Prices and profitability in the supply chain
Farm gate prices
Differences between States/regions
Historically, the farm gate prices of drinking milk and manufacturing
milk have been set differently, with drinking milk attracting a premium due to
the increased costs associated with the production of milk year round to ensure
continuous supply and the price for manufacturing milk, used in the production
of manufactured dairy goods for both domestic and export consumption, set in
accordance with movements in international commodity prices.
Figure 4.1: Pre- and post-deregulation factory paid
Source: Dairy Australia, Australian Dairy Industry in
Focus 2010, p.15.
In Tasmania, Victoria and South Australia, where milk produced is
primarily destined for the manufacturing milk market and is export-focused,
producers are more exposed to volatility in the farm gate price of milk.
Traditionally, these same producers have tended to produce on a seasonal basis
thus reducing their production input costs.
In contrast, producers in the states of Western Australia, Queensland
and New South Wales, where the majority of milk produced is drinking milk for
the domestic market, have been protected from the volatility of the export
market. A premium price is also paid to producers in these areas to secure
supply and to avoid high transport costs.
However, the required year round milk supply generally imposes higher
production costs as supplementary inputs are sourced during the winter months.
Another defining factor of dairy production in these regions is that the
supply contracts are generally of longer duration given the processors' need to
secure year round drinking milk supply. In May 2010 Dairy Australia noted that
farmers supplying processors in NSW and Queensland were on two to three-year
The strength of competition may also be another factor which causes
divergences in farm gate prices across states. During the committee's previous
dairy inquiry evidence was given that National Foods was offering farmers in
New South Wales 44 cents per litre while only offering Tasmanian farmers 33
cents per litre. A Tasmanian expert gave the following explanation:
Senator MILNE—...Is there no logical explanation for this
business of National Foods offering 44c in New South Wales compared with their
offering down here?
Mr Smith—...It is the market that they are in there. It is
not the costs of production...
Senator MILNE—So you think it is because there is competition
in the marketplace in New South Wales [that prices there are higher].
Trends in farm gate prices
Changes in farm gate prices over the past few financial years have been
summarised as follows:
Farmgate milk prices reached record highs in 2007/08; and
despite falling 15% during 2008/09, remained well above those of previous
seasons. However the collapse in world dairy commodity prices during late-2008
saw a stepdown in milk prices during the second half of the 2008/09 season for
the 75% of Australian dairy farmers who supply exporting companies.
Consequently, the 2009/10 season opened with the lowest milk prices in a number
of years. Nevertheless, prices improved strongly during the year to finish
within 12% of the previous season.
Table 4.1: Trends in typical factory paid prices
* MS refers to milk solids.
Source: Dairy Australia, www.dairyaustralia.com.au/Our-Dairy-Industry/Industry-Statistics/Milk/Farmgate-Prices.aspx
(accessed 23 February 2011), originally sourced from dairy manufacturers.
Increasing divergence between state
farm gate prices
As can be seen by Table 4.1 above, the farm gate prices in the regions
that are focused on domestic drinking milk production have, over time, shifted
away from the prices in the export states. For example, Queensland farm gate
prices were 11 per cent above those in Victoria in 2004–05, but are
estimated to be about 65 per cent more than Victorian prices in
2009–10. It is important to note that during this period factors such as the
economic downturn caused by the global financial crisis had a significant
effect on international prices, and therefore the farm gate prices in the
exporting states. This clearly supports the argument that there are two distinct
markets for drinking milk in Australia, and that the different characteristics
and issues faced by each need to be considered individually.
Income for dairy farmers has been decreasing in recent years. A survey
of the financial performance of Australian dairy farms by ABARE found that
average farm cash income for dairy industry farms fell from $129 300 per farm
in 2007–08, to $88 000 per farm in 2008–09, and was estimated to fall to
around $50 000 per farm for 2009–10. ABARE noted that, on a national level,
this trend was as a result of lower farm gate prices, high purchases of fodder
due to dry conditions and low availability of irrigation water and increased
interest payments due to increased average debt.
Figure 4.2: Farm cash income and farm business profit
(average per farm)
Source: Australian Bureau of
Agricultural and Resource Economics, Australian dairy: financial performance
of Australian dairy farms, 2007–08 to 2009–10, June 2010, p. 3.
