This chapter addresses the second question posed by the committee in its
Second Interim Report; namely, the impact of the supermarkets' price
decisions on the outcome of renegotiated contracts with the processors and farm
gate prices. In so doing, the chapter examines the nature of the processors'
pricing structures, the contract negotiation process and the outcomes of renegotiations
(or other factors which have affected the incomes dairy farmers receive) since
the price cuts were introduced.
Impact on processors and possible flow on effects
Processors that hold contracts for private label milk balance the low or
negative returns they receive from those products with higher returns from
their other branded sales. As discussed in chapter 3, this is done for a
variety of reasons, including volume management and business stability
Figure 5.1 below provides an indicative picture of how the full retail price
paid by consumers for private label and branded milk is distributed among the participants
in the supply chain.
5.1: Components of the retail
price of milk, brands v private label (March 2011)
Note: As contracts between
retailers and processors are generally commercial-in-confidence but farm gate
prices are public, the chart reflects some uncertainty about the actual share
of revenue received by retailers and processors.
Source: Freshlogic; published
in Dairy Australia, Northern Dairy Industry Regional Industry
Outlook—Update: June 2011, p. 8.
One aspect that is clear from Figure 5.1 is that an increased shift to
private label milk at the expense of the branded milk will have significant
implications for the revenue received by processors. As noted in chapter 3,
there is very little difference between private plain white milk and branded
plain white milk in terms of quality and other specifications. Accordingly, any
extra costs involved should be attributable to factors like marketing and the
need to distribute the products to a larger number of smaller, dispersed
The exact size of these additional costs is unclear. The National
Association of Retail Grocers of Australia (NARGA) suggested that for a two
litre bottle of milk in Western Australia, the difference in the cost of
distributing private label milk to Coles versus branded milk to independent
stores is about six cents. NARGA also estimated that the marketing component of
branded milk equated to about seven cents for a two litre bottle. This results
in a differentiation of 13 cents for the processor to provide branded milk
compared to private label, yet the wholesale price paid by a smaller store is
significantly higher than that paid by the major supermarkets. NARGA concluded:
It is the same product but there is a $2 difference in cost
to the small retailer versus to Coles, and the only extra cost of that
processor selling to the smaller store is the ... distribution and marketing
costs. We have been saying for some time that the only way that the processors
can continue to supply cheaper house-brand or generic milk to both Coles and
Woolworths is to recoup that margin that they lose on the supply of the product
by the sale to other customers. It is clearly happening in this case.
... We have also been saying for some time that we believe
we have been seeing the waterbedding effect in the dairy sector in Australia
where you have got high prices for ice-cream and yoghurt. Again, I would assume
that the processor is recouping margin out of that.
If the new prices for private label milk are maintained and the market
share of private label milk continues to grow, the business model of offsetting
low, nil or negative returns on private label milk with higher returns on
branded milk and other products could result in significant pressure on the
As noted in chapter 3, Lion Dairy & Drinks has advised the committee
that their return on private label milk is now expected to be negative.
For the most part, this appears to be an outcome that is a consequence of the
processors' business models and their decisions to supply private label milk in
the first place. The ACCC warned about arguments focused on the impact of
private label milk on branded products, noting that many of them appeared to
originate from 'very well-heeled vested interests':
... our main concern is with the farmers on the one hand
and with consumers on the other, because they are the smaller parties in all
this. But some of the arguments that are being mounted have little to do with
the farmers or consumers; they have a lot more to do with the position of the
Nevertheless, the degree to which any losses suffered by the processors
are passed onto farmers remains a key concern.
Lion Dairy & Drinks (formerly National Foods) advised that,
generally, their contracts with farmers are for a minimum of one year, with a
number of two and three year contracts also offered.
These timeframes generally do not necessarily align with the contracts
the processors have with the supermarkets. Woolworths advised that their
contracts are for either 12 or 24 months, whereas the majority of Coles'
are for three years.
The interaction between the contracts the processors have with dairy farmers
and those with the major supermarkets was explained by Lion:
For farmers, the pressures arise because they must make
investment decisions about the size and composition of their herds and the
nature of their plant and equipment. Those decisions necessitate a longer term
investment horizon and exposure to ongoing fixed costs. Consequently, farmers
look to the processors to provide guaranteed cash flows over the farmers'
investment horizons. However, the processors are not able to commit to supply
arrangements with farmers until the processors have finalised their contracts
for house brand volumes with the supermarkets.
