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Cheese, this is confusing!

If you're not sure why cheese prices are so low after being so high for so long, take heart. Even the experts are shrugging their shoulders this year.

July 7, 2004

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Cheese is serious business to pizza operators, so we do our share to stay abreast of price changes and market cycles relative to this most precious commodity.

That means I scan several dairy Web sites daily and call an analyst or two each week just to talk about market conditions. I've known most of these experts for at least a few years, and I can tell you their opinions on the situation have always been reliable.

And then there's 2004, the year when even the smartest dairy minds have said more than once, "Beats me what's going on."

Analyst Alan Levitt told me several days ago that 2004 is perhaps the craziest year he's ever seen in the industry. History shows that, by and large, the dairy market is fairly predictable. But when block cheese prices soar to $2.20—23 cents higher than the previous record set

Steve Coomes, Senior Editor

And spectacular it was over the past week and a half, when the cheese price dropped from $1.80, where it held for nearly six weeks, to around $1.40. As analyst Jerry Dryer has told me more than once, "When this market corrects, it corrects hard."

Even sages like Dryer and Levitt thought the cheese market would correct itself far sooner than it did. And a couple of months ago, Dave Deal, a former Little Caesars executive who now advises pizza companies on dairy purchasing strategies, told me that the sale of as little as one load (40,000 pounds) of cheese, can send market prices soaring or tumbling.

Yet this spring, in the course of about two months, more than 400 loads passed through the CME without barely a move on the price scale.

Perhaps more spectacular was the fact that Dairy Farmers of America, the country's largest dairy cooperative bought every one of those 400-plus loads. Levitt said he kept thinking, "Surely they'll stop this soon," and yet DFA kept right on buying. Once it was all over and DFA stepped away from the pit, Levitt could only surmise, "Somebody definitely needed the cheese."

Not worth figuring out

As I found out this past weekend when my wife's PC went belly-up and needed a complete reformat and installation, trying to figure out what happened is much less productive than doing what's necessary to fix it. All my hand wringing and complaining did nothing to get the machine up and running again. The solution came when I asked for help from people far more computer savvy than me.

The same goes for the cheese market. You can spend an enormous amount of time wondering why prices rise and fall seemingly without reason, or you can prepare yourself to deal with it when it happens. Let the Levitts, Deals and Dryers of the world watch the details, and then listen closely when they warn of market moves.

What operators can do is pretty simple:

1. Control portions strictly. If there was a lesson to be learned in this most recent price crisis, it was this one. From what I'm hearing, it appears many operators have finally knuckled down and started weighing and/or cupping their cheese.

Consider it this way: Another price-comparable commodity is gasoline. How sloppy are you when putting that liquid gold into your tank? You probably wince at every drop spilled on the side of the car. If you're not doing so already, treat your cheese the same way. Last I looked, shredded mozzarella was still more expensive than petrol.

2. Negotiate a percentage-over-block price with your supplier. This helps in more ways most operators even know. Not only does it demonstrate a firm commitment to your supplier, it allows him to commit to his supplier who then contacts a broker to buy fluid milk futures. That in turn tells dairy farmers how much milk they need to produce for their customers, which makes market demand more predictable, and predictability equals price stability. While that may seem like a far off goal, the dairy market is actually well balanced. A shift in supplies of as little as 1 percent can send prices crashing or rising, depending on supplies. Imagine how much firmer it would be if everyone did a better job of predicting their usage and contracting ahead.

3. Consider hedging strategies. Unless you're a commodities whiz, you'll likely need the help of a broker to invest safely in the milk futures market. Deal believes pizza companies with as few as 10 stores should consider this strategy, not for the purpose of getting rich, but for the purpose of smoothing out the price highs and lows.

The goal is to offset high cheese prices by buying milk futures contracts at low prices and selling it at high prices (all of which the broker does for you).

The end result for a pizza operator is price predictability. To grossly oversimplify this idea: A conservative player would position himself to pay $1.50 (CME block rate) for his cheese throughout the year. He'd budget that cost into his food cost, profit margin and menu prices.

If the price goes above that, he's making out well, but if it goes lower, then he's paying more than his competitors. The bottom line is that he's paying the same price all year round. Knowing what to expect, Deal says, gives the operator peace of mind because he's planned for that price. Meantime, his competitors are either cheering or cringing and taking whatever the market dishes out.

By the way, milk futures prices for the fall are very favorable, and after a spring full of Maalox moments, perhaps now is the time to consider a more sane strategy.