the dairy industry generated $5.92 billion in net farm receipts. Today, there are 11,962 dairy farms, and the average dairy farm has 77 cows per farm. But what are the costs involved? In today’s dairy marketplace, it is important to know the “ins and outs” of the cost of production.

Have you ever wondered what the cost of dairy production is in Canada and how it is determined? Are you interested in how it affects your operation’s bottom line?

Yearly, the Canadian Dairy Commission (CDC) undertakes a national study of the cost of producing milk at the farm (COP study). The study involves randomly selecting dairy producers (for example, 220 farms in 2012) to measure the COP, as a representation of the Canadian dairy farm population.

Studied costs are broken down into three sections: cash costs, capital costs and producer labour, which includes the milking herd plus replacement animals.

“Cost of production is a factor that can be used in establishing regulated prices. It is one measure of producer expenses involved in producing a commodity at a specific point in time.

In general, COP formulas include variable input costs (feed, labour, etc.), fixed input costs (depreciation, plant and administration, overhead, etc.), levies paid by producers to operate national agencies and provincial boards, and a return on labour and investment,” states the Ontario Ministry of Agriculture, Food and Rural Affairs.

COP is measured as dollar cost per hectolitre of milk produced. In 2012, the COP for one hectolitre of milk was $77.79, and once indexed to the third quarter of 2013, the COP is $78, as outlined in the National Cost of Production Calculation chart in Table 1.

These costs are then evaluated and used to set the price of milk, which is released Feb. 1 in the following year. In making its pricing decisions, CDC reviews the advice of industry stakeholders, COP calculations, market conditions, the changing dairy environment and the general economy.

Each provincial milk marketing board purchases the milk from the producers at this set price and then sells it to milk processors. Quota purchased by the producers limits the amount of milk they can sell as part of supply management.

The supply management policy, established in the early ’70s, controls the price of milk in Canada by restricting the supply through controlling the amount produced domestically and limiting imports.

The Market Sharing Quota (MSQ) is determined by estimating the domestic demand for dairy products on a butterfat basis. 2014 quota prices in Ontario, Quebec, Prince Edward Island, New Brunswick and Nova Scotia are capped at $25,000 per kilogram of butterfat per day, whereas the highest price is found in British Columbia at $43,500, states the Dairy Farmers of Ontario website.

Now getting down to business with the COP, how can it affect operational income? Statistics Canada reports that in 2012, the average gross total farm operator income for dairy cattle and milk production was $95,998, a 28 percent increase since 2008.

In terms of operational costs, there will be a difference of COP when comparing national averages to your farm’s averages, but they both have an effect on your bottom line. With milk prices fluctuating yearly based on the CDC studies, Kimberly Shipley from MNP LLP in Red Deer, Alberta, states “supply management and cost of production go hand in hand.

“Business planning for today’s dairy producer requires an in-depth understanding of the producer’s specific cost of production.” Shipley continues, “Increasing efficiencies on farm and improving management practices are methods to increase profit.

The beauty of supply management is that most farms are family farms, where a family provides most of the labour, management and has the opportunity to benefit from efficient farm practices.

Each farm has its own unique individual cost of production, and the average COP is calculated on a national basis. Understanding the individual farm’s COP to compare to the national average can be a tool to help increase profit on a per-farm basis.”

Shipley specializes in serving supply-managed dairy and poultry producers in Alberta and delivers business advice to help her clients overcome industry challenges and take advantage of emerging opportunities.

Upon consultation, Shipley explains, “Basically, I would look at the dairy operation’s financials and look to see if their ratios are out of line. A good common ratio we look at is return over feed, as it is one of the largest expenses, but we would also look at vet and breeding costs, which are also a large percentage of costs.

By looking at the variances in ratios, we can highlight possible issues for the producer, then it is up to the producer to look at why they are having these variances and can use this to start a discussion with other service providers to find the problems and discuss solutions.”

Understanding cost of production is imperative regardless of farm size. “No matter what size of operation, it is important to look for farm efficiencies where they operate at the right size for the overhead they have.

A lot of it comes down to management practices on-farm and production efficiencies. On a farm, individual cost of production is very much impacted by how good a herd and business manager they have, as it is the same with any business.

For example, having an extra 20 cows is not necessarily going to be more efficient; it’s more like if that farm has 20 cows less, how they can maximize their barn and practices to be a profitable operation.”

The nitty-gritty of the COP is that there is a cost to produce milk, and with every monthly milk cheque, the goal is to achieve a profit in the end. Expert consultations are always a good idea, but managing your costs and continuing to find operational efficiencies will be sure to put you ahead of the game in the future.

References omitted due to space but are available upon request. Click here to email an editor.