Real-World Application: Product Costing in a Dairy Plant

Every kilogram of butter, ghee, or skim milk powder that leaves a dairy plant carries with it a carefully calculated cost – one that determines whether the plant makes a profit or runs at a loss. But how exactly does a dairy plant figure out what it costs to produce each of these products? A detailed case study of a cooperative dairy plant in Erode district, Tamil Nadu offers a practical, real-world answer to that question. The plant, which received 725 lakh litres of milk during the financial year 1999-2000, applied process costing techniques to estimate production costs across its full product range – providing a textbook example of how costing theory works on the factory floor.

About the dairy plant and its product mix 🔗

The Erode dairy plant operates as a feeder-balancing dairy under the cooperative set-up. It collects milk from its own milk-shed area and also receives diverted milk from other cooperative unions and state federations, converting the surplus into storable dairy products. During the study period, the plant manufactured Skim Milk Powder (SMP), Butter, Ghee, Standardised Milk, Dudh Peda, and Flavoured Milk, among others.

In terms of revenue contribution, SMP was the clear leader, accounting for 42.93% of total revenue from 477.5 tonnes of output. Butter followed at 39.48%, and Ghee contributed 16.37%. Products like Standardised Milk, Dudh Peda, and Flavoured Milk each had less than 1% individual revenue share. This product mix reflects a common pattern in Indian cooperative dairies, where high-volume, shelf-stable products like SMP dominate production to balance seasonal milk surpluses during the flush period.

The costing method used: process costing 🔗

Process costing is the standard technique for industries that manufacture large, homogeneous quantities of products through continuous operations – cement, mining, and dairy manufacturing all fit this profile. In process costing, costs are accumulated across production departments or stages, and the total cost is then divided by total output to get the cost per unit.

In the Erode plant, this technique was applied product by product, with data collected on milk inflow, raw materials consumed, utility costs, manpower, and other operational expenses for the full financial year. The approach gave the plant a reliable per-kilogram or per-litre cost figure for each product it manufactured.

How costs were allocated across products 🔗

Not all costs can be directly traced to a single product – and that’s where allocation decisions become critical. The plant followed a structured approach:

Direct allocation for raw materials and direct expenses 🔗

Raw materials – primarily milk and cream – were directly assigned to each product based on the quantity consumed. If a specific volume of milk was used to produce SMP, that milk cost was directly attributed to SMP. Similarly, labour directly involved in butter-making was assigned to the butter cost centre. This approach aligns with standard traditional cost allocation, where costs traceable to a product are assigned directly rather than spread across products.

Overhead allocation based on time, benefits, and relevance 🔗

Overheads – indirect costs like factory rent, utility generation expenses, and administrative costs – cannot be directly traced to a single product. The plant allocated these based on criteria such as time spent in production, benefits derived from a shared resource, and other relevant factors.

For instance, if the factory operates 24 hours a day and Ghee manufacturing occupies 8 hours, one-third of the shared facility cost is allocated to Ghee. If a piece of equipment serves multiple product lines, its maintenance cost is distributed among those products in proportion to usage time. Proper overhead allocation like this ensures that no product is artificially undercosted or overcosted – both of which create problems for pricing and profitability decisions.

Cost of production: product-by-product findings 🔗

The study produced specific cost estimates for each major product. These figures are specific to the case plant and will naturally vary across plants depending on scale, location, and input prices – but the structure of cost components is broadly instructive.

Skim milk powder (SMP) 🔗

The cost of producing SMP worked out to Rs. 70.19 per kg. Raw materials accounted for 83.25% of the total cost, processing cost for 15.36%, and packaging for just 1.39%. SMP’s high processing cost (relative to other products) reflects the energy-intensive spray-drying process used to convert liquid milk into powder. SMP and Ghee together represent the two primary products that Indian dairies use to convert flush-season milk surpluses into shelf-stable goods – making their cost structures particularly important to understand.

Butter 🔗

The average manufacturing cost of Butter was Rs. 91.23 per kg. Of this, raw materials (primarily cream) were worth Rs. 82.65 per kg, with processing adding Rs. 8.58 and packaging contributing roughly 1% of total cost. The relatively lean processing cost for Butter reflects a simpler manufacturing process – cream is churned and separated, with far less thermal treatment than SMP production.

Ghee 🔗

Ghee carried an average cost of Rs. 113.05 per kg. Raw materials made up 87.92% of the cost, processing 7.29%, and packaging 4.79%. The notably higher packaging cost percentage for Ghee – compared to SMP and Butter – reflects the premium, consumer-ready packaging formats that Ghee commands in the market. Ghee holds a unique commercial position in Indian dairy: culturally significant, resistant to global commodity price cycles, and increasingly export-oriented, making accurate costing of this product especially important for plant managers.

Standardised milk 🔗

Although not a major revenue earner for this plant, standardised milk was produced to meet local consumer demand. Its production cost was Rs. 10.91 per litre, with raw material costs forming the highest share at 91.86% – the largest raw material proportion of all products in the study. Processing and packaging costs were 4.75% and 3.39% respectively. Liquid milk’s cost structure is highly input-dependent, leaving very little room for margin unless volumes are very high.