The Senate Select Committee on Agricultural and Related Industries
examined dairy farm costs during its inquiry into food production:
ABARE data indicate that an average farm's total production
costs would be approximately 38 cents per litre in 2008-09. National Foods
however disputes this figure arguing that, based on its estimates, milk
production costs would be around 35 cents per litre. The Tasmanian Department
of Primary Industries estimated dairy farmers' costs of production at 42.3
cents per litre in 2007-08, 37.9 cents per litre in 2008-09 and 38.3 cents per
litre in 2009-10.
The costs faced by farmers differ between states and regions. The
committee heard during its previous inquiry that costs are generally lower in
Tasmania than in other regions.
Conversely, Queensland was acknowledged to be a less suitable area for dairy
production, with the Queensland Dairyfarmers' Organisation noting that although
Queensland farmers are paid more on average, this is countered by higher costs.
During this inquiry, the committee again heard evidence that the levels
of profitability were low and precarious:
The ABARE farm survey exercises for 2009-10, said that the
average farm profit in Queensland and northern New South Wales was 2c a litre
for those farms. So if you took 2c a litre off those farm industry returns,
there is the farm profit for that region.
The nature of how farming investment decisions in the dairy industry are
made was described to the committee:
One of the other things, which we often miss with dairy
farming, is that the time frames for business planning are so long...we were
given some very strong price signals three years ago to grow business with
incentives from all the milk companies to produce new milk. That led to a very
large wave of investment and leveraging to do that because there were strong
signals in all markets that milk was growing to say, ‘Here is additional money
for you to produce more milk over and above the milk that you produced last
year.’ Those investment decisions have three, five, 10 year turnaround times to
get returns. On top of that the actual programming of decisions that we make
with herd management and milk production in the short term have minimum
12-month turnarounds. But having no information that we can actually rely on it
makes business development in this market next to impossible.
Uncertainties in the dairy industry related to future prices and
profitability could affect investment decisions made by farmers:
The current action instigated by Coles will further damage
the confidence of the dairy industry and may have the added effect of reducing
Australia's total milk production. Already, there are indications by some dairy
farmers that they are not prepared to invest further funds in their farms and
will exit the industry.
Contracts between farmers and processors
The committee received helpful evidence about the contract arrangements
between farmers and the major processors, notably those with National Foods and
The contracts between the major processors and farmers are usually for a
few years in duration. National Foods advised that, typically, their contracts
with farmers are for a minimum of one year, with a number of two and three year
contracts also offered.
The contracts the processors have with the major supermarkets differ in
duration; Woolworths advised that their contracts are for either 12 or 24
months, whereas Coles informed the committee that the majority of their
contracts end in January 2014.
The interaction between the contracts the processors have with dairy farmers
and those with the major supermarkets was explained by National Foods:
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.
After the merger of National Foods and Dairy Farmers in 2008, virtually
all supermarket private label milk was provided by National Foods.
Since then other processors have gained contracts, such as Parmalat to supply
Woolworths in Queensland.
Both National Foods and Parmalat utilise 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 they supply National Foods, through the Dairy Farmers Milk
The current practice is for LNNF [Lion Nathan National Foods]
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.
In July 2010, the Dairy Farmers Milk Co-operative (DFMC) described the
basis of the AFD and two-tier pricing model used by National Foods as follows:
The overarching requirement of the AFD is to maintain the
appropriate milk price signals for All Year Supply and to align DFMC milk
intake to the commercial needs of National Foods Limited (NFL) and its
subsidiaries. As a consequence, every DFMC member has an annual allocation.
Each supplier has been provided with their annual allocated
maximum volumes per month (either as a flat allocation which attracts a flat
milk price or a variable allocation which attracts a variable milk price).
These monthly maximum volumes represent the T1 price which is negotiated by
DFMC with NFL. Supply over these allocated litres may attract T2 pricing.
Excess milk supplied above the regional AFD will be sold on
the best economic return possible.
Parmalat appears to essentially follow the pricing system in place prior
to deregulation, which paid 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
manufacturing price. While Parmalat also utilise a two‑tier pricing
system, unlike National Foods' model their tiers are linked to specific end
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 differences between the National Foods and Parmalat arrangements
were examined further:
Parmalat base theirs directly on the branded sale. Their tier
1 is just the branded sales, and that is why it varies from month to month. It
will drop off if you have a bad month or a slow month. December is always low
with Christmas, because they do not sell as much milk, and we expect
significantly less. So that is directly related to sales. Tier 2 is less, but
is not quite as low as the National Foods one.
