The Art of Milk Supply

Posted on February 19, 2019


The picture presented by the milk supply chain in Australia isn’t a pleasant landscape, it has all the coherence of a Salvador Dali painting crashing into a Picasso.

Surrealism and cubism are distortions of reality and the milk supply chain is in Australia is no different. How it got to that place is a history lesson that needs to be considered when considering a pathway forward.

To find the genesis of the milk crisis it is important to travel back to 2001. At that time the milk pricing mechanisms were changed to allow the markets, not regulators, to set the price. For a decade, things ticked along and the market operated so that the milk price paid by the consumer was reflective of the whole supply chain, the supermarkets, the processors and the farmers.

Like a cannon ball in the middle of a trampoline Murray Goulburn (MG) was a massive organisation that sat in the middle of the industry. Everything orbited around MG. MG represented both processors and farmers interests because it was a co-operative so it was a packager and seller of bottled milk while remaining accountable to their farmer membership.

Like an oracle would each year, MG would appear from its temple and would pronounce its price. Other processors would issue a price somewhere in the range of MG’s price a few days later to maintain the polite illusion that market forces were at play. Invariably the price from other processors would be in the ball park of MG’S price. MG’s size and broad representation meant that it was representative of the whole supply chain and as a co-operative it was mindful of both farmers and processors because it was equally concerned for both.

Then several things happened almost at once. Firstly, MG lost its way as it sought to become a company rather than a co-operative. As a company it failed to negotiate the reefs and shoals of the commercial world. The balance sheet became more important than the balance in the industry.

At about the time that MG commenced its metamorphosis, the major supermarkets, Coles then followed reluctantly by Woolworths, began their $1 milk campaign. This campaign didn’t focus on the cost of production it focussed on the retail price.

MG played along and suddenly the power to set a milk price that reflected the cost of production shifted from MG to the supermarkets. A few years later, MG collapsed.

Since that time there has been no single processor big enough to challenge the supermarkets on price, leaving the major retailers in charge of prices by demanding their $1 milk continued to be profitable for them. By 2017 the distorting forces had become so pronounced that the Commonwealth Government referred the industry to the ACCC.

The ACCC made many important findings but basically, they laid the blame of farmer suffering at the feet of the processors.

All that needed to happen was that when the cost of production changed the processors would exercise their price variation clauses. These are clauses in contracts that say when the cost of production changes the price of the product changes. There is little evidence that any of the major processors have exercised their options under their price variation clauses with the supermarkets.

Why?

Processors which provide drinking milk to the supermarkets in the $1 variety always have other branded products on the supermarket shelves next to the $1 milk they provide to the supermarkets. If a processor moves to exercise a price variation clause on supermarket labelled milk, they run the risk of having their other products either removed or their shelf facings limited.

Because no processor is large enough to challenge the supermarkets they are also on the horns of a dilemma and they are forced to pass the cost onto the farmer.

Compare this to petrol, where the supermarkets also maintain an interest. In those instances, the suppliers of petrol are big enough to vary their prices and the supermarkets follow the lead.

There is no doubt that the supermarkets would become very popular if they changed the price of fuel to $1 per litre and held it there for a decade. But they don’t because they cannot threaten BP and Shell.

Nothing prevents a supermarket from offering $1 petrol, but what they cannot do is bludgeon international oil company into a lower price as they do with processors and farmers.

The dairy industry doesn’t mind if supermarkets make milk cheap, in fact the dairy industry wouldn’t mind if the supermarkets gave the milk away for free if the supermarkets were still paying the processors and farmers a price that reflected the cost of production.

The problem is that the supermarkets artificially declare prices and then expect to be subsidised by both processors and farmers.

Whilst welcome, the Woolworths announcement of $1.10 litre milk does nothing to address the artifice which is a milk price that is totally disconnected from the cost of production. In fact, in an important way the picture is even now more distorted than it was.

The South Australian Dairyfarmers’ Association, supports a free market to set a milk price. What is occurring isn’t a free market. It is supermarkets setting a course and shackling farmers and processors to it like so many slaves in the galley’s bilge.

The supermarkets need to be mindful that they are placing demands that will break the system. The casualties are already real. Since the introduction of $1 milk the number of dairy farms in South Australia have fallen from 286 to 228. They continue to shut down.

The supermarkets sell water which reflects the cost of production which is why bottled water now costs much more than bottled milk.

The risk for the supermarkets is a sharp backlash that will lead to calls for a regulated industry and which will invite government intrusion into the market space. If processors cannot move on price it won’t be long before some of them join Murray Goulburn as a memory and many farmers will go with them.