"Milko has long had unbalanced finances and we have been forced to implement several, comprehensive cost-efficiency measures in recent years," said Milko president Lars Reyier in a statement on Thursday.
Reyier continued to point out that the number of dairy cows in Sweden has almost halved since 1985.
"As elected officials, we have both a mission and a responsibility to search without reservation for modern structural alternatives within the dairy market which grants members the best possible sales and compensation for their milk," he said.
Milko is owned by around 650 farmers in Sweden and they must approve of any proposed merger at an extraordinary general meeting.
Due to the dominant position of Milko and Arla on the Swedish dairy market, the approval of the Swedish Competition Authority (Konkurrensverket) will also probably be required.
Arla is already Sweden's largest dairy and this position will be further strengthened by a merger with Milko.
The firms work together in Gothenburg already and Arla bought Milko's dairy in Sundsvall earlier this year.
Milko's operations are predominantly located in Värmland, Hälsingland, Dalarna, Jämtland and Ångermanland.
The company's turnover was 2.2 billion kronor ($356 million) in 2010, but is a relatively small player in the Swedish dairy market in comparison to Arla, a global firm with 16,000 employees.
Arla has production in 13 countries, is owned by Swedish and Danish dairy farmers and posted a turnover of 59 billion kronor in 2010.