Changes to the contract arrangements between the major supermarkets and
the processors can cause significant uncertainty and unease. For example, the
holder of Woolworths' private label contract for New South Wales recently
changed from Lion to Parmalat. This change triggered significant concern from
the Dairy Farmers Milk Co-operative (DFMC), suppliers to Lion:
We had been hopeful Parmalat would come to an agreement with
Lion to continue to source milk through DFMC. This would have created stability
and certainty in the NSW market. However, we have been informed the
negotiations between Lion and Parmalat have broken down. We continue to push
for these negotiations to recommence but in the meantime we understand Parmalat
will now be out in the market trying to convince NSW dairy farmers to supply
them directly without the support and assurance of working through a
Co-operative. Potentially, Parmalat could also begin drawing on milk supplies
in Victoria and bringing it into NSW.
Lion Dairy & Drinks and Parmalat are the major players in drinking
milk processing. At the time of this inquiry, both Lion and Parmalat utilised a
multi-tier pricing structure in their contracts, however, the milk that is
allocated to each tier, and the variation in the prices between each tier,
differ. Clover Hill Dairies described how it supplies National Foods, through
The current practice is for ... [Lion] ... to
announce what is known as an Anticipated Full Demand (AFD) to DFMC. For DFMC to
meet their obligations under the AFD system our regional dairy farmers are
allocated milk allotments akin to quota and sell this milk to DFMC 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 50% of the price of Tier 1 allotment milk. This
milk is known as Tier 2 milk ... A secondary processor to processor
milk markets occurs for Tier 2 milk. There is no transparency at farmer level
as to what Tier 2 milk is being sold to other processors for.
The Queensland Dairyfarmers' Organisation explained:
Tier 1 milk, under the Lion payment scheme, includes all milk
sold by Lion as bottled fresh milk including both processor proprietary branded
milk and supermarket store brand milk.
Parmalat appears to pay different prices for drinking milk and
manufacturing milk, except for the drinking milk which goes into the
supermarkets' private label products, which is bought at the lower price. While
Parmalat also utilises a two-tier pricing system, unlike the Lion/National
Foods model, its tiers are linked to specific end products, and the price of
the top tier can vary month-by-month, depending on retail sales:
There is a group of farmers in Queensland who actually have
an arrangement with their company where they get a certain percentage of their
cheque from branded sales and then other. With a reduction in branded sales
those farmers are expecting to see a cut in part of their margin this year. We
do believe that there may be an anomaly in that because of the drop in production
in Queensland. So the cents per litre figure might not necessarily change, but
the total volume of the branded sales will change. We hope to be able to verify
that when we see the milk cheques.
The operation of Parmalat's Pauls Daily Access Scheme (PDA) was
explained in detail in evidence received by the committee:
The PDA scheme only relates to total PAULS branded milk sales
and each farmer in the PDA scheme has an allocated daily milk supply volume
under the PDA. PDA dairy farmers can trade PDA volume among themselves
according to how much milk they calculated they would want to supply in the
Parmalat pays a higher price for this PDA (or tier 1 milk)
but if the farmer failed to supply the PDA amount across the month as specified
by the amount of PDA they held, then penalties would apply. All milk supplied
over the allocated PDA amount would be collected but paid at a lower
manufactured (or tier 2) price. Currently the average base price for PDA milk
is approximately 58 cents per litre.
If Parmalat's PAULS branded milk sales do not reach the total
PDA level in the state, then farmers are only paid the percentage that sales
were of the total state PDA amount. The rest of the farmer's milk supply would
attract the lower manufactured (or tier 2) price, which is currently
approximately 44 cents per litre.
What overall impact have the pricing decisions had on farmers' incomes?
Conflicting claims were put forward on this issue. The Australian Dairy Farmers
provided the results of modelling undertaken based on current trends being
extrapolated for the rest of 2011. One scenario suggested the overall supply
chain would be devalued by $28 million, the other as much as $227 million. The
Australian Dairy Farmers commented:
A loss of $44 million from the value chain due to the shift
to private label (home brand) products as outlined in scenario one would lead
to a drop of 2 cents per litre in the farmgate price. For the vast
majority of northern NSW and Queensland dairy farmers this would result in the
loss of any profit margin on their milk.
Coles considers that:
... conditions for the dairy industry as a whole have
improved, with steady to rising farm gate prices by all milk processors so far
for the FY12 season. Predictions of imminent and severe reductions in farm gate
prices as a direct result of the Coles retail milk price reductions in January
2011 have simply not occurred.
The overall picture for farm gate prices since January highlights the
split in the Australian dairy industry between the regions which produce
largely for manufacturing and export, and those that produce to satisfy
domestic demand for drinking milk.
The state of the manufacturing milk regions, particularly for farmers in
Victoria, appears relatively solid compared to recent years. Murray Goulburn,
the price leader for the southern manufacturing areas, recently announced an
opening price for the 2011–12 season which equated to a weighted average of
$4.90 per kilogram of milk solids. It also forecast a final price of between
$5.30 and $5.50.