Under the National Foods model, and to some degree under the Parmalat
contractual arrangements as well, it is clear that the full effects the retail
price cuts will have on the prices offered to farmers will not be realised
until their contracts are renegotiated. National Foods 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.
Clarity of contracts
After its previous inquiry into competition and prices in the Australian
dairy industry, the committee recommended that contracts with farmers should
offer a clear, consistent formula for milk pricing with unambiguous conditions.
In its submission to this inquiry, this recommendation was supported by
the Queensland Dairyfarmers' Organisation who claimed there is a 'real need for
greater transparency and comparability for dairy farmers with regard to
contracts offered by processors'.
Farmers in areas such as Queensland, where separate major processors hold
contracts for supply of private label milk to the major supermarkets, could
particularly benefit from this.
The prices paid by the major supermarkets, and consequently the profits
earned by the processors, are quite different for branded and generic milk. Dairy
Farmers Milk Co-operative suggested that private label milk could have a significant
effect on the profitability of a processor:
...when Dairy Farmers was about a $1.2 billion business, with
a lot of products and a lot of milk in a lot of places, Parmalat was half the
size and made equal if not more profit, and the simple reasoning was that they
were not in private label milk. They were not in the game. That is the effect
of being in this game. Of course there is a lot of milk for the processors.
They have got a lot of milk and farmers in localities. They need throughput.
They bid for this. Part of it is the processor fault. But it is just the
exposure of the market to these two big players, and one of them now is abusing
Coles' submission claims that National Foods, Fonterra and Parmalat have
announced profit margins higher than Coles.
Coles also suggested:
In terms of their overall margins, there is an assumption
made that lowering the retail price automatically means that the farm-gate
price will be put under pressure. Our view on that is that there are higher
levels of profitability within those companies overall and they can look for
alternatives to improve their overall efficiency, improve their innovation,
improve their product development and look to other ways to make savings should
they wish to protect the margin, or invest some of it in the dairy industry
here. There are a number of different ways in which they can take action
through their broader level of economic strength, rather than just simply taking
the easy route of squeezing the dairy farmers.
National Foods' submission provided information about their profit
An EBIT this year of approximately $100 million provides a
return on invested capital of approximately 2.5%, whereas the accepted cost of
capital in Australia is around 10%. The book value for Kirin of National Foods’
business was written down by $832.3 million in 2010.
Kirin has a strong commitment to social responsibility and
has a longer term focus for delivering acceptable shareholder returns. Indeed,
patience has been required by Kirin who recently updated the market in Japan
that there has been a significant deterioration in business conditions
affecting National Foods.
National Foods elaborated at their hearing, advising the committee that
their margin on Coles and Woolworths' private label milk was close to zero,
with their overall profitability on milk sales (generic milk plus National
Foods' branded milk) being approximately two per cent.
National Foods also advised that they were making a loss on their private label
contract with Coles prior to the wholesale price increase recently paid by
Fonterra also objected to statements about the comparative profitability
of milk processors:
It has been suggested that the processors who sit between the
farmers and retailers are the ones who are making unreasonably high margins and
taking value out of the system. Nothing could be further from the truth. Dairy
processing is a capital intensive exercise and those in the industry struggle
with seasonal conditions, price volatility, higher input and energy costs,
higher safety and quality costs, and erosion of margin. Further, developing
market leading dairy brands with consumer propositions around health,
wellbeing, superior nutrition, taste and convenience, requires significant
investment in research and development. Dairy processors in Australia make only
a modest return on their invested capital and this may be a reason why
Australian interests have sold dairy assets to foreign entities in recent
Suppliers of the processors were also willing to recognise that milk
processing companies are in a difficult operating environment:
Senator O’BRIEN—In the circumstances of New South Wales and
Queensland markets, for example, they are already higher than Victoria and
Tasmania. The point that I am raising with you is: is there a point below which
the processor cannot go if the processor wants to keep a consistent supply of
milk for processing?
Mr Phillips—There will be a challenge for them. If the retail
price gets squeezed down, they will have to take it in their own margins. But
since January there has not been any change in actual processing costs: the
costs of buying the bottles, packaging and all that associated with production.
