Something about prices II. The introduction of Multi Component Pricing for milk…

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Merijn T. Knibbe
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I’m tinkering with the idea of a kind of periodic table for prices. Below, a very rough sketch of what I have in mind relating to administered prices and market prices as well as the sectors of the national accounts (cost prices, shadow prices etcetera have to be added).

Gardiner Means defined the difference between market and administered prices (quoted in Gu (2012) on p. 13):

“In an engineering economy prices are fixed by administrative action for periods of time. Price is determined before a transaction occurs. In a trading economy prices are developed in the process of trading andprice is not determined until the transaction occurs. In an engineering economy supply and demand never equate except by coincidence“.

Earlier I discussed how the Dutch central bank introduced the ‘risk free interest rate structure’ for Dutch pension funds (an administered price and covered by the yellow triangle in figure 1). Today I’ll discuss a company-company administered price: the ‘Multi Component’ farm price of milk (covered by the pink triangle).

Figure 1. The Administered Prices/Market Prices matrix for the institutional sectors of the National Accounts 

Before discussing this first some political economy: the so called ‘risk free interest rate structure’ directly influences the income and wealth of millions. In figure 1 I included the central bank into the government showing how the government influences the income and wealth of millions by setting this price. I might however add, consistent with the national accounts, a fifth row/column consisting of financial institutions which would show that the financial sector sets this price and influences the income of millions… I chose to put the blame on the government (by setting this price too low, wealth and income of millions were set too low, too). That’s a choice. The institutional set up of models is hugely important.

The discussion below is mainly based on M. Knibbe, M. Molema and R. Plantinga, ‘Fair value?The price of milk and the intricate path of bio-based productivity growth in Dutch dairying, 1950-1980‘, forthcoming.

What do Business to Business Administrated prices look like? Do these even exist? They sure do and are important. An example: milk prices. As is well known, from about 1880 dairy farmers changed from producing cheese and milk to producing of milk. Instead of selling dairy products on a competitive wholesalers market they started to sell milk to a local factory which, as milk is uniquely perishable and most rural roads were bad, had a kind of monopsony (only buyer). Bad take: ‘there was crying over spilt milk’. But this crying was at the factory, as these factories were large enough to have laboratories which could detect bacteriological problems with the milk. They even often invested in local roads and pioneered motorization of transport to improve access to the factory. This, however, led to an increase of scale which only enhanced the power of factories. To prevent exploitative relations, farmers established cooperative factories. But like private factories, these cooperatives had to set prices, too. How to do this was a hotly debated issue. Soon, it became generally accepted to pay not for milk as such but to pay the amaount of of fat. Milk, however, does not only contain fat but also lactose (a kind of sugar) and protein. As at the time it was possible to estimate fat content on the cheap while measuring protein content was expensive, protein was not included in the formula’s used to estimate the price of milk (these formula’s were based on the market price of butter and cheese). Comes in Rommert Politiek. Already before finishing his Wageningen University and Research PhD. (1957) on the hereditary nature of protein content of milk in combination with new possibilities to measure protein content of milk he convinced leading people in the Frisian cooperative dairy community (Friesland was, at the time, the main dairy producing province of the Netherlands) that paying for protein as well as fat (Multi Component Pricing, MPC, by now the international standard, if you want to be baffled look here) was a viable and promising way to go. The cooperative dairy industry in Friesland was, at the time, however highly dispersed while Friesland was, and to a large extent still is, a high trust society meaning that during six months or so extensive deliberations with the 82 cooperatives and their members followed. Once everybody agreed, within weeks a new protein laboratory was built, hundreds of thousands of milk samples were tested and milk started to be paid on a Multi Component bases. And then – nothing happened. The whole scheme was designed to entice farmers to start breeding protein cows – but the didn’t. MPC did not work. Or at least not as intended. To an extent because European Union subsidies were still based on fat. And also (see the article mentioned) because farmers preferred more extensive production enhancing strategies: more cows, feed and fertilizer instead of breeding protein cows. After a rapid initial spread MPC even declined somewhat – until factory accountants discovered that they could use it to make more precise and elaborate estimates of the costs of producing different kinds of cheese (which contain different amounts of protein and fat) and other ‘mixed’ products while the government made it more or less obligatory. The word often used to defend was ‘billijk’, which translates as ‘fair, reasonable’. MPC was considered to be a fair way to pay for milk, fairer than paying just for fat. If prices are based on (market) power, it’s good to have a system which disperses power in a way that your treated in a fair way, when it comes to what still were monopsony prices. Farmers agreed with and accepted the system and its costs, even when they did not use it as intended, as it was ‘fair’.

The points: prices and pricing are based on estimates: weights, amounts and qualities. Elaborate inter-company systems exist to define and measure these variables. By now, lactose has been added too, while quality adjustments, first based upon bacteriological quality of milk but nowadays increasingly based on intangibles like animal welfare, are almost as old as the dairy industry itself. The establishment of these elaborate structures, including laboratories and even basic research. Efficiency sure is a variable, too. Farmers, ahem, do not like it when ‘their’ organization pays less than others. But they also like to be trated in a ‘fair’ way, also when it comes to pricing. Technological improvements (better roads, better storage, faster means of transport) mean that it’s easier for farmers to switch to another buyer. But this other buyer will have his own laboratories and pricing formulas. In dairy production, except for some niche markets, administrated and not ‘free market’ prices are bound to dominate trade. Administrated prices rule the roost within companies – but often also between companies. The pink triangle in the rough system shown above is far from empty.