Dairy Australia considers that for the manufacturing regions:
Improved milk prices, combined with low grain prices and
generally favourable seasonal conditions have provided southern farmers with
the best production conditions for more than a decade. In some regions, the
excessively wet conditions have actually curtailed feed production and herd
Dairy Australia qualifies this assessment by noting:
While cashflows have generally improved, this has merely
enabled many producers to restore their financial positions following the
shocks of the previous two seasons, and the finance sector is also now
generally operating with much tighter controls on debt exposures.
Other developments, such as Coles' announcement that Bega will now
produce its entire private label cheese range (half of which was previously
imported from New Zealand), are welcomed by the committee and will be a boost to
the southern manufacturing regions. However, it is unlikely to offer any
comfort to farmers in the drinking milk production focused areas.
For the drinking milk focused-states, whether the impact of the retail
price cuts in private label milk would be felt by farmers immediately, or after
some delay when their contracts are renegotiated, appears to depend on whether
a farm ultimately supplies Parmalat or Lion (or another processor).
Lion hinted at what the future may bring:
... the nature of our procurement with our farmer base is
through longer term contractual arrangements and the impact of a sustained
discounting arrangement that is beneath what last year we were saying was an
unsustainable price will only be fully felt by the suppliers that supply milk
to us when those contractual arrangements fall due.
Any assessment is also complicated by other factors. For instance the
uncertainty and disruption caused by changes to the private label contract
arrangements in New South Wales noted earlier may also be contributing to
Without dismissing the extent or overlooking difficulties faced by
farmers in other areas of the country, developments in three states—Queensland,
New South Wales and Western Australia—have been particularly noteworthy.
Dairy farmers in Queensland have had a difficult 12 months, with the
floods presenting particular challenges for the industry. In the last year, 40
dairy farmers have left the industry in Queensland.
As shown by Figure 5.2, since January 2011 milk production has not met the amount
demanded for domestic consumption within the state.
Figure 5.2: Queensland milk production v packaged milk sales
Dairyfarmers' Organisation, Submission 94B, p. 24; from Dairy Australia
Early in the committee's inquiry, it became clear that some of the
contractual arrangements in place meant that certain Queensland farmers could
be immediately impacted by any changes at the retail end of the supply chain:
... farmers whose milk payments are linked to branded milk
sales will see a reduction in their milk cheques. For some this may be as early
The implications of the monthly variation built into Parmalat's contract
arrangements, and the ease in which shocks would promptly impact farm incomes
was explained in detail to the committee:
With the PDA, Pauls Daily Access, system with Parmalat you
get paid your tier 1 each month—your higher priced milk—as a percentage of what
is basically your PDA quota. There are two figures that are important in
calculating the payment: the actual sales figures and then what they have sold outside
the area to bolster up another milk pool in Central Queensland. In February
last year the initial figure of sales percentage was 84.23 per cent, which was
then bolstered up to 88.8 with what they were selling just outside the region.
In November it was 84.59. That is the bolstered-up figure; the original figure
was 82.85. But when you come to February 2011 the initial figure is 77.9, so
the amount that they get paid their better price for has come down
significantly. The bolstered-up figure is 80.89. That shows already a
significant drop off, even since September. Particularly when you compare month
on month with a year ago—because months do vary, normally—that is a significant
fall, down from the base figure in southeast Queensland of 84.23 to 77.94. To a
dairy farmer that is a significant drop in his income for that month.
5.3: Pauls Daily Access one million litre dairy farm monthly returns and
percentages, February to July 2009–10 compared to 2010–11
Dairyfarmers' Organisation, Submission 94B, p. 19.
The Queensland Dairyfarmers' Organisation estimates that one group of
185 producers who supply Parmalat have lost about $767,000 up to July 2011
as a result of the private label discounting. They further estimate that this
would total $1.5 million for the entire year if the sales trend continues.
It appears that farmers who supply Lion Dairy & Drinks in Queensland
are also facing lower incomes as the renegotiated contracts for 2011–12 yielded
a real decrease in their prices. Table 5.1 shows the prices paid by Lion Dairy
& Drinks (formerly National Foods) for the 2010–11 year announced at the end
of July, compared to their 2010–11 prices. On these figures, Australian Dairy
Farmers commented 'it is worth noting the annual inflation rate in Australia to
June 2011 was 3.6 per cent'.
Table 5.1: Outcome of Lion Dairy & Drinks 2011–12 prices in Queensland
Australian Dairy Farmers submitted that Tier 2 milk is used for manufacturing
dairy products and has increased in price in Southern Queensland due to higher
demand in the market place.
Australian Dairy Farmers, Submission 150B, p. 9.
The Queensland Dairyfarmers' Organisation argued:
... with higher margin processor proprietary branded milk
losing market share to supermarket store brand milk with little or no margin,
the overall return from the sale of Tier 1 milk by Lion has declined.