So it is a drop in processor margins. Ultimately that will have to come back to
a lower farm gate price. Given that ABARE said that the average profit for
farmers in Queensland and northern New South Wales last year was 2c a litre, it
does not take much of a price movement to see that farm gate profit disappear
if there is a drop in farm gate prices. Then you either have a reduction in
local production, and there is a question then about what actually happens to
pricing in the longer term. That is one of the issues the industry have about
the sustainability of the move. It may drop prices now but if we see a
reduction in regional production in those areas, to get sustainable milk
supplies in those volumes you are either going to have to move it from another
region, with a lot of transport added in, or pay farmers higher prices. Neither
of those are consistent with the dollar a litre retail price.
[Coles] are going to use any excuse to extract value, and one
of them is: ‘Everyone else is making more money than we are.’ They probably
are, the price they paid. But I do not think National Foods is making a lot of
money in dairy at the moment, and this will squeeze them further.
Transparency of pricing information
The committee received evidence from a number of submissions and
witnesses regarding the lack of transparency of pricing and other conditions
throughout the dairy industry supply chain. This is likely to result in
information asymmetry between participants in the industry which may affect
While retail milk prices are available on shelf every day for
everyone to see, there is a lack of transparency about what the multinational
milk processing companies pay Australian dairy farmers at the farm gate.
Coles believes there should be greater transparency of farm
gate pricing by the multinational milk processing companies so that everyone
knows what is really going on. The multinational milk processing companies
should not be able to sit between Australian dairy farmers and customers and
protect their profit margins.
National Foods were asked for their view on Coles' statement, with their
Group Sustainability Director stating:
I do not know how to respond to that other than to say that
we are being very transparent. We do not have a lot of margin to share. To the
extent our margins are pressurised from to two to one to zero, there is not a
lot to share with the farmers, but we recognise that the farmers need to have a
sustainable business proposition as well. Other than that, I do not know how to
respond to that, because I just disagree with it.
In fact, it seems that information on farm gate prices is readily
available (as demonstrated by Table 4.1). Murray Goulburn appears to issue a
media release detailing changes to their farm gate prices when they are made.
Dairy Australia collects and publishes both on their website and in regular
publications farm gate prices by region. The availability of this information
was mentioned to the committee:
Senator O’BRIEN—I am interested to know whether Dairy
Australia can supply the committee with details of the sorts of prices that
dairy farmers have been obtaining for their milk in the various states over the
last two years. Are you able to supply us with that information?
Mr Phillips—That is public information. That is up on our
website. We can provide that. It is in our Dairy in Focus publication,
which has the farm gate price by state.
Norco also advised that it publishes its farm gate prices each year, and
The reality is that when farmers are investigating their
options regarding which processor to supply they freely share other processors'
prices between themselves.
The apparent discrepancy in the transparency of the prices between the
processor and the producers, compared to the retailers and the processors, was
further discussed during Australian Dairy Farmers' appearance at a public
Senator COLBECK—...I wanted to make sure it was on the record
that some of the arguments that are being used by Coles in this whole debate
are pretty spurious. In their letter they talk about transparency in pricing.
You gave some evidence that farm gate prices are on your website, so it is
pretty easy to get information on farm gate prices. The real place where prices
are hidden is, in fact, between the wholesaler and the retailer. That is where
we have trouble getting a real understanding of what the numbers are. So where
costs are really hidden is not at the farm gate; they are, in fact, hidden
because of commercial-in-confidence reasons between the wholesaler and the
retailer. Would that be correct?
Senator COLBECK—You do not have any sense of any of those
Mr Griffin—No, I am not aware of any. I have asked the
question: is it commercial in confidence? That is the answer we get.
Senator COLBECK—So for Coles to claim that the lack of
transparency is, in fact, at the farm gate is not necessarily the case.
Mr Griffin—That is right.
The confidentiality agreements between retailers and processors and the
resulting lack of transparency in their pricing was also noted by a number of
other producer organisations, including the South Australian Dairyfarmers'
Association, the DFMC and the Queensland Dairyfarmers' Organisation.
This limits the ability of individuals and organisations to analyse
pricing and related issues in the dairy industry:
Given that the company margins are confidential it is hard to
be 100 per cent specific, but, in the work that we do in tracking it, there is
probably between a 30c to 40c a litre difference in the margins for the
processors between their branded product lines at the moment and what they sell
to the supermarkets as house brands. If there is a significant shift to house
brands then most of that milk is being sold at a significantly reduced margin
and that just means that there has to be a drop-off in industry revenue
somewhere that has got to be worked through.
The Australian Bureau of Agricultural and Resource Economics and
Sciences (ABARES) aims to 'provide professionally independent, world-class
research, analysis and advice to inform decision-makers on current and future
policy challenges affecting Australia's primary industries'.
