Contract milking

There has been a significant shift towards CM agreements in recent years. They are lower risk to a CM than variable order sharemilker (VOSM) agreements, given the payment is a fixed rate that is not related to milk payout. Contracts offer some income security to milkers in a low milk price but do not offer the same profit opportunities as VOSM contracts in high milk price years.

If you are considering a contract milking arrangement it is important you do your due diligence and make sure it is the right move for you and your farming business.

Skills required

• Farm management skills.
• Financial management/budgeting skills.
• People management (if staff are employed).
• Health & Safety knowledge.
• Environmental compliance and regulations for the region.

Advantages for the contract milker

• Provides the opportunity to move into business ownership and grow equity at a greater rate than might be possible as an employee.
• Given milk production is relatively stable compared to milk price, the contract milking agreement reduces the financial risk for the contract milker compared to a variable order sharemilking agreement.
• Contract milking agreements are relatively easy to enter and exit and are often on a one year rolling contract for this reason.
• Minimal equity is required.
• Having ‘skin in the game’ as a progressing farmer brings a vested interest in increasing productivity.

Advantages for the farm owner

• Can take a more hands-off approach with the farm.
• A set income for the contract milker per kgMS makes budgeting simpler than for a variable order sharemilking agreement.
• The contract milker has ‘skin in the game’ and therefore has a vested interest in the farm management as this affects productivity.

Determining the contract rate

In simple terms the contract rate is struck by agreeing on the costs the contract milker must cover and dividing that figure by an “average” production figure,to provide a $/kgMS rate. The average production should be reflective of the farm’s history and production system. Typically, the contract milkers costs will include:

• Farm operating costs: staff (including relief staff), dairy shed costs, electricity, and cost of vehicles provided for contract use. Sometimes a share of feed and nitrogen costs can also be included.
• Administrative costs: a CM must be able to cover their own administrative, accounting, ACC and insurance costs.
• Depreciation: Is the loss value each year of plant, machinery and office equipment such as computers, that needs to be allowed for in the agreement or contract.
• Wages of management plus a contract milker premium: it’s important a CM gets a better return than they would get from being employed as a farm manager because they are taking on business risk.

The contract calculation must be transparent and well-understood by both parties. Our CM Premium Calculator provides a comprehensive way to work through the contract rate, helping you compare the profitability of contract milking with managing a farm.

Timing of payments

The timing of payments is negotiable. Because CMs often enter agreements with low equity, providing some income in advance will assist them to cashflow the first few months of the contract until milk starts to flow.

Minimum annual payments

In some contracts, especially those on smaller farms, a minimum annual payment to the CM may be agreed to ensure that they receive a fair return for the effort they invest in the farm. This safeguards them from scenarios like droughts that could significantly affect production.

Top-up payments

Sometimes a contract milking agreement may include extra payments on top of the agreed contract rate. In these arrangements, the CM receives an agreed top-up payment in the event the milk price rises above a certain threshold. However, because the CM is shielded from milk price decreases, this is not standard.

This approach does provide the owner with the ability to even out the risk of having to offer a high contract rate ($kgMS) in low milk price years.

Top-up payments can be paid throughout the year, based on an agreed schedule, or at the end of the year once the final milk price is known. Arrangements should be recorded in the agreement.

Other considerations when entering a contract milking agreement

For the contract milker:

• The contract rate required to provide a reasonable return can vary widely between farms. A contract rate of $1.50/kgMS on one farm may well provide a better return than $2/kgMS on another. Likewise, top-up payments may not be an indication of a better contract. Doing your budgets and due diligence is critical.
• It is important to understand that your payments are not affected by a change in milk price. Whilst this protects you from a drop in milk price there is no benefit to you from a lift in the milk price unless the owner includes top-up payments.
• Proft margins for a contract milker at the smaller end of the farming scale (<150,000 kgMS)are sometimes insufficient to allow you to build equity and progress.

For the farm owner:

• Budget wisely. If the payout drops significantly, the CM pay rate is fixed and it is you that must buffer the reduced income.
• As in any business arrangement, a fair and reasonable contract rate needs to be agreed to ensure a viable business for the contract milker and a sustainable outcome for your business. A good arrangement will help with the success and longevity of the relationship.
• Instilling good reporting mechanisms that satisfy your need to show how the business is tracking will allow a more hands-off approach. If you are closely monitoring and directing the day-to-day activities of the contract milker then the relationship between you may be closer than that of an employee.

Keys to success

• Good budgeting is essential to understand the costs and profitability of a Contract Milking business before agreeing on a rate and signing the contract.
• A basic annual farm plan should be agreed before the season. This will ensure both parties understand what inputs can be expected throughout the season and have confidence in the milk production target.
• The contract rate is set at a fair price for the work provided and costs covered by the contract milker. To calculate this, use our budgeting tools.

Who else can help

Contract Milking 101: A short course to build an understanding of contracts and budgeting to give new contract milkers the best chance of success.

Your Agri-bank: As a contract milker you may require some seasonal financing. The agri division of your bank can help work through the budget.

Accountants: As a business owner you will need to deal with a range of financial issues that will require an accountant. A good rural accountant may also help you work through the finances of a position as a first step in an ongoing relationship.