The organic milk price war

NEW YORK (CNNMoney.com) -- People looking for another reason to buy organic milk besides the health and environmental benefits may get one they never anticipated - price.

With costs surging for conventional milk, consumers this summer will find prices for the two types of milk getting closer and closer, as opposed to when once organic milk could cost three or four times as much.

Conventional milk prices are getting pushed up by a variety of factors - Australian drought, disappearing European subsidies, higher feed costs due to corn-based ethanol production and swelling global demand chief among them.

At the same time, organic prices have stabilized and in some cases dropped due to what experts call a one-year glut in production caused by farmers taking advantage of a regulatory grace period regarding feed requirements. Hundreds of new farms are going organic, creating an abundance of milk that has even led to a price war of sorts in some parts.

The increased competitiveness and dynamics of the milk market have some organic producers salivating at an opportunity for growth and others lamenting the bottom-line results of a cut-rate market.

"People do trade up," said Theresa Marquez, chief marketing executive for LaFarge, Wis.-based Organic Valley Family of Farms, the nation's largest organic farmers cooperative. "That will increase demand for organic. We are seeing a pretty robust demand and continued growth for organic milk right now."

The $14 billion organic foods industry has been growing rapidly over the past five years, with dairy accounting for some $2.14 billion in sales. It's milk, though, that is expected to see the biggest surge in 2007, due primarily to the Department of Agriculture giving farmers one last year to feed cows 80 percent organic feed and 20 percent conventional to be certified as organic.

Starting next year, farms will have to go 100 percent organic. That extra year provides farmers a substantial savings, leading many to join the organic bandwagon this year in hopes of cashing in.

The resulting growth in milk supply has been the leading market dynamic this year, with organic giant Dean Foods (Charts, Fortune 500), owner of Horizon Organic products and Silk soy milk, revising its earnings forecast downwards because of what it cited as "a significant near-term industry-wide oversupply of raw organic milk."

Ed Maltby, executive director of the Northeast Organic Dairy Producers Alliance, predicts a 70 percent increase in organic milk supply in 2007 before returning next year to the traditional 20 percent or so growth.

The resulting glut this year has caused some interesting scenarios on supermarket shelves, Maltby said. In some areas, organic milk can be had at a price of $5 for two half-gallons, about 30 percent off the typical price.

"From the point of view of the consumer, it's the larger brands that are looking to maintain their market share" that are cutting prices, he said. "We're hoping that will increase consumers' consumption of organic milk, because it is produced in a way that benefits the environment."

For its part, Dean Foods indicated in its earnings guidance that it will do what it must to protect market share.

"This program includes lowering prices in response to competitor actions, pursuing expanded distribution, increasing our advertising support and continuing to drive innovation to maximize the long-term potential of the brand," Dean Chairman and CEO Gregg Engles said in a statement.

After years of languishing under government controls, pricing has become a sensitive subject in the dairy community.

Many farmers have been looking forward to this year's price surge, in which a gallon of conventional milk is running at $3.38 nationally and expected to hit $4 or more in the coming months. Dairy farmers suffered during last year's drought and are hoping to recoup their losses this year.

As such, undercutting prices at a time of burgeoning supply and increased public demand is creating a bit of a stir in the organic market, in which prices can vary greatly from market to market depending on feed costs. Organic Valley milk, for instance, can run anywhere from $3.29 to $3.99 a half-gallon and up to $5.99 a gallon, while other organic milk can go as low as $3.99 a gallon.

Organic Valley's Marquez took the pricing statement from competitor Dean Foods as a warning to her company. But she said the co-op hasn't done anything unusual this year in terms of promotions.

"We believe in sustainable pricing in the agricultural community," she said. "We will not low-ball our milk. We'll probably lose customers before we go into a price war."