However, their work in the dairy industry is also limited by key information
being treated as commercial-in-confidence:
Senator MILNE—...You said that, in the work that you are doing
on this issue, you are looking at the various factors, including farm gate
prices. Have you done an analysis from the farm gate to the retail sector of
the different margins? Is there a graph or an analysis of exactly what those
margins in various states, for example?
Mr Morris—We at this stage only have the information up to
the farm gate. In the submission that we provided to the committee, we provided
some information on the costs of production for farmers, which is derived from
our farm surveys and the price that is received at the farm gate.
Unfortunately, there is not a lot of information that we can access at this
stage, anyway, on the costs through the rest of the chain through to the retail
sector. We would love to have that information, but unfortunately we do not.
The committee noted in Milking it for all it’s worth that ‘it is
not an easy matter to apportion the typical supermarket price of milk...between
the costs and profit margins of the various players in the chain'.
The report’s attempt to allocate the components of the retail price of milk
from the information available to the committee resulted in a significant
The evidence submitted to this inquiry has provided some insights into
wholesale pricing at this point in time:
I have looked at the National Foods presentation and they are
saying about 54 per cent of the wholesale price is the cost of milk. I think
they have let us in the door there because no-one wants to talk about these
things, but I know from the Dairy Farmers Milk Cooperative that the average
milk price is probably about 54c or 55c. We are looking at a dollar offer
The availability of pricing information in Australia may not be in line
with other jurisdictions:
Information on wholesale and retail prices is more difficult
to obtain. Unlike the United Kingdom where Dairy Co (the United Kingdom equivalent
of Dairy Australia) regularly publishes the margins obtained along the supply
chain, the prices received by processors in Australia remains a mystery.
Impact on dairy farmers
The unclear pricing arrangements between processors and retailers may
affect the ability of dairy farmers to collectively bargain effectively:
Mr Brokenshire—At the least I and my colleagues in the dairy
industry would like access so we can see some transparency. Then I guess it is
up to us to be able to drive our argument based on some knowledge...
Senator O’BRIEN—I suggest that, if you are involved in
bargaining, these are the sorts of issues that dairy farmers ought to be
Mr Brokenshire—I totally agree, but there is one problem—they
say, ‘We can’t give you that information,’ ‘We won’t give you that
information,’ or, ‘We don’t have to give you that information.’ That is our
dilemma. If we had that information, it would make it much easier for us to
bargain. We are bargaining pretty much blind— seriously.
The DFMC recommended that the government require the major supermarket
chains to publish the contract terms and wholesale prices of their private
label milk contracts with processors in each state.
The DFMC discussed this recommendation at a public hearing:
Senator RYAN—...I wanted to talk about your suggestion that you
recommend the government require Coles, Woolworths, Aldi and Franklins chains
to publish the contract terms and wholesale prices of their private label milk
contracts with the processors in each state. I am not sure but is that required
in any other sector that you are aware of?
Mr Zandstra—No, honestly I cannot say.
Senator RYAN—I was not sure whether you were drawing upon
another idea for it.
Mr Zandstra—No. The issue here is that everyone is wondering:
what really is the wholesale price? This revolves around Coles still selling
this at a pretty tidy margin. We can imagine from the previous Tasmanian
inquiry on the percentage margin that they said they had, and the amount of
drop that they have had, and also the increase in the wholesale price, but I do
not know where that line of margin is.
The DFMC was also asked why the dairy industry should be singled out for
transparency of contracts when this was not the case for other industries,
including for suppliers of other grocery items:
...the reason this is happening in milk is that it is exposed
to this sort of hold-up situation. It is a staple; it is sold every day; it is
produced every day; there is a cold chain there—National Foods and others, say.
Milk can easily be used for marketing reasons rather than value reasons and
that is the issue here. We like to know what the value point is on the shelf,
because it has clearly been used for marketing reasons here now. It is to
generate traffic down to the back of the store and all these sorts of things
and to get convenience trade. Pretty well, Coles have said they have forfeited
their margin or are carrying the cost of this. Well what is that? Are they
still there at margin? We can hardly say it is loss leading if we do find they
are making some money on this—I clearly believe it is loss leading in certain
areas. So we really have to know this relative to milk.
Some submissions proposed that the government go further. Clover Hill
Dairies suggested that the terms and conditions of contracts should be
monitored, with onerous conditions removed, and that each processor must gain
ACCC approval of their contract.
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