Size, Productivity and Exit Decisions in Dairy Farms

The U.S. dairy industry has seen major restructuring in the last few decades. The number of U.S. dairy farms has declined significantly and the decline has been concentrated among smaller farms. In the meantime, average dairy herd size increased from 19 cows in 1970 to 175 in 2010 and milk yield per cow doubled over the same period. Herd size, exit and technical efficiency are related in varied ways. Many farm-level production structures are cheaper to build in large scale while asset use can be more efficient on larger facilities. Economies of scale motivate a link between larger herd size and levels of profitability that would support continued production. Technical efficiency should also affect the intention to continue production and expand scale as the more productive are better motivated and likely better positioned to continue operation and increase in size. These incentives have not been explored for dairy production. The three decisions are likely interrelated and should be investigated in an integrated, systemic manner that accounts for endogeneity. Employing data from the USDA’s 2010 ARMS Phase III, Dairy Production Practices and Costs and Returns Report, we first estimate technical efficiency using Stochastic Production Frontier analysis. The efficiency estimate is then incorporated into a system of equations that includes the exit decision and herd size. The results suggest that smaller and less efficient farms are more likely to exit and more efficient dairy farms tend to expand, results which do seem consistent with theoretical considerations and with current trends in dairy structural change.