Ongoing impact of milk wars

There is a dire shortage of milk in NSW and QLD and consequently as reported in my post “Coles no-one believes the spin anymore” NSW and QLD dairy farmers are no longer being paid just 12c/litre by milk processor Lion for their off quota milk (large volumes of their milk known as T2 milk) as of 1^st December 2012.

Milk is now in short supply in NSW and QLD

Believe it or not paying farmers more does not automatically equate to more milk because as I mentioned previously cows are not machines and you cant turn their udders on and off. Now you may ask why the milk processor Lion got itself in this position, bizarre as it may seem?.

Cows are not machines

Here is my take on it (and mega apologies it is complicated). ……

First it is necessary to understand the way in which the domestic (fresh milk ) dairy industry operates. New South Wales and Queensland are the main domestic milk market states followed by South Australia and Western Australia.  The largest domestic milk processor Lion has very little manufacturing capacity (which means it cant produce longer life products), little presence in export markets and supplies the bulk of house brand label milk to Coles in NSW.

 

The current practice is for Lion to announce what is known as an Anticipated Full Demand (AFD). AFD is what they believe is the milk required from farmers to service their customers retail milk sales.

To fill this AFD dairy farmers are allocated milk allotments akin to quota and sell this to Lion at an announced price. This milk price is known as Tier 1 milk. Farmer suppliers who produce above their allotment or do not hold an allotment receive a lower price which is currently close to 25% (11c/litre) of the price of Tier 1 allotment milk. This milk is known as Tier 2 milk. This system is designed to force farmers to have a flat milk supply curve with the extra costs this incurs, has little transparency, and effectively acts a restraint to trade, encourages rent seeking and serves to drive costs up.

This graph of milk sales vs milk production clearly shows achieving a flat curve (red line) isn’t exactly easy for the cows and the farmers and its a very expensive goal to chase for many reasons 

Tier 2 milk is traded between processors creating a secondary milk market and effectively they are each others customers. A little too cosy for my liking as there is no transparency at farmer level as farmers have no idea what prices are being paid by the processors for milk being traded in this secondary market.

Secondly the Australian liquid milk market is I believe manipulated by the the duopolies in a number of ways.

Whilst house brand label products generally provide lower margins to both the retailers and manufacturers, they offer greater control of the supply chain, and reinforce loyalty to the retailer rather than manufacturer brand. Increasingly the use of house brand private label products has seen supermarkets reducing the shelf space available to branded products, narrowing the range of branded suppliers within each category and driving consumers toward house brand label products. This in turn increases competition amongst manufacturers for the house brand label contracts and drives down wholesale prices. 

Over the past 10 years the retail price gap between branded and private label prices as widened, as their increased share has prompted processors to try and claw back margin through branded products.

With house brand milk being sold by Coles and now Woolworths and Aldi at one dollar per litre this means milk is now cheaper than water and soft drinks in our supermarkets.

On top of this the purchasing practices of Coles in particular markets equate to running a Dutch auction. This means processers have no way of know if they have lost the contract fairly and squarely has they have no way of knowing what the winning bid was. In a world where fair is equal retailers should bid by tender for products rather then rely upon undisclosed supply arrangements.

 

Pivotally contracts are very short term and currently only for two years. This means domestic processors in order to coordinate their activities and to share their risks are prone to undertake opportunistic behaviour and they in turn offer their suppliers short term contracts that often have onerous conditions attached to them.

The current milk shortage is a reflection of Lion’s short term view of the market place , lack of knowledge of and sadly lack of interest in what happens on farm.

Lion’s contract with Coles comes up this year. Lion are very nervous they may not retain the contract and hence they don’t want to be stuck with farmers on contracts if they suddenly find themselves without a market for their milk  This is believe has led to the Tier 2 milk strategy which makes producing milk off quota unviable and did force a number of dairy farmers out of business which has led to the current milk shortage in NSW and Qld

This has meant Lion now heavily trades on the secondary milk market ( excess milk that processors like the biggest cooperative in Australian the Victorian based Murray Goulburn don’t need). Whilst this comes with a number of serious risks for them in reality you cant blame them.

So currently we have large volumes of milk coming to NSW from Victoria and similar amounts of milk from NSW going to QLD. The big risk for Lion is Murray Goulburn will sell their milk to whoever will pay the highest price and as they are heavily involved in the export market if it is overseas buyers that is where it will go   

 

Behind this smile is one very worried dairy farmer

I love the farm but sometimes I hate farming – it shouldn’t be this scary and its time to get our dignity back. There are a number of ways you can help our dairy farmers get their dignity back and a great way to start is to sign this petition found here 

Wish list for 2013 – Dairy Farmers get their dignity back