Dudh Peda 🔗

Dudh Peda, a traditional desiccated sweet popular in the region, had a production cost of Rs. 47.41 per kg. Its cost structure was notably different: raw materials at 64.68%, processing at 26.59%, and packaging at 8.73%. The higher processing cost share reflects the labour-intensive, heat-based reduction method used to make this product. The significant packaging cost is also consistent with the retail-ready, gift-market positioning of traditional sweets.

Fixed vs. variable cost segregation 🔗

Beyond the raw-processing-packaging split, the study also analysed costs from a second angle – separating them into fixed and variable components. This is essential for understanding how costs behave when production volumes change.

Variable costs change in direct proportion to production volume – raw materials, direct labour, and utility consumption all fall into this category. In the dairy plant, raw material costs are inherently variable since more milk intake means higher input cost. Fixed costs, such as depreciation on plant and machinery, administrative salaries, land and building charges, remain constant regardless of whether the plant processes 500 tonnes or 5,000 tonnes in a period.

The study found that cost structures vary across products in terms of their fixed-variable composition. Products like SMP, which require significant capital-intensive equipment (evaporators, spray driers), tend to carry a higher proportion of fixed costs. Simpler products like standardised milk or butter have a higher variable cost share. Understanding this split matters because it directly informs break-even analysis – the minimum production volume at which a product covers all its costs – and guides decisions about whether to continue, scale up, or discontinue a product line.

A similar study conducted at a cooperative milk plant in Haryana reinforced this point, finding that most dairy products were manufactured above their breakeven levels – a outcome that’s only possible when management has a clear picture of both fixed and variable cost components.

Why these cost figures are plant-specific 🔗

The study clearly notes that the cost figures derived are indicative and applicable only to the case plant. Several factors cause cost structures to differ significantly from one plant to another:

Installed vs. utilised capacity is one of the biggest drivers. A plant running at 90% capacity will have far lower fixed cost per unit than one running at 40%. Input costs – primarily milk procurement prices – vary by region, season, and cooperative structure. Milk procurement prices across India vary depending on fat content, state cooperative policies, and seasonal availability. Technology and equipment also matter – a plant with modern, energy-efficient spray driers will have lower utility costs per kg of SMP than an older facility. Finally, labour productivity and local wage levels create further cost variation across plants and geographies.

This context is important for any dairy entrepreneur or plant manager who attempts to benchmark against published case study figures. The structure of costs – raw materials dominating, followed by processing and then packaging – tends to be consistent, but the absolute numbers will shift based on operational reality.

What product costing enables in practice 🔗

The findings from this Tamil Nadu plant illustrate what a well-executed product costing exercise makes possible. When a plant manager knows that SMP’s raw material share is 83% of total cost, it tells them that improving milk procurement efficiency will yield far greater savings than cutting packaging costs. When Ghee’s processing cost is known to be 7.29% of total, it becomes possible to evaluate whether switching to a more efficient clarification process is worth the capital investment.

At the pricing level, accurate manufacturing overhead allocation ensures that every product’s selling price genuinely covers its full cost – direct and indirect. Underpricing a product because overheads were not properly attributed leads to silent erosion of profitability that may not surface until the plant is already in financial distress. Accurate costing also supports decisions about which products to prioritise during peak milk inflow periods and which to scale back when raw material prices rise.

For cooperative dairy plants specifically, where the mandate includes both commercial viability and farmer welfare, getting product costing right is not just a financial discipline – it is central to sustaining the entire cooperative model. India’s cooperative dairy sector, which spans thousands of village-level societies and handles millions of litres of milk daily, depends on financially sound processing plants to ensure farmers receive remunerative prices year-round.

What do you think? Given that raw material costs make up the dominant share of production cost across all dairy products, what strategies could a cooperative dairy plant adopt to manage milk procurement costs more effectively – especially during lean season when milk supply drops? And considering how significantly fixed vs. variable cost ratios vary across products like SMP and Ghee, how should a plant manager decide which products to prioritise when production capacity is limited?

References

1. http://dairy-technology.blogspot.com/2014/02/case-study-on-product-costing-in-dairy.html
2. https://www.linkedin.com/pulse/costing-types-cost-system-manufacturing-businesses-jamshaid-manzoor
3. https://biz.libretexts.org/Bookshelves/Accounting/Managerial_Accounting_(OpenStax)/06:_Activity-Based_Variable_and_Absorption_Costing/6.02:_Calculate_Predetermined_Overhead_and_Total_Cost_under_the_Traditional_Allocation_Method
4. https://madrasaccountancy.com/blog-posts/manufacturing-overhead-allocation-methods-explained
5. https://www.iasgyan.in/daily-current-affairs/skimmed-milk-powder-smp
6. https://west.dairyindustryexpo.com/indias-ghee-export-engine-consolidates/
7. https://www.vintti.com/blog/variable-costing-formula-accounting-explained
8. https://www.researchgate.net/publication/327108052_Economics_of_manufacturing_different_milk_product_and_breakeven_point_analysis_in_sirsa_cooperative_milk_plant_Haryana
9. https://apps.fas.usda.gov/newgainapi/api/Report/DownloadReportByFileName?fileName=Dairy+and+Products+Annual_New+Delhi_India_IN2024-0049.pdf
10. https://qoblex.com/blog/manufacturing-overhead-formula-complete-guide-to-accurate-cost-calculation/
11. https://en.wikipedia.org/wiki/Dairy_in_India