Consequently Lion's ability to improve farm gate prices has been undermined
directly by the current supermarket price war.
Although Coles contend:
Coles fully funded lower retail milk prices and substantially
increased contract payments to its major milk processors in Queensland in
January 2011. The payments to our milk processor suppliers were sufficient to
offset any impact on their margins from the expected shift from branded to
private label milk. As a result, there should not have been any impact on farm
gate returns as a direct result of Coles' pricing initiatives. Coles’ position
is supported by the fact that farm gate prices offered to dairy farmers in
southern Queensland and far north Queensland have been broadly steady or
increased for the FY12 season.
New South Wales
Dairy farmers in New South Wales have also faced some specific challenges
recently as a result of changes to private label contract arrangements. As
noted in chapter 3 and at paragraph 5.11, Parmalat recently gained the contract
previously held by National Foods to supply stores in New South Wales. Given
the volume associated with private label contracts, this change caused significant
uncertainty for producers in the state. Negotiations over farmers' contracts as
Parmalat attempts to source supply to fulfil its new contract have also been
difficult. The Australian Dairy Farmers submits:
ADF understands that in New South Wales farmers are being
asked, following initial discussions in the week of 22-26 August, to take
a drop in farmgate price of 3-4 cents per litre for new contracts with a major
processor, Parmalat ... This issue is directly related to the unsustainable
pricing of milk at $1 per litre. At this price there is fundamentally not
enough money in the value chain to ensure a sustainable return to dairy farming
families. It should also be noted that this follows a drop of more than 10% in
milk prices across the board to farmers in New South Wales last year.
The NSW Farmers' Association pointed out that, for a farm producing one
million litres a year, a two cent decrease in price per litre represents about
$20,000 lost income. It also noted:
Short term changes in contractual supply with processors is
putting dairy farmers very business at risk as they cannot turn the milk tap on
and off at a whim.
The Western Australian dairy industry has faced challenges and
uncertainty for some time, with events such as the collapse of Challenge Dairy
in late 2010 compounding matters.
The committee was advised that in Western Australia, the farm gate price
announced by Lion for the 2011–12 season was 41 cpl, compared to 42.04 cpl the
previous year. The committee was also advised that for Harvey Fresh suppliers,
their price increased by approximately 1.3 per cent (less than inflation) to
about 39.2 cpl.
The operators of a dairy farm located in the south west of Western
Australia advised they had been informed they will receive a one cent per litre
reduction (on average) in their farm gate milk price as a result of the retail
A reduction of one cent per litre probably sounds
insignificant. In reality it is just the rounding that occurs at the
supermarket checkout, which often goes unnoticed by the consumer. However, to a
dairy farmer, one cent per litre can be the difference of any particular dairy
farmer remaining in the dairy industry. For a farmer producing three million
litres of milk annually, this equates to $30,000!
It has been estimated that the private label milk price cuts will take
between $22 million and $28 million out of the Western Australian
although Coles disputed these findings claiming, among other things, that the
analysis did not appear to take into account factors such as the collapse of
One key area of concern for the committee was the speed and ease in
which a certain group of farmers in Queensland contracted to Parmalat were
affected by the cuts in the retail price of private label milk led by Coles.
These contract arrangements appear to enable that processor to reliably
source and manage the supply of milk for their brand. However, the processor also
competes for tenders to supply private label product. Under these arrangements,
it appears the risk of any retail price movements or other shocks that affect
the sales of branded products are in large part being passed immediately onto
the farmers. It is not clear why this should be the case; in most other
industries, companies performing an intermediate function in a supply chain do
not seem to have the ability to change the price of their inputs so readily.
The monthly variation in prices under some arrangements also leads to
some concern, as they likely affect medium-term planning and investment
decisions and create further uncertainty for dairy farmers.
5.43 The committee urges processors to make their pricing structures for
sourcing drinking milk:
- reflect the volume they estimate they require to meet their total
- offer more stability in prices rather than changing frequently; and
- not be dependent on the final retail sales of branded versus
private label milk.
The committee also reiterates the following recommendation from its 2010
report Milking it for all it's worth.
5.45 The committee recommends that contracts with dairy farmers should offer
a clear, consistent formula for milk pricing with unambiguous conditions.
The committee is particularly concerned about evidence received
regarding the deficit in drinking milk production in Queensland, and, given
current market signals, the likely ability of the dairy industry in the
drinking milk-focused states to meet future demand.
5.47 The committee recommends that the Government commission a study of the
dairy industries in Queensland, New South Wales and Western Australia. The
study should focus on the future sustainability of the dairy industry in each
of these states and their capacity to meet future local consumer demand. The
report of the study should also examine possible policy options and be tabled
in the Senate.
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